Time to Rethink Monetary Policy in Emerging Economies: Touching the tip of an iceberg

Abstract

The global economy appears to be trapped in a low growth state due to structural impediments that have accumulated over the last two decades. Since the global financial crisis, expansionary macroeconomic policies have provided only temporary relieve but fell short of fundamentally addressing the global demand deficiency. Authorities have gained some time through unconventional monetary policy (QE) but the latter is not without risks. The ongoing normalization in China with respect to investment growth and in the United States with respect to monetary policy should thus be regarded as necessary. Further delay would likely have tipped the balance from a net positive to a net negative effect on the global economy. However, in the short run, there are costs. The slowdown in China played its role in the sharp drop in energy and commodity prices (along with global oil supply conditions), in trade and its associated investment flows. The termination of quantitative easing and the beginning of the rate hike in the United States is tightening liquidity conditions in emerging economies (EMs). The latter is adding burden on EMs who are already struggling to cope with the spillovers from slowing China. Furthermore, if global financial instability lingers on beyond the necessary correction, it could start exerting its own negative influence on the already weak recovery.