In a recent Financial Times interview, Gita Gopinath, the International Monetary Fund’s (IMF) chief economist, warned that the emerging market economies cannot afford a repeat of the 2013 Bernanke “taper tantrum.” That tantrum occurred when the Federal Reserve signaled a sooner-than-expected withdrawal of monetary policy stimulus, which sparked a surge in global borrowing costs.
Judging by his speech at Jackson Hole last week, it seems Federal Reserve Chairman Jerome Powell did not receive Gopinath’s memo. By opting to maintain the easiest of monetary policies at a time of rising inflation, Powell risks letting inflationary expectations take hold. That in turn might require the Fed to slam on the monetary policy brakes sometime next year to keep inflation in check, which could cause global borrowing costs to jump by more than they did in 2013.
From the perspective of the U.S. and world economic outlook, Gopinath does us a service by drawing attention to the emerging market economies’ acute vulnerability to a rise in global borrowing costs.
Not only do these economies now constitute around half of the global economy and for many years have been the world economy’s major engine of economic growth. These economies are now burdened with more debt than they have ever had before, including a $4 trillion mountain of dollar-denominated debt.
Compounding these problems, their economies are now being hit particularly hard by the COVID delta variant for want of being able to afford adequate vaccination programs. Little wonder then that the World Bank keeps warning us to brace ourselves for a wave of emerging market debt defaults.
The renewed delta wave, especially in Asia, now seems to be throwing into question the Federal Reserve’s optimistic assumption that the global supply-chain problems that we have been experiencing will soon dissipate. It has to be of concern that several major Chinese ports have experienced delta-related closures, while emerging market exporters are having difficulty finding shipping lines to take their goods. Meanwhile, there seems to be no sign of any easing in the shortage of semiconductor chips, which is causing automobile companies to continue to cut back production in a serious way.
Even if the Federal Reserve proves to be correct that today’s global supply-chain problems are but a passing phenomenon, it seems to be playing with fire by pursuing as easy a monetary policy that it is doing at a time that inflation is running at its fastest pace in the past 30 years.
According to Goldman Sachs, the Fed is maintaining the easiest monetary policy conditions in more than a decade. It is doing so even at a time that the economy is recovering at the fastest rate in decades and at a time that over the past two years public spending has increased by a staggering $5 trillion, or as much as 25 percent. As former Treasury Secretary Larry Summers keeps pointing out, this highly expansionary fiscal and monetary policy mix has to raise the risk of economic overheating, whose inflationary effects would be exacerbated if today’s global supply-chain problems prove to be more permanent than the Fed is anticipating.
All of this hardly bodes well for the emerging market economies or for the avoidance of large adverse spillovers from those economies to the rest of the world economy. With the IMF’s encouragement, those economies substantially increased their public spending in response to the pandemic. This has left them with gaping budget deficits and with record public debt levels. That makes those economies highly vulnerable to any sharp increase in global borrowing rates.
Powell is doing the emerging market economies and, by extension, us no favor by delaying the start to meaningful monetary policy tightening. To the contrary, by so doing he heightens the chances of a larger surge in global borrowing costs than would have occurred had he tightened U.S. monetary policy in a timelier manner to deal with inflation. That in turn raises the risk of the full-blown emerging market debt crisis next year about which Gita Gopinath is warning.
Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.