What happens when the days of low interest rates and strong global liquidity end?

By Desmond Lachman

 
According to an old Wall Street adage, when the winds are strong even turkeys fly. By this it is meant that when global money is ample, even those emerging market countries with highly impaired economic fundamentals have little difficulty in borrowing abroad to finance their wayward budget ways. However, when global liquidity dries up and interest rates rise, those same economies come crashing down to earth sending ripples through the world’s financial markets.

With the Federal Reserve poised soon to start dialing back its ultra-easy monetary policy, world economic policymakers would do well to keep the old Wall Street adage in mind. This would seem to be especially the case considering that the emerging market economies now constitute around half of the global economy. It would also seem to be the case considering how highly compromised many of these economies’ public finances have become in the Covid-19 pandemic’s wake.

The 2013 Bernanke taper tantrum provides a vivid example of what can happen to vulnerable emerging market economies when the Fed starts a monetary policy tightening cycle and global liquidity dries up. In the immediate wake of Mr. Bernanke’s announcement that the Fed was going to put an end to its bond-buying program, the so-called Fragile Five group of emerging market countries -Brazil, India, Indonesia, South Africa, and Turkey–all experienced sharp sell-offs in their currency, equity, and debt markets. Those sell-offs in turn had a ripple effect on world financial markets.

 
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Πηγή: aei.org