Editor’s Note: Claude Lopez is Director of International Finance and Macroeconomics Research at the Milken Institute. The opinions expressed in this commentary are her own.
All eyes will be on the Federal Reserve later this month as it considers lowering interest rates for the first time since the global financial crisis of 2008. As the world’s most powerful central bank, the Fed should take into consideration how changing interest rates may affect emerging nations’ economies.
Yes, the Fed’s first responsibility is to keep the US economy healthy. Likewise, the other globally-influential central banks — a group that includes the European Central Bank, the Bank of Japan and the Bank of England — must first look to the welfare of the economies they serve. But because policy changes by these important central banks affect the exchange rates of currencies and determine how money flows through international markets, their actions can have global repercussions.
When one of the major central banks raises interest rates, it has an impact on their currency’s exchange rate. The incremented increases of the US interest rate between December 2015 and December 2018 contributed to making the dollar more attractive to investors. As investors buy dollars, it appreciates relative to other currencies. For emerging economies with dollar-denominated debt, the stronger dollar makes it harder to pay off the loans. The increased debt burden may grow into a potential threat to domestic growth and financial stability.
The four major central banks maintained historically-low interest rates for more than a decade to give their domestic economies a boost. And for the most part, these policies succeeded.
Yet we have seen that subsequent interest rate increases have sparked incipient crises in several countries, including less-developed members of the G20 such as Argentina and Turkey.
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Numerous factors are at play in Turkey’s slide, including domestic political tensions, US tariffs and ill-advised government actions. But it is clear that, by maintaining historically-low interest rates for a long period, the Fed facilitated Turkey’s accumulation of a high external debt.
While most Americans felt little, if any, pain as the Fed continued to raise rates last year, each quarter-percent increment pushed Turkey closer to the brink because of the large holdings of dollar-denominated debt accumulated when rates were low. The challenge for Turkey is to reimburse its external debt while its own currency is falling against the dollar.
Inflation soared, and foreign investors fled as the lira’s value plunged. The lira is down 22.25% against the dollar since March 2018, when the Fed initiated the first of last year’s rate hikes. The lira’s decline has made it tougher for Turkey’s government and businesses to service foreign debt and has raised the cost of imports. The dollar isn’t the only problem. Turkey has kept its own rates very low, which has fueled domestic inflation as well.
Although decisions earlier this year by the Fed and the Bank of England to postpone additional rate hikes eased pressure on Turkey, the lira’s weakness, double-digit inflation and declining confidence plague the country.
Turkey isn’t alone. The long period of low U.S. interest rates had a global impact as the stock of dollar-denominated debt has ballooned to more than $11.5 trillion, putting Mexico, Argentina, Brazil and other nations potentially at risk.
The central banks aren’t blind to their influence. Concerns about trade and global growth recently contributed to the Fed’s decision to hold off on additional increases.
What the Fed and other major central banks lack — and need — is a regular, independent review of how their policies affect the rest of the world, and, in particular, nations with limited ability to respond to rapid shifts in global markets. To this end, Think 20, an advisory committee to the G20, has recommended that G20 representatives meet regularly to assess the impact of their policies. A joint task force of the International Monetary Fund and the Financial Stability Board would disseminate the information gleaned from these meetings.
The G20 finance ministers and central bank governors agreed at their June 2019 meeting on the need to strengthen international standards to ensure a more open and resilient financial system. Such a system is essential to sustainable growth. In a letter to the G20 leaders, Financial Stability Board Chairman Randal Quarles seconded that, emphasizing the importance of global coordination.
The agreement is a welcome step toward a more forceful position on global cooperation, including more closely monitoring central bank policies. Refinements should include specific measures, such as those in the T20’s recommendations to the G20. The economic instability in Turkey and Argentina offer compelling reasons to push for greater cooperation and communication. Without it, global stability will remain vulnerable to continuing cycles of debt and currency crises triggered by monetary tightening from globally-important central banks.