While it is true that interest rate differentials due to differences in national monetary policies can encourage investors to seek higher returns across borders, the current policy differences may not be the “dominant force” behind continuing inflows into emerging markets, Bernanke told a seminar at the London School of Economics.
“My reading of recent research makes me skeptical that these policy differences are the dominant force behind capital flows to emerging market economies,” Bernanke said.
“Differences in growth prospects across countries and swings in investor risk sentiment seem to have played a larger role.”
“Moreover, the fact that some emerging market economies have policies that depress the values of their currencies may create an expectation of future appreciation that in and of itself induces speculative inflows,” he added.
Policymakers in emerging markets have complained that since the Federal Reserve started its policy of quantitative easing to boost the US economy, ultra-low interest rates in developed countries pushed capital into emerging markets, leading to the sharp appreciation of their currencies.
However, Bernanke said the trade-weighted exchange rates of emerging markets, “with some exceptions, have not changed much from their values shortly before the intensification of the financial crisis in late 2008.” Former Treasury Secretary Larry Summerssaid during the same debate that the role of central banks has changed in the wake of the financial crisis that erupted more than five years ago.
The old model of a central bank focusing solely on fighting inflation did not allow for "most of what has preoccupied us in the last five years: the provision of finance in extraordinary ways,” Summers said.
“Make no mistake, if a loan is absolutely riskless... someone in the private sector will make it,” he said, stressing that now central banks must focus on their role as lender of last resort.
NO NEW DEMAND
But Axel Weber, the former head of the Bundesbank who is now chairman of UBS, said that the policy of asset purchases– adopted by major central banks in developed countries – “just redistributes demand away from appreciating currencies” without actually creating new demand.
“I think central banks really need to weigh very carefully whether continuing with these policies will not, down the road, create many more problems,” Weber said.
He added that current moves to bring banking supervision under the central bank's authority – as is the case with the European Central Bank (ECB), which recently received permission to act as the supervisor for banks in the eurozone – may put at risk the independence of the institution, as "you can’t have monetary policy and banking supervision under one roof."
He was pessimistic on the world economic recovery, saying: “we’re not really out of the woods yet; it may be a bit too early to draw lessons.”
“Cypriot developments are a timely reminder there still remain high risks,” Weber said. “Maybe the mood we saw improved ...was too good to be true.”
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