IMF: American Monetary Policy May Harm Developing Nations

Federal Reserve

According to an IMF note obtained by Reuters, the monetary policy of the United States will play a major role in driving global growth patterns, potentially harming the economies of developing nations.

The note, which was prepared for the meeting of the G20 in St. Petersburg this Thursday and Friday, warns of the problems that could come from volatility in currency markets. While the IMF acknowledges the importance of allowing fluctuations in response to market changes, it cautions that a potential announcement of the U.S. tapering of quantitative easing could send undesirable shockwaves through worldwide currency markets. In addition, it warns that such a step will have long-term effects for the growth prospects of some of the largest developing economies, such as Brazil, China, and India.

The IMF also expressed concern about the potential for a global economic recovery, citing the institution of a consumption tax in Japan, the lack of stability in the European banking system, and rumors of the U.S. tapering of quantitative easing as factors that could hamper a recovery in many of the world’s strongest economies.

The notion of quantitative easing impacting currency exchange rates is nothing new from a theoretical standpoint. When the American government buys back its own bonds as part of quantitative easing, this creates additional demand, which drives up the price of the bonds. This, in turn, drives down the yield of the bond.

For a foreign investor, in order maintain the same yield, that investor’s currency would have to appreciate with respect to the U.S. dollar in proportion to the factor that the yield was driven down. This explains how quantitative easing has been directly linked to the rise in value of Asian currencies with cheap American currency causing cash inflows into those nations.

However, now many people believe that the Fed will roll back its $85 billion per month bond buying program during a meeting to be held in mid-September. This has caused the value of many Asian currencies (the Yuan excluded) to drop dramatically, as well as leading to cash outflows from developing nations, making it all the more difficult for any of those countries to realize economic growth.

Yi Gang, an executive in China’s central bank, has begun to spearhead the call for Asian countries to sign currency swaps and work together to combat the impact of the tapering of quantitative easing.

As early as last month, Yi Gang warned of the adverse effects that the tapering of quantitative easing could have on the economies of developing countries. He called for the focus of the upcoming G20 meeting to be awareness and cooperation over the issue, expressing his warmest sentiments towards a potential American recovery but warning against the types of policies that led to international economic crises during the late 1990s.

For the U.S., though, the decision is not so cut and dry, seeing as current quantitative easing programs have been a lengthy and costly method to combat an economic contraction where the worst appears to be over. The question discussed in St. Petersburg might not be whether quantitative easing will come to an end, but rather how to ensure that such taperings have as few negative impacts as possible.

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