Financial integration in the last few decades has resulted in closer alignment of monetary conditions across countries. While such integration at times of ample global liquidity has provided resources for investment, emerging market and developing countries have also faced policy challenges in managing large and volatile capital flows, especially if they were already faced with a current account surplus.
How did Asian economies respond to spurs of excess global liquidity?
Countries pursuing policy independence through exchange rate flexibility can better insulate the domestic economy from pervasive global liquidity shocks that could fuel asset prices and inflation. Conversely, countries that accommodate the global monetary gap through foreign exchange interventions can benefit from capital flows when global liquidity expands.
Since foreign exchange intervention with no sterilization is likely to lead to inflationary pressures, countries have often taken a middle-ground strategy to dampen the impacts of capital inflows using sterilization with moderate exchange rate flexibility.
In fact, what we found in our study is that global monetary policy was broadly transmitted to Asian emerging countries. In other words, excess or tight global liquidity has led to expansionary or contractionary monetary condition in emerging countries suggesting that the latter did not really have much monetary independence.
What has been the impact of excess global liquidity on Asian emerging economies?
We found that expansionary monetary policy had a positive impact on growth. However, we also found evidence that it also led to higher inflation. This likely reflects the balancing act played by central banks in dealing with capital inflows in addition to domestic considerations.
We also found evidence that loose global monetary policy has contributed to the widening of the saving-investment gap in Asia. Expansionary monetary policy has tended to contribute proportionally faster to output growth than investment such that it reduced the investment to GDP ratio. This empirical finding could be attributed to consumption and exports being more sensitive to interest rate changes while import is slow to respond to changes in domestic demand. The negative effect of expansionary monetary policy on investment to GDP ratio is larger than its effect on saving to GDP ratio so that the net saving/GDP in Asia (imbalance) rise with the global monetary gap.
What do these results imply?
Our findings lend support to the existence of a feedback loop between the global monetary gap and global imbalances. First, the negative link between the global monetary policy and Asia's net saving to GDP ratio suggests that global monetary expansions are partly responsible for the large current account surplus in Asia. Second, policy inter-linkages reflect that intervention was required in addition to exchange rate adjustments in dealing with capital flows. The resulting build-up of reserves has funneled vast quantities of dollars into international capital markets and induced low returns on U.S. government securities. Third, the large capital reflows to global financial markets in turn has exacerbated the excess global liquidity which fed into Asian domestic monetary conditions, completing the feedback loop.
Hence, global policy coordination for rebalancing would require the realignment of global and domestic monetary policies. Reducing the excess global liquidity will help reduce global imbalances.
Il Houng Lee (李一衡) is currently the IMF Senior Resident Representative in China and a former Advisor at the Asia Pacific Department of the International Monetary Fund.
This article is based on an IMF Working Paper published in September that you can download from the IMF website. The paper was authored by Il Houng Lee and Woon Gyu Choi, a Senior Economist at the IMF Institute of the International Monetary Fund.
Links and Sources
The Economic Observer: 全球货币政策扩张部分导致国际经济不平衡
IMF Resident Representative Office in China: Official Website
