Federal Reserve vice-chairman Janet Yellen launched a robust defence of the US central bank’s policy of quantitative easing in Tokyo on Wednesday, claiming its positive contribution to global growth outweighed the negatives, principally excessive exchange-rate appreciation in emerging economies.
“On balance, stronger US growth is beneficial for the entire global economy,” Yellen said at a panel at the IMF annual meeting. Yellen said although “interest-rate differentials” played a role in driving capital flows to emerging economies, investor appetite for risk and exposure to expanding economies largely account for the strong demand for emerging market assets.
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She said that “developing countries do have tools” – principally a looser fiscal and monetary policy – to offset any negative economic impact from a stronger currency. “Interest-rate differentials do drive capital flows and [this] undoubtedly puts press on exchange rates [but] it is not the Fed’s intention to make things more difficult,” she said, acknowledging the political fallout from the Fed’s latest round of asset purchases.
Key emerging economies have struck a relatively sanguine tone in recent months over loose US monetary policy and have largely refrained from lashing out over the Fed’s latest move to ramp up asset purchases. However, Brazil – a key proponent since autumn 2010 of the view that lax G7 monetary policies are designed to weaken exchange rates, a weapon in trade protectionism – has recently restated its critique, with finance minister Guido Mantega sounding the alarm over a global "currency war".
Former Colombian finance minister Juan Carlos Echeverry told Euromoney in August "we have to at least fight the currency war – if we don’t fight, we’ll lose”. Nevertheless, the softening of economic growth in the large emerging economies has served to moderate the pace of new capital inflows this year and exchange-rate appreciation, more generally.
In addition, analysts are doubtful emerging central banks’ currency reserves are likely to maintain the growth momentum of recent years. Since currency reserve holdings are a proxy for monetary intervention into the forex markets and, subsequently, a symptom of the global currency war, this suggests fears that the Fed’s latest move to expand its balance sheet will trigger a destabilizing tide of capital to emerging economies are over-blown.
In other comments, Yellen expressed concern about the Fed's challenge of gradually unwinding its interventions in the bond market – which she said had knocked off a cumulative 80 to 120 basis points on the US Treasury 10-year note. "[When] we plan to sell off many of the assets, both long-term and short-term rates will rise, and we know it will be a challenge to [unwind exposures] in a timely way to stop inflationary pressures," she said.
Yellen added that interest-rate risk could damage banks' profitability but noted that term premia had been structurally reduced since the tenure of former Fed chairman Paul Volcker, whose inflation battle subsequently served to anchor US inflation expectations.