Let's hope tapering of US monetary policy does not impact us

Wednesday, February 19, 2014    

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IN the global economy, prior to the global economic crisis which erupted in late 2008, developed countries were expected to be the engine of economic growth as they had been for the post-World War period, with the expectation that developing countries could find opportunities to export and attract foreign capital inflows.

Instead, it is China and the emerging economies, including those outside of Asia, which assumed the role of drivers of global economic activity. Now, instead of promoting economic growth in developing countries, the United States, Japan and European Union are a drag on global growth and in many instances their policies increasingly have negative effects on a wide range of developing economies.

The US Federal Reserves, or the Fed (central bank) has commenced "tapering" its quantitative easing (QE) of monetary policy which was aimed at stimulating economic growth in the US economy. Tapering is jargon which means that the Federal Reserve will, over time, reduce the amount of bonds that it will purchase.

On December 18, the Fed started to adjust its quantitative easing policy by $10 billion per month to $75 billion from the original $85 billion per month. Subsequently, on January 29, it announced that it would taper quantitative easing by another $10 billion per month to $65 billion. The plan is to continue the programme until the end of 2014. The decision to accelerate the pace of tapering is predicated on evidence of economic growth which the Fed feels sufficiently confident is momentum which will be sustained.

QE tapering will increase interest rates and this will see a reorientation of global capital flows to the US and, to that extent, there will be less available to developing countries. The reduced global liquidity arising from the US Federal Reserve's gradual tapering of its stimulus measures is having an adverse impact on the capacity of developing countries to garner financing for their current account and fiscal deficits by resorting to international financial markets.

The countries that will be hardest hit will be those with the least capacity for adjustment because of lower than adequate international reserves, current account deficits, larger then prudent fiscal deficits, and high debt/GDP ratios. They will face higher national and international interest rates in order to finance their budgets. It will also increase the cost of borrowing for the private sector and could slow private investment and economic activity. Unfortunately, these features are characteristic of many developing countries and certainly the most vulnerable economies of any type.

Tapering has had a disruptive effect on some countries, most notably Turkey and South Africa where their exchange rates have been hit hard by changes in capital flows. These repercussions confirm that the increase in financing costs in the US resulting from QE tapering is likely to more seriously impact emerging as against advanced economies.

In February, a report from one of the rating agencies estimated that emerging market economies could suffer a cumulative GDP growth loss of between 2.8% and 3.1% during 2013-2016, depending on the speed of the tightening. Advanced economies could also see a negative impact on their already slow economic growth.

Hopefully, QE taping will have little or no impact here in Jamaica.





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