Yes, another blog post on the Fed’s failed monetary policy. I hate to keep blogging on this particular issue, but it continues to be the major economic issue facing us. Now that the effects of the easy credit bubble deflating are becoming apparent to everyone, including famed corporate takeover investor Carl Icahn, the IMF is warning the Fed not to raise interest rates, lest it
trigger a wave of emerging market corporate defaults and panic in financial markets as liquidity evaporates….The IMF said an “illusion” of abundant liquidity may have encouraged “excessive risk taking” by some investors that could cause market ructions if many investors suddenly rushed to the exit. “Even seemingly plentiful market liquidity can suddenly evaporate and lead to systemic financial disruptions,” the IMF said. “When liquidity drops sharply, prices become less informative and less aligned with fundamentals, and tend to overreact, leading to increased volatility. In extreme conditions, markets can freeze altogether, with systemic repercussions.”
But did not this “abundant liquidity” come from the Fed? And who was a cheerleader for global easy money, which resulted in low interest rates in the US, driving “hot money” to higher yielding emerging markets in search of return? Was it not inevitable that at some point interest rates would normalize? Was it not inevitable that the reversing financial flows would cause the problems the IMF suddenly seems to realize? Yes, the IMF has been a cheerleader. Consider the following reports from the IMF:
In 2010 the IMF said
Monetary policy should remain accommodative because of muted inflation, subpar growth, and lingering financial strain. The Fed has maintained the policy rate at a record low while signaling that conditions are likely to warrant keeping the rate at exceptionally low levels for an extended period. In light of larger downside risks, the Fed’s recent decision to resume its purchases of government securities (using resources from maturing government-sponsored-enterprise debt and mortgage-backed securities in its portfolio) is appropriate.
The same song played in 2013 at the IMF,
Given the sizable economic slack, slow employment recovery, and stable inflation expectations, the accommodative monetary policy stance continues to be appropriate. Any unwinding in monetary policy accommodation should be guided by the strength of the recovery, while considering other potential issues such as inflation and financial stability challenges. Careful calibration of the timing of exit, and effective communication about the strategy, will be critical to ensure a smooth normalization process and to minimize risks of negative global spillovers. If financial conditions tighten further and threaten to derail the nascent recovery, the Federal Reserve may need to ease monetary policy conditions through forward guidance or changing the timing and extent of the tapering
And yet again in 2014, the IMF said
Monetary policy should manage the exit from zero interest rates in a manner that allows the economy to converge smoothly to full employment with stable prices while containing risks to financial instability, which, if they materialized, could have negative global spillovers. Financial stability concerns arising from a prolonged period of very low interest rates should be addressed with tightened supervision, stronger prudential norms, and strengthening of the macroprudential framework.,
Really? More regulation is going to solve the mess they have created? The only thing that is clear is that for the IMF, never is a good time to normalize interest rates. Nevertheless they are correct in their concern over the systemic threat by a reversal of financial flows from emerging markets to the US. The pain in Brazil, Turkey, China, etc. is only beginning–when you blow up a really big bubble, it usually ends in signficant pain. This feels strangely akin to the ’97 Asian financial crisis, which resulted in significant pain across most of Asia as US “hot money” left Thailand, Malaysia, etc. and returned home. Unfortunately there is not a good solution to the mess they’ve made…but the best plan surely cannot be to kick the can further down the road.
Further, as we’ve argued previously, it is not clear that simply keeping interest rates low will stem the flow of capital back to developed markets. Without significant new infusions of liquidity, the bubble will deflate on its own w/o pricking. Indeed, that is what I believe is happening now. The commodity boom is over for this cycle, and it will be very hard to put Humpty Dumpty back together again. Keep your crash helmets on.