The transmission of Federal Reserve tapering news to emerging financial markets
Joshua Aizenman, Mahir Binici, Michael M Hutchison, 4 April 2014
In 2013, policymakers began discussing when and how to ‘taper’ the Federal Reserve’s quantitative easing policy. This column presents evidence on the effect of Fed officials’ public statements on emerging-market financial conditions. Statements by Chairman Bernanke had a large effect on asset prices, whereas the market largely ignored statements by Fed Presidents. Emerging markets with stronger fundamentals experienced larger stock-market declines, larger increases in credit default swap spreads, and larger currency depreciations than countries with weaker fundamentals.
The quantitative easing (QE) policies of the US Federal Reserve in the years following the crisis of 2008–2009 included monthly securities purchases of long-term Treasury bonds and mortgage-backed securities totalling $85 billion in 2013. The cumulative outcome of these policies has been an unprecedented increase of the monetary base, mitigating the deflationary pressure of the crisis.
Topics: Exchange rates, International finance, Monetary policy
Tags: asset prices, Credit Default Swaps, emerging markets, exchange rates, Federal Reserve, stock markets, tapering
Managing the exchange rate: It's not how much, but how
Atish R Ghosh, Jonathan D Ostry, Mahvash Saeed Qureshi, 2 April 2014
In a world of volatile capital flows, emerging markets are increasingly resorting to managing their exchange rates. But does this strategy increase their susceptibility to crisis? This column argues that while intermediate regimes as a class are the most susceptible to crises, ‘managed floats’ – a subclass within such regimes – behave much more like pure floats, with significantly lower risks and fewer crises. ‘Managed floating’, however, is a nebulous concept; a characterisation of more crisis prone regimes suggests that it is not the degree of exchange rate management alone, but the way the exchange rate is managed, that matters. Greater against-the-wind intervention by the central bank to prevent currency overvaluation reduces, while greater intervention to defend an overvalued currency raises, the crisis likelihood.
The choice of exchange rate regime is a perennial issue faced by emerging markets. Conventional wisdom, especially after the emerging markets crises of the late 1990s, was the bipolar prescription: countries should choose between either floats (the soft end of the prescription) or hard pegs (monetary union, dollarisation, currency board).
Topics: Exchange rates
Tags: emerging markets, exchange rates, managing floats
The credit cycle and vulnerabilities in emerging economies: the case of Latin America
Julián Caballero, Ugo Panizza, Andrew Powell, 2 April 2014
In recent years credit growth in Latin America has been very strong, and countries have become more reliant on foreign bond issuances. This column argues that these phenomena are linked, and may have led to vulnerabilities which domestic and international supervisors are not well-equipped to assess. There is no systematic information on firms’ currency mismatches and hedging activities, and none that includes those of subsidiaries that may be located in other jurisdictions, preventing an accurate analysis of the true risks.
Over recent years credit growth in Latin America has been very strong, and countries have become more reliant on foreign bond issuances. These phenomena are linked, and in Caballero et al. (2014), we argue that they may have led to vulnerabilities which domestic and international supervisors are not well-equipped to assess.
Topics: Exchange rates, Financial markets, International finance
Tags: carry trade, credit conditions, exchange rates, Latin America, original sin
How did the Global Financial Crisis misalign East Asian currencies?
Eiji Ogawa, Zhiqian Wang, 19 January 2014
Since the East Asian financial crisis of 1997, the emphasis on regional monetary cooperation has grown. This column discusses recent research into intra-regional exchange rate misalignments. In the aftermath of the Global Financial Crisis, investors in the US and Europe withdrew from emerging markets, causing a depreciation of emerging-market currencies against the US dollar. At the same time, the appreciation of the Japanese yen – fuelled in part by intra-regional capital flows – has increased the misalignment of intra-regional exchange rates.
Some East Asian countries experienced a serious currency crisis in 1997. The crisis was blamed on both the de facto US dollar peg system and double mismatches of domestic financial institutions’ balance sheets in terms of currency and maturity. Following the Asian currency crisis, recognition of the importance of regional monetary cooperation has steadily grown.
Topics: Exchange rates, International finance
Tags: currency crisis, East Asian financial crisis, exchange rates, financial crisis, global financial crisis
Policymaking in crises: Pick your poison
Kristin Forbes, Michael W Klein, 24 December 2013
Government interventions to control capital flows and reduce exchange-rate volatility have long been controversial. The Global Financial Crisis has made the debate more urgent. This column discusses recent research that evaluates such policies against the counterfactual of no intervention. Depreciations and reserve sales can boost GDP growth during crises, but may also substantially increase inflation. Large increases in interest rates and new capital controls are associated with reductions in GDP growth, with no significant effect on inflation. When faced with sudden shifts in capital flows, policymakers must ‘pick their poison’.
In 2010, the Brazilian finance minister Guido Mantenga declared a ‘currency war’ because of the harmful effects of the strengthening of the real. He blamed the currency’s appreciation on easy money in advanced countries, and to a lesser extent on reserve accumulation in some emerging markets.
Topics: Exchange rates, Macroeconomic policy
Tags: Brazil, capital controls, currency war, exchange rates, foreign exchange reserves, global financial crisis, India, Indonesia
Tapering talk: The impact of expectations of reduced Federal Reserve security purchases on emerging markets
Barry Eichengreen, Poonam Gupta, 19 December 2013
Fed tapering has started. A revival of last summer’s emerging economy turmoil is a real concern. This column discusses new research into who was hit and why by the June 2013 taper-talk shock. Those hit hardest had relatively large and liquid financial markets, and had allowed large rises in their currency values and their trade deficits. Good macro fundamentals did not provide much insulation, nor did capital controls. The best insulation came from macroprudential policies that limited exchange rate appreciation and trade deficit widening in response to foreign capital inflows.
In May 2013, Federal Reserve officials first began to talk of the possibility of the US central bank tapering its securities purchases from $85 billion a month to something lower. A milestone to which many observers point is 22 May 2013, when Chairman Bernanke raised the possibility of tapering in his testimony to Congress.
Topics: Exchange rates, Monetary policy
Tags: capital controls, Capital inflows, currency war, emerging markets, exchange rates, Federal Reserve, Macroprudential policies, monetary policy, tapering
Are exchange rates predictable?
Barbara Rossi , 14 November 2013
Predicting exchange rates is still an inexact science. Economic models perform poorly, and a plethora of alternative methods have been attempted. This column guides the reader through the state of the art, reviewing various predictors, models, and data specifications. Despite a large and divergent literature chasing this holy grail, the toughest benchmark remains the random walk without drift.
The predictability of exchange rates is a crucial question in international finance and macroeconomics. Policy decisions of central banks and policymakers all over the world rely, directly or indirectly, on exchange rate forecasts. The same holds for private business and practitioners' decisions.
Topics: Exchange rates
Tags: exchange rates, forecasting, predictions, random walk
Should Brazil’s central bank be selling foreign reserves?
Márcio Garcia, 25 September 2013
The recent reversal of capital flows to emerging markets raises the question of whether and how to intervene in currency markets. Brazil’s central bank has intervened heavily, spending more than $50 billion and promising to double that by the end of the year. However, almost all of that intervention has taken place in onshore derivative markets that settle in real. This column argues that such interventions can be effective, but that central banks must stand ready to use their foreign-exchange reserves if necessary.
The US dollar’s rise in August and the Brazilian Central Bank’s (BCB) interventions in forex markets have started a debate about whether the BCB should keep on intervening as it has been doing, mostly via currency derivatives markets, or if it should also be selling its international reserves.
Topics: Exchange rates, International finance
Tags: Brazil, capital flows, Central Banks, derivatives, exchange rates
The real exchange rate and export growth: Are services different?
Barry Eichengreen, Poonam Gupta, 18 January 2013
Increasingly, services form a larger and larger share a country’s exports. Do exchange rates matter as much for services and they do for goods exports? This column argues that they do. Distinguishing between traditional services (such as trade and transport, tourism, financial services and insurance) and modern services (such as communications, computers, information services) suggests that the effect of the real exchange rate is especially large for exports of modern services.
The role of exports in economic growth and, in turn, of the real exchange rate in export promotion features prominently in literature on development and globalisation (Rodrik 2009, Haddad and Pancaro 2010). Much of this literature dates, however, from an era when ‘exports’ meant ‘exports of merchandise‘.
Topics: Exchange rates, International trade
Tags: exchange rates, exports, services
Currency intervention as global monetary easing: The case of Japan in 2003-04
Petra Gerlach-Kristen, Robert McCauley, Kazuo Ueda, 7 November 2012
Do incidental large-scale bond purchases have a global portfolio balance effect? This column argues that one country’s bond purchases can ease monetary conditions abroad. Whether this effect is welcome depends on the phase of the business cycle, but the authors emphasise that it is of paramount importance for resolving the current crisis that Eurozone policymakers closely consider the effects of large-scale bond buying.
One consequence of monetary easing in major economies most affected by the financial crisis is the subsequent currency appreciation in apparently separate economies that are less affected by the crisis, such as those of Japan, Switzerland, and many emerging economies.
Topics: Exchange rates, Financial markets, Global crisis, International finance
Tags: bonds, Eurozone crisis, exchange rates, Japan, monetary policy