Easing on EMs

Bernanke's making tidal waves and garnering support as well as opposition for his defence against the Fed's easing policies on emerging market economies. 

On the surface, it seems genuine enough (the argument, that is!) - in a capital-mobile network of economies, the zero-boundedness and short/medium-term promise of zero rates in advanced economies tend to cause a "search-for-yield" thus possibly leading to hot money flows into EMs and in the process, creating all sorts of unwanted troubles such as currency appreciation, asset bubbles, volatility and stoking inflation fears at a sensitive time. 

Now firstly, this is a sensitive issue that needs  a good bit of further empirical study. A couple of weeks ago, Jose-Antonio Campo had a piece on this where he essentially went down the middle path. He gives the Fed credit for acting boldly given that the recovery was sluggish, there was no fiscal manoeuvre left and the gridlock in DC was too strong. Here's the problem though (and this comes back to Triffin once again) - The dollar is the international reserve currency of the world. And such expansionary monetary measures are bound to create significant externalities and imbalances in the rest of the world, effects that (as Campo says), "the Fed is clearly not taking into account". 

I'd summarize Bernanke's defence but Weisenthal at Business Insider has a short and sweet round-up of the rebuttal:

a) Interest rate differentials aren't the only determinant of private inflows, growth differentials for example, also play a role.

b) Data shows that since the advent of ultra-easy monetary policy, flows have actually eased. (I'll get some data on this)

c) Emerging Market economies aren't exactly powerless and helpless to do anything

d) Stronger currency = greater ability to buy imports, woohoo! to domestic demand (and to hell with all exporters!)

There's a dilemma when EM economies have to calm speculation and cool the economy. Raising rates to adopt even a strict anti-inflationary stance could end up attracting more short-term funds and hot, volatile money. The problem is the alternative. A US recession and inaction from the Fed could be extremely painful for the global economy, already facing a bleak and sluggish outlook. I don't think anyone denies this and desires this above all.

Andy Mukherjee over at BreakingViews mentions an IMF study (I haven't read it), that concludes a 3% reduction in probability of an EM surge for every 1% rise in US interest rates. Yet, he also agrees with the premise that the ups and downs of the EZ crisis over recent times have caused sometimes implausible shifts in investor sentiment. To him though, what Bernanke failed to mention is an economy without QE which might have led to lower oil and commodity prices, something of great importance to EM policy makers. 

But in a world without QE, to revisit the earlier point, the impact on the global economy of a US slowdown might be far worse. Bernanke raised valid points, some of which were indisputable, but he also left a few openings in his analysis which will undoubtedly be questioned in the very-near future.