New York Fed has determined that new dollar hegemony is not good for emerging economies and other emerging economies

Readers may wonder why the New York Fed would publish a research paper that describes a new mechanism by which a US that cares only about the impact of its monetary policy on the US could have bad consequences for emerging economies.

At the IMF, the research arm has long remained on the left of the “program” and has frequently produced papers describing the counterproductiveness of austerity measures. One famous study from the early 2010s found that countries with weak economies had fiscal multipliers greater than one, which in simple terms means that budget cuts will actually worsen the debt-to-GDP ratio as the economy shrinks more. than reducing borrowing. Keep in mind that this key discovery had little impact on how the IMF does business.

The Fed hires very smart financial economists. While some may aspire to stay at the Fed, for most, a promising career path is to get into the research division of a large Wall Street firm or into a money manager. For them, publishing insightful articles advances their careers. They also make the Fed look more like an honest intellectual broker, although they are unlikely to spur calls for change.

A longstanding criticism of the Fed’s lack of interest in the international implications of its interest rate changes is that hot money comes in and out of higher risk developing countries. A group of central bankers complained to Bernanke during his 2014 tantrum, but to no avail. As we wrote in 2015:

India’s central bank governor Raghuram Rajan addressed Bloomberg criticizing the Fed for its inability to coordinate policy with the rest of the world. And Rajan cannot be discounted as a supporter of his country’s policies. Rajan is a serious economist, former Chief Economist of the IMF, best known in wide circles for his presentations Poorly received newspaper at Greenspan’s last Jackson Hole session, which said that financial innovations make the world more risky and may well cause a full-blown financial crisis. And he took office only in September of last year, so he also does not defend the policies he pursued…

Rajan is straightforward by the standards of official discourse:

Some of his key points:

Emerging markets suffered both because easy money was flowing into their economies and because it was easier for them to forget the necessary reforms, the necessary fiscal measures that needed to be taken, in addition to the fact that emerging markets tried to support global growth with huge Fiscal and monetary stimulus in emerging markets. This is easy money that has been overshadowed by the already strong fiscal stimulus from these countries. The reason emerging markets were unhappy with this easy money is that “it will make it harder for us to make the necessary adjustments.” And the industrialized countries at that moment said: “What do you want from us, we have a weak economy, we will do whatever is necessary. Let the money flow.”

Now, when they withdraw this money, they say: “You complained when they arrived. Why should you complain when it’s gone?” And we complain for the same reason when money goes out as it comes in: it distorts our economy, and the incoming money makes it harder for us to adjust for sustainable growth and prepare for what the money is. go away out

Return to current post. IN Imperial dollar cycle, Federal Reserve Bank of New York authors Özge Akinci, Gianluca Benigno (Professor of Economics at the University of Lausanne) and
Serra Pelin describes how dollar-denominated export pricing undermines emerging economies, making their goods less competitive and making dollar financing more costly. From their article:

Our analysis is based on the multipolar dimension of the world economy, consisting of the United States, advanced economies, and emerging markets. In our multi-country DSGE model, as in the Dominant Currency Paradigm (DCP), we assume that firms in emerging markets set their export prices in dollars, while firms in advanced economies set their export prices in their own currency. . Thus, a stronger dollar creates a competitive disadvantage for emerging market economies. We also assume that there are financial constraints, so firms need to borrow in dollars to finance purchases of imported intermediate inputs. As we show in our simulations presented in the recent staff report, these two forces make the strengthening of the dollar particularly detrimental to the manufacturing sector in emerging markets.

The chart below visualizes the imperial dollar circle. Tightening US monetary policy sets the circle in motion, causing the dollar to appreciate. Given the structural features of the global economy, policy tightening and the appreciation of the dollar are reducing manufacturing activity around the world, helped by a relatively larger downturn in emerging market economies. The resulting decline in global (outside the US) production will be reflected in the US manufacturing sector due to the reduction in final foreign demand for US goods. These same forces will also lead to falling commodity prices and global trade. At the last stage of our mechanism, given that the US economy is relatively less subject to global changes, the reduction in world production and world trade is associated with a further strengthening of the dollar, strengthening the circle.

Behind the dollar’s imperial circle lie two key asymmetries in the structure of the international monetary system and the US economy. The first asymmetry arises from the fact that the global use of the dollar in the international monetary system greatly exceeds the relative size of the US economy. The following diagram captures this fundamental asymmetry.

…. In addition to its dominant role in trading accounts, the US dollar is also the dominant currency in international banking transactions. About 60 percent of liabilities and claims in international and foreign currencies are denominated in US dollars (see Bertaut et al. (2021)).

In addition, as discussed by Bruno and Shin (2021), a strong dollar generally reduces the availability of dollar financing needed to support supply chain linkages. As a result, dollar movements affect global activity through this financial channel. The chart below shows the relationship between the broad dollar index and global supply chain imbalances, a metric that is based on the Federal Reserve Bank of New York’s Global Supply Chain Pressure Index (GSCPI).

The second asymmetry arises from the fact that the US economy is less subject to changes in world trade compared to its trading partners…

is still in this smart and well presented articlewhich I encourage you to read in full, but the excerpts above give you the gist of the argument.

Note that the effect of interest rate increases and dollar price changes on trade billing and dollar (as is common in trading) funding is to increase economic cycles, which increases volatility and volatility. Economists call “procyclical” what = “bad”.

Secondly, even though the world has become more globalized, the share of US exports in GDP is low by world standards, and therefore we are not much affected even indirectly (for example, the tightening of interest rates that hit our export partners).

I hope you will forward this article to potentially interested readers.

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