Emerging Economies on Their Own

NEW YORK – There was a remarkable similarity between European Central Bank President Mario Draghi’s statement after a recent meeting of the ECB Governing Council and US Federal Reserve Chair Janet Yellen’s first testimony to Congress: both asserted that their policy decisions would take into account only domestic conditions. In other words, emerging-market countries, though subject to significant spillover effects from advanced economies’ monetary policies, are on their own.

This confirms what emerging-country authorities have known for a while. In 2010 – following the Fed’s announcement of a third round of quantitative easing – Brazilian Finance Minister Guido Mantega accused advanced countries of waging a global “currency war.” After all, advanced economies’ policies were driving large and volatile capital flows into the major emerging markets, pushing up their exchange rates and damaging their export competitiveness – a phenomenon that Brazilian President Dilma Rousseff later referred to as a “capital tsunami.”

Recently, the impact of the advanced economies’ withdrawal of monetary stimulus has been just as strong. Since last May, when the Fed announced its intention to begin tapering its asset purchases, capital has become less accessible and more expensive for emerging economies – a shift that has been particularly painful for countries whose large current-account deficits leave them dependent on foreign finance. In response, Raghuram Rajan, Governor of the Reserve Bank of India, has called advanced-country policies “selfish,” declaring that “international monetary cooperation has broken down.”

To be sure, emerging economies have plenty of their own problems to address. But there is no denying that these countries have been victims of advanced economies’ monetary policies, which have increased capital-flow volatility over the last three decades. According to the International Monetary Fund’s April 2011 World Economic Outlook, though the volatility of capital flows has increased worldwide, it is higher in emerging market economies than in advanced economies. Boom-bust financial cycles are driven largely by shocks generated in advanced economies, but they are key determinants of emerging markets’ business cycles.