Tapering the Global Economy

Political debates and media coverage of the quantitative easing program have ignored the policy’s effects on the global economy. However, the choices made in upcoming meetings of the Federal Reserve’s Open Market Committee will have tremendous consequences in emerging markets.

By Zachary Toal
November 25, 2013

Ask a policymaker in the United States about tapering, and the answer is likely to produce a response centered on the domestic economy. From Wall Street to Main Street, discussion of the Federal Reserve ending its quantitative easing program evokes sentiments of uncertainty and fear. Quantitative easing was essentially the only topic of discussion in the confirmation hearing for the Chair-nominee of the Federal Reserve, Janet Yellen, on October 14. Unfortunately, the current debate on quantitative easing and tapering has excluded its largest stakeholder.

Discussions on when to start tapering the government purchase of bonds have so far been solely concentrated on whether the U.S. economy has recovered enough since the financial crisis. In reality, the policy affects every consumer and producer of American products abroad. The choices made in upcoming meetings of the Federal Reserve’s Open Market Committee will have tremendous consequences in emerging markets.

Concerns of inflation notwithstanding, the program’s advocates point to its efficacy in public equity markets, as the Dow Jones Industrial Average and the S&P 500 indices both peaked at new all-time highs this month. Critics of the program’s success denounce the idea that markets represent accurate indicators of economic recovery, instead claiming that the economy’s fundamentals remain on weak footing. The unemployment rate in the United States substantiated this argument, increasing from 7.2 percent to 7.3 percent last month. This dialectic reverberated throughout questions during Yellen’s hearing. Senators Elizabeth Warren, Bob Corker, and, in particular, Sherrod Brown were concerned about when American workers will see the benefits of the stimulus. Yet, as exhaustive as it seemed, the hearing failed to adequately incorporate the global context of quantitative easing.

The international economic community has not ignored this context, and reiterated its worries in the past few weeks. World Bank President Jim Yong Kim stated last month that, “fifty percent of U.S. exports are to developing countries.” Many of these exports are intermediate products and services used to produce final goods in developing economies. President Kim also noted in his address that the August 2011 “near miss” on the debt ceiling in the U.S. increased the cost of borrowing in developing countries by a quarter of a percent. If the Federal Reserve reduces its quantitative easing prematurely, developing countries will be forced to cut back production and consumption of goods dependent on U.S. exports. Further, the Organization for Economic Cooperation and Development (OECD) reduced its forecast for global growth next year to 3.6 percent from 4.1 percent. Although emerging market nations were once considered amplifiers for growth in advanced economies, the OECD warned that the inverse is now more likely to occur in the next few years.

The potential for tapering’s magnified effects in dependent emerging economies appears in the feedback loop of the current global economy. Production and growth in emerging markets depends not only on consumption in developed nations, but also on access to capital. With inadequate private equity markets, developing countries often rely on foreign investment in capital markets to finance domestic growth. According to Morgan Stanley Research, the level of debt in emerging markets doubled to $1.6 trillion from $800 billion in the last four years. This significant increase in debt occurred for two reasons. First, reduced production and consumption in developed nations forced emerging market economies to borrow more to finance their outstanding debts. Second, the Great Recession pushed down bond yields in advanced nations, leading investors in the United States and Europe to seek higher yields abroad. The levels of total external debt in Brazil, Mexico and Turkey are larger – in Turkey’s case, 300 percent larger – than each of their foreign currency reserves. Repayment of this debt relies on relatively stable interest rates and exchange rates. Future tapering may negatively impact or remove those conditions.

Though the Federal Reserve understandably prioritizes domestic concerns, ignoring tapering’s effect on developing nations will hurt the U.S. economy in the long run. The Federal Reserve Board of Governors and its Chair must take into account the global context of its policy choices on quantitative easing and the implications of tapering on emerging market economies. As the Federal Open Market Committee begins to consider alternative measurements that might influence the timing of a reduction in securities purchases, the Committee should include international macroeconomic indicators in its decision. Moreover, the Federal Reserve should work to suppress interest rates through 2015, which would give developing countries time to adjust to increased borrowing costs.

If interest rates on U.S. bonds rise and the dollar strengthens too quickly, emerging markets will be faced with a flight of capital from their portfolios and an inability to repay short-term debts. Such an exit en masse of investments in emerging markets will be catastrophic for economic growth in developing countries. Production of U.S. imports and consumption of U.S. exports will be adversely affected, and the consequences for developing countries are likely to be disproportionately severe. The Federal Reserve must be careful not to provoke a tapering of the global economy.

Zachary Toal is a M.A. candidate at the Elliott School of International Affairs in the International Affairs program, concentrating on finance and economic policy. He previously earned his B.A. in international security and European studies at the University of North Carolina in Chapel Hill.

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