Developing nations like China and Turkey are forced to use different monetary policy instruments than in the United States, which makes their policies a bit more difficult to understand than in the United States. Even small developed countries like Switzerland do not have the freedom to conduct monetary policy as they wish at all times. In the U.S., prior to 2008 the Federal Reserve would cut the federal funds target rate when they wanted to raise output and inflation, and raise the rate when attempting to cut output and inflation. Since the U.S. financial crisis and Euro crisis global monetary policy has been more difficult and less straightforward for developing and/or small developed nations due to the ‘hot money‘ that has been moving around the globe.
Several countries have been forced to resort to policy that would appear to conflict with the goals that are set for monetary policy. For example, following a recent earthquake in China, the PBOC (People’s Bank of China) cut reserve requirements to banks in that province. This should increase lending in those areas, but what about their overall concern about inflation? In Turkey, their central bankers have been trying to fend off high inflation there, while also cutting interest rates to back expansion. In Brazil, their central bank has been attempting to pull off a similar feat of raising output while stemming high inflation. Swiss central bankers have faced a somewhat different problem as those fearing the breakup of the Euro or weakness elsewhere flooded the Swiss market with funds. The Swiss central bank responded by fixing their exchange rate to keep it temporarily weaker than it would otherwise be to help keep their foreign trade balance in line. These international issues have often arisen because of the U.S. policy of low interest rates and quantitative easing over the last several years.
Try to use the following terms correctly in your posts. Note that central banks have ‘instruments’ which they use to impact ‘targets’ which ultimately helps them reach their ‘goals’. In the U.S. the Fed typically uses the open market operation instrument, to move the federal funds rate towards their target, hoping to ultimately reach their goal of full employment and stable prices.
Questions you might consider
- What do you think is the main reason that the PBOC uses reserve requirements as a primary instrument of monetary policy? What tools has Turkey used in addition to reserve requirements so that they can raise interest rates on overnight lending? How are these tools similar across countries?
- Does the U.S. economy’s return to health through unusual monetary policy ultimately benefit countries like Turkey, South Africa, Indonesia, India, Brazil, or Jamaica more than it would if the Fed didn’t do anything at all? Would we expect capital outflows from the U.S. even if the Fed hadn’t done anything in 2008-2014?
- Wearing a “classical” hat for a moment, is the Fed even able to impact the U.S. economy in a meaningful way? If not, then why are they able to impact foreign countries in an even more substantial way?
- How has the Swiss exchange rate peg affected their people and trade balance in the last few years. How would they have likely fared if they hadn’t done anything at all and let their exchange rate strengthen as predicted?
Remember, don’t try to answer all of these questions, just focus on one, provide some evidence, and support your opinion.