Federal Reserve Chairman Ben Bernanke’s Federal Open Market Committee announced a third round of quantitative easing (QE) QE3 on September 13,2012 to stimulate the economy. Quantitative easing (QE) is basically a monetary policy used by central banks to stimulate the national economy when conventional monetary policy has become ineffective.
The idea behind Quantitative Easing is that the central bank uses this supply of newly created money to buy up government bonds and other financial sector assets. The purpose is to drive down yields on bonds and provide more financial sector liquidity. It is used in economies where the use of normal expansionary monetary policies has become impossible. In such economies, normal monetary policies no longer work because base interest rates have already been reduced to such an extent that it is not really possible to lower them any further . The need for such aggressive monetary actions in recent years can be traced to the U.S. real estate bubble, which burst in 2007, and to the more-recent sovereign debt crisis in the eurozone.
QE pumps money into the economy and increases liquidity. This flood of new money due to QE won’t find a home domestically, it will find places to settle down in many of the emerging markets. Are investors going to want to keep their money in U.S. dollars that are earning nearly 0% interest when they could be shifting that money into emerging market currencies where they could earn 5%+ per year? Hence, quantitative easing will significantly increase capital flows into emerging markets.Apart from this, Emerging markets have been a popular target of excess capital for a number of reasons:
- Their overall ability to take on debt remains strong
- They have experienced minimal balance sheet impairment compared to developed markets
- They have relatively innocuous levels of pre-existing leverage
So what are the ill-effects associated with Quantitative easing in emerging markets?
- Inflation and Currency fluctuation: If capital comes into emerging markets too quickly due to QE, it drives up their currency exchange rate and has the potential to create strong inflation in a short amount of time. Emerging markets are generally very dependent on their exports, and if a country’s currency gets very expensive, all of a sudden its exports are less attractive. Therefore, there are many negative effects that U.S. quantitative easing has on emerging market economies.
- Threats of retaliatory measures:The consequences of QE could be a first-order concern in monetary policymaking. This practice can affect foreign exchange in a way that may disrupt trade flows and prove counterproductive . QE has led emerging markets to go on the offensive against the United States, and many countries have begun intervening in the foreign exchange trading markets in an attempt to devalue their own currency values. If country’s begin intervening in the market on a regular basis, it could create severe imbalance and dangerous conditions.