ECON430-Topic #2: Should Central Banks Consider Foreign Effects?

With Janet Yellen taking over as Fed Chair we should examine the reach of United States monetary policy. When the Fed changes its monetary policy in response to a contraction it has impacts on foreign capital flows. The quantitative easing of the past several years has led to capital flows from the U.S. to higher interest rate foreign countries. This reversal in capital flows leads to more investment and potentially rapid expansion in emerging market economies. Some in the Fed, like Governor Powell have discussed the reach of the Federal Reserve to emerging markets, and downplayed the role that the Fed plays in foreign markets. Former Chairman Bernanke also stressed that the Federal Reserve does not have a responsibility to manage other countries economies.

However, others do not see it the same way. As implied by Powell, there were certainly changes in international capital movements when the Fed changed policy and conducted massive quantitative easing. Brazilian President Rousseff complained in 2012 that the U.S. monetary policy was distorting the Brazilian economy through excessive easing which affected their exchange rates and ability to export goods. Her comment “Expansionist monetary policies … ultimately lead to a depreciation in the value of the currencies of developed countries, thus impairing growth outlooks in emerging countries.” India’s reserve bank governor Rajam has made similar claims about India’s ability to compete during monetary policy easing. Specifically, he stated “The U.S. should worry about the effects of its polices on the rest of the world… We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country.” The taper has worried countries across the G20 that the taper could hurt economies like Indonesia. Poorer countries like Jamaica have even less ability to fend off any pressure they might experience due to the Fed’s taper.

Questions you might consider

So does the evidence support the belief that the Fed is being selfish? Or is there evidence that what is good for the U.S. is ultimately good for emerging market 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?

Finally, is one of the reasons we haven’t seen much impact of QE in the U.S. due to the ‘leakage’ of stimulus to foreign economies? If so, shouldn’t this help our export sectors?

Remember, don’t try to answer all of these questions, just focus on one, provide some evidence, and support your opinion.

16 thoughts on “ECON430-Topic #2: Should Central Banks Consider Foreign Effects?”

  1. Should the Americans constitute the only developed nation to take blame for pushing up other countries’ currencies? Japan and England are other countries pursuing aggressive monetary policies trying to push down their currencies to boost up exports and bound imports, subsequently diverting demand from their trading partners to themselves. Due to the inherent nature of nationalistic pressures, most if not all developed sovereign states will eventually use whatever is at their discretion to gain the economic upper hand and the United States does not have the authority to control other nation’s central banks’ actions. We can only provide a model/example of sound monetary policy but as history has shown throughout, the world will continue in a spiral of economic confrontation unless we change this sovereign conflict to a pluralistic form of unity and a somewhat shared economic wealth between nations. But that is only an idealistic reality that globalization proponents never could have dreamed of.


  2. The Fed does seem to be acting selfishly when you look at how emerging markets have struggled during the original massive quantitative easing and the subsequent tapering off. Expansionary monetary policy (QE) has created a global glut of liquidity which forces depreciation in the value of emerging market currency. On January 1st, 2008, the Brazilian Real, Indian Rupee, and Jamaican Dollar had exchange rates of 1.75 real/$, 39.41 rupee/$, and 69.5 Dollar/$ respectively. Now that the QE has had time to take effect all three of these emerging markets have devalued (Jan 1st,2014, 2.36 real/$, 61.63 rupee/$, and 98.10 Dollar/$) With their currency devaluing so much, emerging markets are having much lower growth rates than before QE took place. Also now that the Fed has started to taper off of the QE it is putting pressure on US interest rates to rise which would attract investors to the US and away from the emerging markets. This also pushes down the value of emerging market currency which makes imports more expensive and makes emerging markets poorer. The Fed seems to believe that a strong US economy will help the emerging markets to grow, but it will be hard for them to wait around that long while our monetary policy destroys their currencies.


  3. I do not believe that Fed should even worry about being “selfish”. The job of the United States Federal Reserve is to ensure stability and economic growth in the US. With that being said, the use of monetary policy by the Fed in efforts to restore the economy from the financial crisis has not had a tremendous effect on foreign countries. Quoting Ben Bernanke from a conference at the London School of Economics, “Regarding the effects of monetary easing on exchange rates and exports, I would note that trade-weighted real exchange rates of emerging market economies, with some exceptions, have not changed much from their values shortly before the intensification of the financial crisis in late 2008”. The Fed should continue to do what is best for domestic output and employment, as the return of the United States’s economy will in the long-run have positive effects on not only emerging market economies, but all economies in general.


  4. The ‘leakage’ of stimulus to foreign countries is definitely one of the reasons that US haven’t seen much impact of QE domestically. People generally believe that QE leads to significant increase in inflation and money supply. The truth is, since US interest rate remains close to zero, the return-seeking nature of investment drove capital outflows to emerging markets significantly. According to one estimate, about 40% of the increase in the US monetary base in QE-1 leaked out in the form of increased gross capital outflows, while in QE-2 such number was around 33%. In this case, a large proportion of increase in money supply was directed to emerging markets. This ‘removal’ of money supply in U.S. did mitigate the effect of QE. Moreover, QE can only cause any impact, especially inflation, when there is a dramatically increased total money supply resulting from bank lending. Now, bank lending is not that impressive, which is also why the overall money supply has not increased as much as people anticipated.

    Generally, one should expect depreciation of U.S. dollar due to QE. It turned out that US dollar were actually appreciating in general. From 2011 to 2013, the U.S. Dollar index, which measures the dollar against a basket of major world currencies (Yen, Euro etc.), was up by more than 12.6%. This was a result from competitive devaluation of almost all major currencies in the world. The fact that dollar remains the world’s reserve currency also keeps dollar from depreciating: at the end of the day, everybody still wants dollar to preserve their wealth more than any other currency in the world. Hence QE didn’t help out U.S. export sectors, since there is no depreciation in dollar.


  5. In some cases it may seem that the Fed is being selfish with their monetary policies. Brazilian President Dilma Rousseff claims that expansionary policies and lower interest rates have increased global liquidity which causes lower growth in poorer countries. She claims these expansionary policies lead to a depreciating value of developing countries’ currencies. Although this is one way to look at the policies of the Fed I believe that their policies are good for the entire world. According to President Barrack Obama our policies have caused our trade and investment to reach record level which in turn creates jobs and business opportunities not only for the United States but for countries such as Brazil as well. One specific Fed policy that could improve the global economy is open-ended bond purchases beginning with the central bank buying 40 million dollars worth of mortgage back securities each month. Fed chairman Ben Bernanke claims, “This policy not only helps strengthen the U.S. economic recovery, but by boosting U.S. spending and growth, it has the effect of helping support the global economy as well.” Even head of the monetary fund Christian Lagarde said that the policies of the Fed, European central bank, and Bank of Japan were “big policy actions in the right direction.” Although there are arguments against the Feds’ policies helping the global economy I believe that they do help the world through increasing job and business opportunities worldwide.


  6. Withdrawal from the High

    India, Brazil, Russia, Turkey, and South Africa are complaining that the United States’ selfish monetary policy is devaluing their currency, forcing higher interest rates, and causing economic turmoil. Is their complaint with the United States, or that their high from the drug, quantitative easing, is running out? Quantitative easing conducted in the U.S. is similar to a drug in that countries are hooked on its effects. The massive bond purchases have rejuvenated confidence in the American banking industry, kept interest rates at all-time lows, and helped stimulate growth. These benefits of the drug do not only apply to the United States, but also to developing nations. The policy induced a flood of liquidity into foreign markets, which led to output growth larger than the developed economies. Also, the benefits are not reducing foreign exports like Japan’s beggar-thy-neighbor policy. The United States is now reducing its intake of the drug, causing emerging markets to experience the withdrawal symptoms: currency depreciation and flight of capital. In order to prevent massive currency conversions, some nations are raising interest rates to enormously high levels, such as Turkey raising its overnight lending rate to 12%. Now that India, Brazil, Russia, Turkey, South Africa, and others are witnessing the economic consequences, they blame the Unites States’ policy, and call it selfish. Are emerging markets really frustrated with America, or are they just bitter about the withdrawal effects after years of riding the high?


  7. The aggressive monetary policy conducted by the U.S. Federal Reserve may create volatility in emerging markets, however, to say the Fed is being selfish is to ignore the fact that the Fed is simply being rational in response to an economic downturn. There is no reason to believe that India or Brazil would not pursue the exact same course of action if they were in our position. Guido Mantega, Brazil’s Finance Minister, called the Fed’s policies “selfish” and continued that “Brazil, for one, will take whatever measures it deems necessary to avoid the detrimental effects of this spillover.” Policy-makers, even in Brazil, are forced to choose the most attractive options available for their country. The traditional “trilemma” of foreign capital effects is the choice between “free capital flows, a fixed exchange rate and an autonomous monetary policy” with only two of the three being possible. Helene Rey argues that financial globalization has turned the trilemma into an “irreconcilable duo: free capital flows may inevitably mean a loss of monetary-poilcy independence.” The emerging-market economies hurt by the Fed’s stimulus must learn to live with the aforementioned trade-off, as many of these countries have emerged because of this globalization. Therefore, they will continue to develop faster and more efficiently by learning to accept their inability to alter the Fed’s strategy. Ben Bernanke believes that growth in the United States is altogether good for the world economy, and I share this belief. Echoing Adam Smith, it seems that being selfish may be the only selfless policy.


  8. The Fed is able to impact economies in meaningful ways, just not always their own. When the 2007/2008 Financial Crisis hit, if the Fed did not act the worldwide economy would have likely collapsed in less than a week. This is a good example of when the Fed should act. However, 6 years later we are feeling the effects of the stimulus bail out. Quantitative easing has caused a lot of damage in developing economies, in particular depreciated currency due to a flood of money supply (capital outflows) from the U.S. and the rest of G4 which in turn has created high amounts of inflation in these economies. The reason domestic capital is flowing into emerging markets is because domestic investors see the higher risk-adjusted returns of the latter as a chance for greater economic return on investment. If there was no incentive QE would have a much smaller effect. A classical economist would argue that the Central Bank can only affect its economy in the short run and in the long run there is basically no use. Though this assertion has no implication for foreign markets. As mentioned with current quantitative easing, much less effect is being done domestically than is abroad. But that is only because of the reasons above, to elucidate, because of interest rate asymmetries. The short run effect of capital injection was of outmost importance, though it may prove to be just a savior in the moment. The classical view would argue that the U.S. economy would have collapsed but would have recovered much quicker and that we would not have to deal with any liquidity or QE “traps.” I side more with the classical view though have a hard time picturing the economy six years later in better shape if the economy did collapse than what it is now, although the classical argument would most likely plead for a greater rebound period than six years.


    Snowdon and Vane, pgs. 26-29

  9. In the short run, quantitative easing by the Fed can be interpreted as selfish. The US conducts its monetary policy with a primary emphasis on how it impacts the US. This means that how these policies impact other economies are a secondary concern to the Fed. However, in the long run, what is good for the US is ultimately good for all economies, particularly emerging markets that are so sensitive to the economic cycles.
    With quantitative easing, capital flowed out of the US and into emerging markets to capture more attractive returns. Now with tapering, and the prospect of more attractive domestic returns, that capital flow has reversed. According to the New York Times, “Investors withdrew $4.3 billion from emerging-market bond mutual funds and exchange-traded funds in the three weeks after May 22.” This puts pressure on emerging economies, because this “hot” money that had flowed into their economies will now be flowing back out of the emerging markets and into the US economy. However, even with recent losses, investors who bought into emerging markets are still seeing gains. The MSCI Index is up 1 percent over the last year, and 203 percent in the last ten years. Bernanke’s final words of wisdom to emerging markets were, “you are on your own.”

  10. We know that U.S is one of the largest economies in the world, so the United State’s policies also affect the economies of other countries. Many people think that whatever policies of FED also aim at US’s benefits and that they do not care about its affects on others. It is completely wrong because if the U.S’s economy collapses, it also negatively impacts other economies because these economies also depend on the U.S’s imports. Therefore, I do not think that Fed is being selfish or causing damages for the emerging markets of other countries. Of course, Fed’s job has to been bring benefits for The U.S’s economy, but it also brings benefits for world’s economies. When U.S economy develops, it also helps to develop other economies, as well. For example, The US is one of the largest import countries of Vietnam for seafood, leather and footwear. Thus, when The US economy develops stably, American people can consume and import more products from emerging markets. Also, a stable American economy helps emerging economies develop successfully. However, when financial crisis occurrs, the US government adjusts the interest rate and encourages banks to pump money into the economy in order to increase output and decrease unemployment. Besides, US cheap capital looks for some places where interest rate is high to invest such as emerging markets that leads to the increase of outputs and develop economies in emerging markets.

  11. The United States dollar has the blessing and the burden of being the international reserve currency. The reputation of the dollar and the size of the United States financial market have led to the monetary policy of the United States to be felt worldwide. The effects of this can be described using BOP accounting. When there is a current account deficit, investment is higher than savings so the demand for the currency will cause currency appreciation. When interest rates are high this current account deficit is higher, and similarly the capital and financial account is in surplus. When The Fed starts lowering interest rate, investors look elsewhere for higher returns. This is where emerging markets thrive. The inflow of investment strengthens their currency and investment. It is important to note though that a stronger currency can have a negative effect on net exports. These markets growth to so fast that it can almost be considered a bubble. A bubble that bursts when The Fed starts tapering and funds start flying out of emerging markets into safer American investments. This subsequently lowers growth and exchange rates.
    The story above illustrates how The Fed can think of only domestic concerns while leaving emerging markets out to dry. The argument that The Fed is doing what is best for emerging markets seems very naïve. In the wake of the recent financial crisis their agenda was to get the US economy on track, to to minimize spill over. The critics are coming from both sides saying that continuing to keep interest rates low will cause appreciation of emerging market currency and lower exports. On the other hang when they raise interest rates the investment in emerging markets will lower causing the bubble to burst. Are The Federal Reserve’s policies selfish? Absolutely, emerging markets are just a side effect. I don’t believe the policies are intentionally hurtful, but they certainly aren’t helpful to emerging markets

  12. From the Fed’s standpoint, it makes sense to taper its monthly $85 billion purchase of long term government bonds during periods where the United States economy is strong. By doing so they are also reducing the global economy’s exposure to risk relative to the performance of the United States economy. The Fed was notoriously criticized in the past for driving interest rates to near zero, which has stymied investment, but by tapering this expansionary policy they are allowing for more expansion in these emerging economies.

    Nevertheless there are viable concerns that arise from the standpoint of emerging economies, specifically India, where the Indian rupee depreciated 20 percent with the Fed’s announcement. Additionally, the Argentinean peso fell 13.8 percent between November 18th and January 22nd, while the consumer price index has risen to around 28.4% since the beginning of 2013. Brazil’s real depreciated by over 13 percent in 2013, and is expected by analysts at Bloomberg that the real would depreciate 2.45 per U.S. dollar in 2014. Volatility in each of these countries’ currencies is also cause for concern as it sends tremors felt by neighboring countries. Such was the case on January 23rd, 2014, where an 8 percent decline in the Argentinean peso caused a 1.2 percent depreciation in Brazil’s real and a 2 percent decrease in the country’s main stock index. The final quarter of 2013 saw the second largest depreciation of 16 major currencies.

    When looking at the Fed’s behavior, there are good reasons to believe that what they are doing is in the best interests of the global economy. However it is understandable for emerging countries to accuse the Fed of being selfish in its latest monetary policy decisions.


  13. On September 13, 2012, the Fed introduced QE3, the injection of $85 billion a month via $40 billion in mortgage-back securities and $45 billion in Treasury bond purchases. The Fed did not begin this massive stimulus program with the intent of being selfish, or boosting foreign economies. The Fed’s primary goal was to stimulate a struggling domestic economy by any means necessary. The colossal stimulus allowed investors to borrow dollars at exceedingly low rates, thus making it possible for those same investors to hunt for yield in developing economies, despite the greater risk. Yet ever since the Fed’s announcement of the taper from $85 billion to $65 billion a month, we have seen tremendous capital outflows from emerging markets into the U.S. as rates begin to rise, thus halting the supply of cheap money. India, Russia, and many other developing nations have criticized the U.S. for their monetary policy by claiming the U.S. should take into account the effect on foreign countries instead of focusing solely on the impact on the U.S. Yet last time I checked, the Federal Reserve Act declared primary mandates of maximum employment, stable prices, and moderate long-term interest rates. An argument of whether the Fed is acting selfish or not takes away from the true underlying issues faced by many of the developing countries, including high current-account deficits, high fiscal deficits, and high inflation. These three underlying issues are not a direct result of the Fed’s decisions but rather stem from poor domestic policy.

  14. Although Ms. Rousseff and Mr. Rajan may have a point when observing that the Fed’s tapering will have some negative consequences for emerging economies such as a drop in the value of respective currencies, but perhaps the devaluation could prove beneficial in the longer-term. Understanding on the part of central bankers in emerging markets that the Fed shall do what the Fed thinks prudent for the United States is a starting point. Then, they may look to the example of Indonesia. According to the Economist (linked article below), last May, when the Fed first sent out signals of a future taper, Indonesia like many other lower income countries was subjected to an outflow of capital which destabilized their currency. Like Turkey, Indonesia had a large current account deficit which was increasingly difficult to finance, but instead of attempting to hike interest rates dramatically to prevent capital flight, they allowed their rupiah to float and raised interest rates more modestly. Indeed, there was some pain in the short term as the rupiah’s value sank, but this also allowed Indonesia to regain ground in their current account- the deficit was halved by the end of 2013. Now, the country is on more solid footing, and can surely weather another financial storm better than other emerging-market counterparts. If a system seems unsustainable by creating too many vulnerabilities, it probably is. It is not the Fed’s responsibility to prop up the lira, the rupee, the real, or the ruble. Indonesia learned that lesson and is better for it.

Leave a Reply

Your email address will not be published.