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US 'beggar-thy-neighbour' policies?

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COMMENTS

2 May 2011 09:43

With stubbornly high unemployment and limp growth in the US, there is not much disagreement that a very accommodative monetary policy is sensible and necessary.

But the combination of near-zero interest rates and large 'quantitative easing' (in Fed-speak, 'QE2') is ruffling feathers in emerging economies, where this is seen as a beggar-thy-neighbour method of stimulating the US at the expense of others.

Most vocal on this is the Brazilian Finance Minister, who used the April IMF meeting in Washington to complain again. 

Guido Mantega began a couple of months ago by talking of 'currency wars'. In Washington he took the opportunity to turn up the volume, criticising the IMF's recent softening of its former opposition to capital controls.

The Fund puts such controls at the very bottom of the policy tool-box, to be used only when all else fails. The Fund's less-than-fulsome embrace of capital controls is seen by the Brazilians as a biased and heavy-handed attempt to constrain their sovereign policy-making rights.

It's not hard to understand this viewpoint (particularly if you also come from a commodity producer, like Australia). The Brazilian real has appreciated by 50 per cent since 2009 (and appreciated by 5 per cent in a single week recently). Brazil has a big labour-intensive manufacturing sector which is squeezed by the appreciation.

Low US interest rates also constrain monetary policy from being tightened to address domestic inflation, currently running at 6.5 per cent, the very top of Brazil's inflation-target band. To raise Brazilian official interest rates above the current 12 per cent would encourage an even-greater inflow of foreign capital (Brazil got $35 billion of capital inflow in the first quarter alone), putting still more upward pressure on the real.

Mantega is the most vocal, but not alone in complaining that soft US monetary policy pushes emerging economies' exchange rates to inconvenient levels and constrains their room for maneuver on domestic interest-policy.

Just about all of East Asia is affected (China excluded, as its rate is still heavily managing). See the latest IMF Regional Outlook.

Ted Truman, now at the Peterson Institute but for many years the US's attack-dog in handling emerging economy relations, argues that accommodative US monetary policy doesn't change the US current account because the lower interest rate stimulates US demand, offsetting the exchange rate effect. If the US current account isn't affected, he asks, where is the 'beggar-thy-neighbour' effect?

Most would find this argument unconvincing. If it were true, then it's hard to see how international imbalances could ever be reduced.

A better argument is that the US has the right to set its monetary policy for the needs of its domestic economy. But then, so too the emerging countries should be free to use the full range of policy-tools (including taxes on capital inflows to reduce international interest differentials) and the full array of prudential policies to ensure that the inflows don't overwhelm their still-evolving financial sectors.

Emerging countries have learned the harsh lessons of the 1997-8 Asian crisis: don't let excessive foreign capital inflows expand your current account deficits, inflate asset prices and make your exchange rate uncompetitive. The inflows are flighty and when they reverse the adjustment is painful.

It's unsurprising that the more volatile elements of these inflows are unwelcome.

Photo, of the former President of Brazil Luiz Inácio Lula da Silva, at the G-20 with US President Obama, by Flickr user Blog do Planalto.

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