Brazil’s economy isn’t doing the Samba. After growing 7.5 percent last year, Brazil has slowed to a near stop in 2012. And Brazil thinks one of its problems is the monetary policy being pursued by Federal Reserve Chairman Ben S. Bernanke.
The Brazil vs. Bernanke rivalry played out most recently in Tokyo where on October 14, Bernanke defended his policies against critics in a speech before a conference sponsored by the bank of Japan and the International Monetary Fund: “I am sympathetic to the challenges faced by many economies in a world of volatile international capital flows. And, to be sure, highly accommodative monetary policies in the United States, as well as in other advanced economies, shift interest rate differentials in favor of emerging markets and thus probably contribute to private capital flows to these markets. I would argue, though, that it is not at all clear that accommodative policies in advanced economies impose net costs on emerging market economies, for several reasons.”
First, the linkage between advanced-economy monetary policies and international capital flows is looser than is sometimes asserted. Even in normal times, differences in growth prospects among countries--and the resulting differences in expected returns--are the most important determinant of capital flows. The rebound in emerging market economies from the global financial crisis, even as the advanced economies remained weak, provided still greater encouragement to these flows. Another important determinant of capital flows is the appetite for risk by global investors. Over the past few years, swings in investor sentiment between "risk-on" and "risk-off," often in response to developments in Europe, have led to corresponding swings in capital flows. All told, recent research, including studies by the International Monetary Fund, does not support the view that advanced-economy monetary policies are the dominant factor behind emerging market capital flows.1 Consistent with such findings, these flows have diminished in the past couple of years or so, even as monetary policies in advanced economies have continued to ease and longer-term interest rates in those economies have continued to decline.
Second, the effects of capital inflows, whatever their cause, on emerging market economies are not predetermined, but instead depend greatly on the choices made by policymakers in those economies. In some emerging markets, policymakers have chosen to systematically resist currency appreciation as a means of promoting exports and domestic growth. However, the perceived benefits of currency management inevitably come with costs, including reduced monetary independence and the consequent susceptibility to imported inflation. In other words, the perceived advantages of undervaluation and the problem of unwanted capital inflows must be understood as a package--you can't have one without the other.
Brazil was not appeased by Bernanke. “Advanced countries cannot count on exporting their way out of the crisis at the expense of emerging market economies," complained Brazilian Finance Minister Guido Mantega. "Brazil, for one, will take whatever measures it deems necessary to avoid the detrimental effects of these spillovers." Mantega has been complaining about the policies of the Federal Reserve and ECB since 2010.
IMF Managing Director Christine Lagarde acknowledged the danger of monetary easing in developed economies leading to economic contraction in emerging markets: "Accommodative monetary policies in many advanced economies are likely to entail large and volatile capital flows to emerging economies...This could ... lead to (economic) overheating, asset price bubbles and the buildup of financial imbalances."
Don’t look for this argument to be settled any time soon – so long as the Fed keeps turning on the spigot and the developing world keeps feeling the flood.