As
the Federal Reserve prepares to gradually wind down its stimulus program, some
fear that the policy reversal could cause emerging economies to fall like
dominoes.
But the question is: Should the Fed
really care?
That's the focus of much debate at a
gathering of central bankers and economists in Jackson Hole, Wyo., Saturday.
While the Fed was trying to save the
U.S. economy over the last four years by pushing interest rates down to
historic lows and going on a bond-buying spree, the value of the U.S. dollar
fell, prompting investors to seek higher returns in riskier markets.
Emerging economies like India,
Brazil, Indonesia and countries in Eastern Europe all benefited from large
influxes in U.S. dollar-based loans over those years.
Real estate prices rose in China,
Korea and Thailand. Stock prices increased in China, Mexico and Russia, and
credit became far more available to borrowers in Brazil, China, Korea and Turkey.
But now, as the Fed prepares to slow
and then eventually end its stimulative policies, the U.S. dollar is already
rising versus foreign currencies like the Brazilian real and the Indian rupee.
Investors are pulling their money out of these countries, triggering fears of a
panic.
"From the Fed's perspective,
communication about tapering is important not only to Americans but to foreign
audiences as well," said Glenn Hubbard, dean of the Columbia University
Graduate School of Business and a former adviser to President George W. Bush.
"A lot of the reaction in emerging markets has been about what the Fed
means."
Here's how a crisis could play out:
As emerging market currencies fall, the fear is that borrowers in these
countries may not be able to pay back their dollar-denominated loans. Should
they default en masse, their domestic banks could suffer or even fail.
Meanwhile, just because their own
currencies are falling, doesn't mean prices will be going down too. In
countries that import food and oil from abroad -- often priced in U.S. dollars
-- basic necessities will become more expensive to the average person.
It's a recipe for geopolitical
unrest, said Philippa Malmgren, president of Principals Asset Management and
former economic adviser to President George W. Bush.
"Ironically, they get even more
inflation now, and this is a profound issue," she said. "People in
emerging markets spend 40% to 70% of their income on food and energy alone.
Where an American can grumble about their grocery bill going up, it's marginal
for most Americans, whereas for emerging markets, it's life and death."
Two papers presented in Jackson Hole
urged central bankers to think of the international repercussions of their own
domestic policies. Christine Lagarde, managing director of the International
Monetary Fund, also delivered a speech calling for more international
cooperation.
"No country is an island,"
she said. "In today's interconnected world, the spillovers from domestic
policies ... may well feed back to where they began. Looking at the wider
effect is in your self-interest. It is in all of our interests."
It's not uncommon for smaller,
emerging economies to coordinate monetary policy efforts. Countries from the
Balkans, the Black Sea region and Central Asia for instance, created a central
bankers club that meets to discuss how to align their policies.
Members include Turkey, Russia, the
Czech Republic, Romania, Albania and Kazakhstan, to name a few.
"We have been coordinating
policy before the crisis and during the crisis, and I think it is also time now
to coordinate the policies after QE3," said Ardian Fullani, governor of
the Bank of Albania.
But for the United States, such
coordination is not likely to be politically popular. Following the financial
crisis, the Federal Reserve offered U.S. dollar swap lines to 14 countries. The
cooperation between global central banks was "extremely successful
overall" in easing tensions, but also drew ire from Congress and the
broader public, noted Jean‐Pierre Landau, a former IMF and
World Bank executive director, in a paper presented in Jackson Hole.
The discussion remains controversial
because it conflicts directly with U.S. law. Congress has charged the Federal
Reserve to form its policies around maximizing American jobs and keeping
American prices stable. It says nothing about say, food prices or wages in
India.
"The Fed is focused, entirely
by law, on domestic things and there's always been that clash," said Alan
Blinder, Princeton economist and former vice chairman of the Federal Reserve
Board. "Anything that pushes us toward cross-border cooperation
potentially clashes with the Federal Reserve Act."
If there's one key message that
comes out of this year's Jackson Hole symposium, it's a new call to bring
monetary policy up to date with the global economy. Indeed, the title of the
confab is "Global Dimensions of Unconventional Monetary Policy."
"Most central bankers believe that
monetary policy is a purely domestic phenomenon and central bankers should only
consider data from inside their own nations," Malmgren said. "The
question is: isn't that a very quaint, old-fashioned notion in a highly
globalized economy?"
