Unconventional Monetary Policy and Cross-Border Spillovers

From the speech given yesterday by the Federal Reserve’s Governor Lael Brainard,

More recently, growth projections have been marked down for emerging market economies, which previously had been an important source of global growth. Increased recognition of the risks to the outlook for major emerging market economies pushed the dollar up further to 15 percent above its level last summer and contributed to a more general tightening of financial conditions over the summer. Much of the focus of investors and policymakers around the world has been on China, where the buildup of past property bubbles, and more-recent stock market, bubbles, together with a steep run-up in business debt levels and questions about the policy framework, have raised concerns. In turn, growth has slowed both in many commodity-exporting countries whose exports are sensitive to Chinese demand as well as many non-commodity-producing East Asian economies that are tied to China through trade and investment and are important destinations for U.S. exports.

The feedback loop between market expectations of divergence between the United States and our major trade partners and financial tightening in the United States means that material restraint to U.S. conditions is already in place. Looking ahead, a further weakening of foreign growth could pose downside risks to the U.S. outlook. Under normal circumstances, policy in the United States could adjust to signs that spillovers from developments abroad were affecting activity in the United States. But with policy rates in the United States at the lower bound, the ability to offset spillovers from adverse developments in foreign economies with conventional policy is constrained, suggesting greater caution than normal.

In conclusion, the Great Recession has sparked innovative actions in a number of countries that have helped monetary policy escape the constraints of the zero lower bound. Just as it appears that unconventional monetary policy can provide accommodation domestically similar to conventional monetary policy, so too it appears that cross-borders spillovers work through the same channels. Nonetheless, the discontinuity of discrete policy changes around the zero lower bound can amplify the effects. In response to heightened sensitivity around these spillovers, countries that have deployed unconventional policy have committed to do so in a way that targets domestic objectives using domestic instruments, thereby helping to ensure their actions would support rather than sap global demand.

“Support rather than sap”, I like that (game theory). A previous post on the feedback loop.

Here is Bernanke on ‘Fed communication‘.


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