When the Fed signalled the forthcoming end of QE, emerging markets became the focus of financial distress. This creates a challenge for them – and policy makers must go beyond temporary measures to defend currencies and stem capital outflows. Exposed countries must move fast to recover their balance, to reassure markets of their long-term stability and to accelerate structural reforms to increase productivity growth.
Special responsibility, then, falls to the International Monetary Fund – the only multilateral organisation with the mandate and strength to mitigate the effects of large central banks’ unconventional policies. During the 2007-09 crisis, liquidity backstops through the IMF and the Fed prevented further economic deterioration. But the IMF has been slow to act here and even recommended both continued monetary stimulus and reduced global financial risk. The speech at last month’s annual gathering of central bankers at Jackson Hole, Wyoming, by Christine Lagarde, head of the IMF – arguing that the world must build “further lines of defence” against a possible emerging markets crisis, but that the IMF was prepared to offer financial support – was an important first step.
However, without follow-through it will prove inconsequential.
QE was the right policy to see off the 2008 financial crisis and ensure a lack of liquidity did not push solvent economic agents into bankruptcy, inducing downward production spirals. But maintaining an active monetary policy once the zero lower bound in interest rates had been reached meant entering uncharted waters. Fed purchases in long-term bond markets ended up bigger than expected, amid private sector deleveraging, synchronous restrictive fiscal policies and liquidity leaking into emerging markets’ financial markets.
For liquidity provision to be sufficient, it had to be excessive. To enable an escape from depression in developed economies, it was almost inevitable bubbles would emerge, especially in emerging markets.
The effectiveness of “forward guidance” has been overstated as a tool to manage the exit from QE. And, no matter how gradual the tapering of QE, abrupt adjustments will occur. It is in the nature of financial markets to overreact and overshoot.
Methods used to bring about an escape from a potential depression built in a bumpy recovery. As always, a central bank’s communication strategy is important, and may mitigate volatility, but should not by itself be considered a crucial policy tool. Second-guessing market participants is bound to be an awkward, self-defeating undertaking for a central bank. Better to have an economics PhD running the Fed than a spin-doctor.
The writer is chair of Grupo Financiero Banorte and was formerly governor of Banco de México and Mexican Treasury secretary