The need for international monetary policy coordination

Since the 1980s, it has been decided that the best way to organise monetary policies is as follows: Each country chooses its own monetary policy according to its domestic needs, without worrying about the effects of its monetary policy on other countries; There is free movement of capital and exchange rate flexibility. This was a complete departure from the previous system, whe re monetary policy primarily sought to ensure stable exchange rates. The adjustment is now made by capital flows and exchange rates: if a country has to conduct a more restrictive monetary policy than others, it has higher interest rates, attract s capital and its exchange rate appreciate s . But the absence of international monetary policy coordination under this setup (monetary policies are chosen without analysing their effects on other countries) raises several problems: When the United States chooses to conduct a more restrictive monetary policy, capital flows to the United States, sending emerging countries in particular into crisis under the effect of significant capital outflows and exchange rate depreciation; When all central banks conduct expansionary monetary policies, the result is a considerable increase in global liquidity which is not monitored by any central bank and contributes to financial instability. International monetary policy coordination would therefore entail the Federal Reserve in particular looking at the effects of its choices on emerging countries (if it did not, emerging countries could use capital controls) and central banks responding to changes in global liquidity and managing it collectively.