US monetary easing has aggravated prices rises in emerging economies, but an opposite problem awaits once the US Federal Reserve begins to tighten again, Institute of International Finance managing director Charles Dallara said this week.
“We may face [a situation where] market participants and other parties are not prepared for a rise in US interest rates,” he told Emerging Markets.
Inflation in asset prices and a glut of liquidity, influenced partly by US monetary policy, “continues to be a problem for many countries in Asia and for many countries in Latin America,” Dallara said.
“I believe this is one of the reasons why we need much more powerful coordination with the G20. It is too easy for [Washington] to follow a monetary policy which it believes is appropriate for the US itself, but which hasn’t adequately taken in to account the global framework in which it operates.
“I think we are in such a globally interdependent world now that we really need to intensify the global framework in policymaking, so that US monetary policy at least is debated in a more global form.”
The Fed’s second round of monetary easing (QE2) “remains an issue for emerging markets,” he said. “The problem will moderate as the year moves on, but it will still be with us until the US begins to tighten. At that point, we may face another set of challenges.”
Dallara ruled out the idea of a QE3, which, until recently, many had believed possible. “The questionable effectiveness of QE2 mitigates against it. I don’t believe that even its most ardent advocates believe that it is really effective.
On the impact of US monetary easing on the dollar, Dallara said: “It’s hard to see the dollar recovering any real strength in the near term.”
But he ruled out the threat of what former ADB executive director and vice president William Thomson suggested to Emerging Markets could be a “dollar panic” before the end of this year.
The “scope for a dollar crisis” is limited by problems facing the euro and yen as the euro area and Japan continue to grapple with their own problems, Dallara suggested.
“The one thing that does worry me about the dollar is the potential for the political cycle to undermine any credible medium-term fiscal reform efforts.
“We don’t need to clean up our fiscal mess overnight, but we do need to send a convincing signal to markets that we are on a path toward that. We could see further disruptive pressures on the dollar.”