BUNDESBANK CALLS FOR CENTRAL BANK COOPERATION Bundesbank board member Claus Koehler called on central banks of major industrialised nations to cooperate closely on exchange and interest rate policies. In a lecture at the University of Surrey, pre-released here, Koehler said that the only alternative to cooperation was protectionism and control on capital movements. "Central banks have sufficient experience of exchange market transactions to steer exchange rates where they want to have them," he said. He added that West German growth forecasts would have to be revised downward because of the recent dollar drop to 1.80 marks from above two marks at the start of 1987. Koehler said that transactions on foreign exchange markets had parted company with transactions in goods, services and investments. It was the scale of speculative transactions that determined market trends. Speculative inflows could cause monetary aggregates to grow. To reverse such a rise in the money stock, interest rates would have to be lowered to allow funds to drain off. "In other words, the monetary policy measures required are different from -- and sometimes diametrically opposed to -- those needed when the money stock is increasing as a result of mounting economic activity," Koehler said. The dollar fall was one means of reducing the massive U.S. Current account deficit. But attempts to keep the depreciation going by talking the dollar down posed problems. The sharp drop of the dollar had led to an immediate steep rise in the cost of U.S. Imports and a sharp fall in the cost of European imports. But the volume effect of falling imports to the U.S. And rising imports to Europe would take time to make itself felt compared with the price effect. "Hence the depreciation of the dollar may well be going further than would be necessary to adjust the current account over the medium term," Koehler said. A reduction in the U.S. Current account deficit would occur only if the growth rate of GNP was higher than domestic demand. In Japan and West Germany by contrast, domestic demand should rise faster than GNP. "In Germany this did indeed happen in 1986," Koehler said. If a further appreciation of the dollar was to be prevented, the U.S. Current account deficit could be offset by an inflow of foreign funds into the U.S.. But only if there was an appropriate interest rate differential would Europe and Japan look for financial investment in the U.S. When selecting monetary policy instruments, a central bank had to pay greater heed than in the past to the impact its measures might have on expectations and consequent decisions. Koehler said the Bundesbank was changing money market rates by operating on the open market rather than adjusting leading interest rates because of the signal this gives to the market and its substantial impact on exchange rates. It was not only important to achieve the domestic goals of price stability, economic growth and full employment but also to tackle international problems like the exchange rate problem, the debt problem and the current account problem. A strategy had to be designed that helped "the safeguarding of non-inflationary economic growth in an international monetary system largely free of disruptions," Koehler said. Given the system of floating exchange rates, it was necessary for central banks to agree to intervene. It sufficed to tell the market where central banks saw exchange rates over the next few years and intervention points should not be set, because they were only testing points for the market, he said. In order to keep the international monetary system free of disruptions central banks should not only intervene jointly but also cooperate on interest rate policies, Koehler said.