The second-in-command at the Federal Reserve said the US central bank was paying attention to tumult in global markets caused by monetary policy tightening, but insisted rates must still keep rising to combat inflation.
Lael Brainard, Fed vice-chair, acknowledged that rate rises across the world — a movement largely led by the Fed — would affect highly indebted emerging markets, with rapidly rising rates potentially causing instability.
“As monetary policy tightens globally to combat high inflation, it is important to consider how cross-border spillovers and spillbacks might interact with financial vulnerabilities,” Brainard said on Friday. She added that the Fed was “attentive” to such vulnerabilities, which “could be exacerbated by the advent of additional adverse shocks”.
At the same conference, hosted jointly by the Fed and its New York branch, Agustín Carstens, general manager of the Bank for International Settlements — the umbrella body for central banks — urged policymakers to stick with their campaigns to tighten monetary policy.
“When you are flying an airplane, yes there might be some turbulence [but] you don’t abort the direction of your flight unless you really face something completely unexpected,” he said.
The Fed is considering whether to carry out what would be its fourth consecutive 0.75 percentage point rate rise at its next policy meeting in November. More generally, the round of interest rate rises and bond sell-offs by central banks across the world has resulted in a surge in borrowing costs and a retreat from risky assets such as equities.
Emerging market stocks have tumbled 29 per cent in dollar terms this year, leaving them on track for the biggest drop since the global financial crisis in 2008, according to a broad gauge by index provider MSCI. The company’s index of developing economy currencies is down 8.4 per cent so far this year.
Global financial markets have also whipsawed this week as a result of turmoil in the UK related to the government’s tax cut and borrowing plan, as well as broader concerns about how aggressively the Fed will need to stamp out the worst inflation problem in four decades.
Asked about the fallout from the UK this week, Carstens said fiscal and monetary policy needed to be co-ordinated and have some “congruency”.
On the same panel, Claudia Buch, vice-president of Germany’s Bundesbank, said the situation also underscored the need for “surveillance of the entire financial sector” to identify potential risks.
“We need to develop the discipline to act in a more forceful way when we are in peace times,” said Cartstens.
A chief concern for policymakers is the implication of rapidly rising interest rates on highly-indebted countries and companies.
The IMF and other multilateral organizations have repeatedly warned about the acute risks confronting emerging and developing economies, many of which are saddled with large stocks of debt, whose servicing costs have ballooned as global interest rates have risen.
In her remarks, Brainard said fears about debt sustainability could propel “deleveraging dynamics”, such as the sell-off of assets in countries with high sovereign or corporate debt levels.
But she underscored the Fed’s commitment to “avoiding pulling back prematurely” from higher interest rates.
In August, the Fed’s preferred inflation gauge — the core personal consumption expenditures price index — increased 0.6 per cent and is now running at an annual pace of 4.9 per cent. This compares with its 2 per cent inflation target.
Brainard warned that the risk of additional inflationary shocks “cannot be ruled out” and emphasized that the Fed met regularly with its counterparts across the world to “take into account cross-border spillovers and financial vulnerabilities in our respective forecasts, risk scenarios and policy deliberation ”.
The Fed vice-chair reiterated that “at some point” it would need to consider if its monetary tightening went too far. She argued that the effects of the policy would take time to filter through the economy and that uncertainty about how far rates needed to rise was high.
Brainard highlighted the impact of tighter US monetary policy on demand for foreign products, which means that those countries’ economies are reined in not just by interest rate rises at home but also by reduced US appetite for their goods.
“The same is true in reverse: tightening in large jurisdictions abroad amplifies US tightening by dumping foreign demand for US products,” she added.