Eswar S Prasad is a professor at Cornell University and a Senior Fellow at the Brookings Institution. His latest book, The Dollar Trap, published by Princeton University Press, explores the global monetary system, and the dominant role played in it by the dollar.
Prasad explains that the dollar cannot for now escape its role as the global reserve currency, “due to weaknesses in the rest of the world and deep problems in the structure of the global monetary system.” There are substantial consequences of this, for the US, other western nations and the developing world.
He spoke to the Prospector about this and other subjects, the full results of which will be published here over the coming days.
Jay Elwes: Do you think that quantitative easing in the US and the UK, has been pro-cyclical—that it has amplified movements in markets and prices that would have taken place nonetheless?
Eswar Prasad: Not quite, because these economies are still well below potential output, especially in the US given where the labour market is right now. There is clearly a lot of room for the economy to expand and do better so in that sense the policy has certainly been counter-cyclical in the sense of trying to mitigate the weaknesses in the economy.
If the economy does recover very strongly and the Fed does not pull back quickly enough it could turn pro-cyclical but I don’t think there is any risk of that at least as yet in the US. The UK does seem to be a little further along in terms of the repair, but my sense is that in the UK too there is a significant output gap that it is likely to mean that we are not able to talk about pro-cyclical monetary policy.
JE: On the question of the renminbi. There was excitement last year when George Osborne secured certain arrangements with the Chinese government for allowing renminbi-denominated deals to go on in the City. Might the renminbi challenge the dollar as the desirable global currency?
EP: So China is an economic powerhouse and a trading powerhouse, everyone wants to be friends with China. So I think the sense that this is a big economic power that has a currency which is becoming more prominent internationally will certainly lead to more central banks signing local currency swap lines with China, perhaps even holding some renminbi as part of…