TWN Info Service on Finance and Development
24 November 2010
Third World Network
Dear Friends and Colleagues,
How the US can fix its
An article by Kevin Gallagher and Stephany
Griffith-Jones appeared in the Guardian on 18 November on the issue
of quantitative easing by US Federal Reserve.
The authors argue that the US
should place prudent capital regulations on the outflow of speculative
capital leaving the US
for emerging economies via the carry trade. This would help prevent
future crises in emerging economies, as crises harm all countries and
are therefore a collective action problem.
Please find the article below.
With best wishes,
Third World Network
How the US can fix its
G20 countries had issues with the
US devaluing the dollar, but the solution lies in cooperation on capital
Kevin Gallagher and Stephany
Thursday 18 November 2010 12.00 GMT
Ben Bernanke has been criticised from different
sides and perspectives for quantitative easing. From one side, inflation
hawks prefer austerity over expansion. Those who favour expansion and growth have valid concerns
that it may not work and, instead, have negative global effects. At
the G20, the United States got criticised – rightly – by emerging
countries for the negative impact of QE2 on their economies.
The results of the recent US
elections make it very difficult for the US to pursue the first best policy
to keep its economy recovering: further fiscal expansion, for a time. As Keynes taught us,
and we have seen during numerous crises, private investment and consumption
will not recover on their own (due both to over-leveraging and lack
of confidence), without the stimulus of aggregate demand, which only
governments can give in these particular circumstances. Once the recovery
is on track, fiscal policy needs to contract, to avoid both overheating
and excessive public debt.
The Fed has already brought the short-term interest
rate to zero, so Bernanke, to his credit, has ventured into the emergency
toolkit. The Fed chairman should be applauded for his willingness to
think past convention. As one of the last policy-makers in developed
countries with significant economic power, he is now almost the sole
voice for expansionary economic policy.
However, on its own, QE2 may, indeed, not be enough
to restore the US
economy to growth; and it will contribute to further overheating of
asset prices in the emerging economies, which could not just complicate
macroeconomic management for them now, but also increase the risk of
To ensure QE2 helps the US economy to grow, mechanisms need
to be found to channel the additional liquidity created by the Fed to
the real economy. The key is to expand credit to small and medium-sized
enterprises, starved of funds at present, and to finance large investments
in infrastructure, including that required to generate clean energy.
Policy-makers must exercise creativity to help
achieve this. The Europeans have a massive institution, the European
Investment Bank (EIB), which last year lent more than $100bn; the US needs to create similar mechanisms
quickly, or use existing institutions to lend more to the private sector.
The Europeans, in turn, should further expand EIB lending.
Internationally, if the US
dug into the emergency toolbox again, it could place prudent capital
regulations on the outflow of speculative capital from the US via the carry trade; this might help avoid future
crises in those countries, which would harm not only them, but also
the US and the world
economy. More broadly, it is time policy-makers stopped letting the
financial sector tail wag the real economy dog.
Before and at the G20 summit, many emerging market
politicians and well-known economists voiced serious concern over the
global effects of quantitative easing. Increased US
liquidity may pull dollars out of the US and invest them in nations with
higher interest rates for rapid speculative return. Known as the carry
trade, such speculative flows push up the value of emerging market currencies
and create asset bubbles.
It is for this reason that the US was criticised at the G20. Brazil,
with interest rates over 10%, has seen an appreciation of over 30% due
in part to the carry trade, and was most vocal in Seoul.
One remedy to the problem already under way is
the use of capital controls in emerging markets. Many nations such as
China, Argentina, Taiwan,
Thailand, South Korea, Peru
have put in place controls to limit excessive inflows. Such controls
have been sanctioned by the IMF – a landmark shift.
The problem is that – on their own – controls
from recipient countries may be overwhelmed by the sheer scale of the
inflows, with investors often finding ways to evade them. Given that
the majority of the carry trade effect will come from the US,
the United States
could start regulating the outflow of capital due to the carry trade.
Controls on short-term outflows would facilitate
the liquidity created by the Fed to stay in the US and have a better chance of going
toward productive investment. Such investment could help developing
countries via trade, rather than causing speculative capital to flow
to emerging markets and cause havoc to their financial systems and their
By stemming criticism from emerging markets, the
US may find more
allies for a global growth agenda. Developing countries have deployed
expansionary policy in the wake of the crisis, and it is working.
It is important that their efforts are strengthened, and not undermined,
by hot money. Together, they could pose a legitimate alternative to
the austerity-ridden Europeans and new members of the US Congress.
Guardian News and Media Limited 2010
TO MAIN | ONLINE
BOOKSTORE | HOW TO ORDER