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Globalizing the Fed

OXFORD – Should the United States worry about whether its monetary policy is wreaking havoc on emerging and developing countries (EMDCs)? That was the question faced by the Federal Reserve at the height of its quantitative-easing program, when its monthly purchases of long-term assets drove yield-hungry investors into these countries, causing their currencies and asset prices to rise. And it is still a pressing question today, now that the Fed is winding down its asset purchases, causing capital flows to reverse and leaving many EMDCs high and dry.

Contrary to what most observers seem to believe, the answer does not lie in scrutinizing the Federal Reserve’s mandate or debating the record of developing-country policymakers. Rather, the question concerns whether, and how, the US wants to lead in the global economy. If the US wants to preserve an open, stable global financial order, it cannot afford to ignore the current turmoil in emerging markets.

Since talk of “tapering” began last year, a growing number of EMDCs have come under pressure: their currencies are depreciating, capital is fleeing, and their central bankers are left with the unenviable task of combating a domestic growth slowdown while maintaining external stability. The incipient recovery in the advanced economies appears to be sparking widespread instability, from Argentina to Turkey to India.

To be sure, some of the EMDCs’ recent struggles are rooted in homegrown weaknesses. But domestic politics is only part of the story. Indeed, some countries with strong economic fundamentals and responsible macroeconomic policies – such as Mexico – are still suffering.