LONDON (Reuters) - Foreign exchange rates and trade barriers are likely to remain big factors for trade flows, despite some research questioning their importance, Bank of England policymaker Silvana Tenreyro said on Monday.
“The dominance of the dollar in international trade is an important phenomenon,” Tenreyro said in a speech at the bank.
“But unlike in some of our stylised models, I think that the exchange rate continues to have important effects on export volumes.”
Tenreyro noted that the International Monetary Fund had warned that exchange-rate flexibility may need to be supported by other policies and the Fund’s modelling even suggested that countries with a high degree of dollar pricing might require larger capital controls.
The effect of trade barriers - such as the increase in tariffs on trade between the United States and China - were also likely to be bigger than suggested by purely macroeconomic estimates of the costs of tariffs, she said.
“Given the identification difficulties, I am inclined to place more weight on the microeconomic estimates of the direct effects of trade barriers on the economy,” she said.
“Even for large economies such as the U.S., these are likely to be damaging to growth. If the initial effects are amplified by falls in confidence and higher uncertainty, the overall slowdown may be larger still. These consequences will be even more material for smaller economies.”
Tenreyro also focused on the risks to the global economy from big holdings of sovereign debt in the banking sector, which were at the root of the euro zone debt crisis and remain a worry in the case of Italy.
While there were concerns about a so-called “doom loop” causing lower lending, weaker economic growth and poorer public finances, there was an important benefit to banks holding their own government’s debt, she said.
“Completely diversifying banks’ holdings of government assets across countries risks a strategic default loop,” Tenreyro said. “When a large share of sovereign debt is held by domestic banks, it increases the government’s incentive to repay.”
Tenreyro did not comment on the immediate outlook for BoE monetary policy in her speech or in a question-and-answer session that followed.
Writing by William Schomberg; Editing by Kevin Liffey