Author丨Xiang Xiufang
Edit丨Li Yingliang
Picture Source丨TuChong
International Monetary Fund (IMF) and World Bank During the 2022 autumn annual meeting, developed economies have become one of the focus topics in order to fight high inflation and accelerate monetary policy tightening, and have a huge spillover effect on emerging markets and developing countries , which has become one of the focus topics.
Against this background, on October 14 local time, IMF First Vice President Gita Gopinath and IMF Chief Economist Pierre-Olivier Gourinchas published a joint blog post, proposing policy recommendations on how countries should deal with the strong dollar. The article
pointed out that the sharp strengthening of the US dollar in the short term has had a huge impact on the macroeconomic in almost all countries. At present, economic fundamentals are a major factor in the appreciation of the US dollar. The appropriate policy responses of countries to depreciation pressures need to be paid attention to the drivers of changes in the exchange rate and signs of market turmoil.
For the United States, although the strong dollar and tightening of global financial conditions have had an impact on the world, monetary tightening is still an appropriate policy when the U.S. inflation rate is still far above the target. Failure to do so will damage the credibility of central bank , make inflation expectations lose the basis, and require more tightening in the future and have a larger spillover effect on the rest of the world .
article reminds that Fed should remember that the huge spillover effect is likely to spill back into the US economy.
The following is the full text (translation for reference):
Since the beginning of this year, the US dollar has appreciated 22% against the yen, 13% against the euro, and 6% against emerging market currencies, reaching the highest level since 2000. Given the dominance of the US dollar in international trade and finance, the dollar's sharp strengthening in a few months has had a huge impact on the macroeconomics of almost all countries.
Although the United States' share of world commodity exports has dropped from 12% to 8% since 2000, the US dollar's share of world exports has remained at around 40%. For many countries working to lower inflation, the depreciation of their currencies relative to the dollar makes the response even more difficult. On average, the conductivity of the US dollar's appreciation of 10% to inflation is estimated to be 1%. This pressure in emerging markets is particularly severe compared to developed economies, reflecting their higher reliance on imports and a greater share of imports denominated in USD. The appreciation of
USD also has an impact on the global balance sheet. About half of cross-border loans and international debt securities are denominated in US dollars. Despite the progress made by emerging market governments in issuing debt in their own currencies, the level of dollar-denominated debt in their private enterprise sector is high. As global interest rates rise, financial conditions in many countries have tightened significantly. A stronger dollar will only exacerbate these pressures, especially for some emerging markets and many low-income countries that are already at high risk for debt difficulties.
In this case, should countries actively support their own currencies? Some countries are resorting to foreign exchange intervention. The total foreign exchange reserves held by emerging markets and developing economies fell by more than 6% in the first seven months of this year.
's appropriate policy response to depreciation pressures requires attention to drivers of exchange rate changes and signs of market turmoil. Specifically, foreign exchange intervention should not replace the reasonable adjustment of macroeconomic policy . Temporary intervention can be made when currency changes significantly increase the risk of financial stability and seriously undermine the central bank's ability to maintain price stability.
As of now, economic fundamentals are a major factor in the appreciation of the US dollar: US interest rates rise rapidly, and US trade terms are more favorable - measuring the price of a country's exports relative to imports (caused by the energy crisis ). In order to cope with the historic inflation , the Federal Reserve has been on the road to quickly tightening policy interest rates. Meanwhile, low inflation rates in Japan and China have enabled their central bank to counter the global tightening trend.
The huge impact of the Russian-Ukrainian conflict on terms of trade (terms-of-trade) is the second major driving force for the strengthening of the US dollar. Eurozone is highly dependent on energy imports, especially natural gas from Russia. The surge in gas prices has brought its terms of trade to the lowest level in the history of the common currency.
As for emerging markets and developing economies outside China, many countries are leading the way in the global currency tightening cycle—perhaps partly due to concerns about their dollar exchange rates, while emerging markets and developing economies for export commodities have experienced a positive impact on trade terms. Therefore, the exchange rate pressure in general emerging market economies is not as severe as that in developed economies. Some countries, such as Brazil and Mexico , have even appreciated.
Given the important role of the basic drivers, the appropriate response is to allow exchange rate adjustments while using monetary policy to bring inflation closer to the target. The increase in the price of imported goods will help make the necessary adjustments to fundamental shocks, as it reduces imports, which in turn will help reduce the accumulation of foreign debt. Fiscal policy should be used to support the most vulnerable without compromising inflation targets.
also needs to take other measures to address some of the upcoming downside risks. What is important is that greater turmoil in financial markets may be seen, including investors' sudden loss of interest in emerging market assets due to retreat to safe assets, prompting large capital outflows.
In this fragile environment, it is prudent to strengthen resilience. While emerging market central banks have stored dollar reserves in recent years, reflecting lessons learned from early crises, these buffers are limited and should be used with caution.
Countries must retain important foreign exchange reserves to deal with the more serious capital outflows and turmoil that may occur in the future. Those countries with capacity should restore swaps with central banks of developed economies. Countries with sound economic policies and need to address moderate vulnerability should actively use the IMF's preventive quotas to meet future liquidity needs. Countries with large amounts of foreign currency debt should reduce foreign exchange mismatch by using capital flow management or macro-prudential policies, in addition to debt management actions to smooth repayment. In addition to fundamentals,
has shown signs of market chaos in some countries as financial markets tightened, such as the currency hedging premium and the increase in local currency financing premium. Severe chaos in shallow currency markets will trigger huge changes in these premiums, potentially causing macroeconomic and financial instability.
In this case, temporary foreign exchange intervention may be appropriate. If a significant depreciation increases financial stability risks, such as corporate defaults, this can also help prevent adverse financial amplification. Finally, in rare cases, temporary interventions can also support monetary policy, that is, a sharp depreciation of the exchange rate may cause inflation expectations to be anchored, and monetary policy itself cannot restore price stability.
For the United States, although the strong dollar and tightening of global financial conditions have had an impact on the world, monetary tightening is still an appropriate policy when the U.S. inflation rate is still far above the target. Failure to do so will damage the credibility of the central bank, dean the inflation expectations, and require more austerity in the future and have a greater spillover effect on the rest of the world.
That is to say, the Fed should keep in mind that the huge spillover effect is likely to spill back into the US economy. In addition, as a global provider of world security assets, the United States can restart the currency swap quota for eligible countries, as it extended at the beginning of the pandemic, providing an important safety valve when money markets are tight. This will beneficially complement the US dollar funding provided by the Federal Reserve's permanent foreign and international monetary authorities' repurchase mechanism.
The IMF will continue to work closely with our members to rely on our comprehensive policy framework to develop appropriate macroeconomic policies during these turbulent times.In addition to providing preventive financing mechanisms to eligible countries, the IMF is ready to provide our loan resources to member countries with balance of payments issues.
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Editor of this issue Li Yutong Intern Luo Xinyu
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