JACKSON HOLE, Wyo. Aug 24 Central banks should coordinate to avoid unwanted side effects as they exit from ultra-easy monetary policies that have left the world awash in cheap money, top policymakers were told on Saturday.
Opening the second day of an annual monetary symposium in Jackson Hole, Wyoming, after a week in which several top emerging markets suffered steep losses, a former Bank of France deputy governor painted a grave picture of the problem.
"The main challenge will be to manage the consequences of monetary policies, and their evolutions, on cross-border liquidity movements," Jean-Pierre Landau concluded in a paper he presented to an audience that included top central bankers from advanced as well as emerging market economies.
"Amplifications, feedback loops and sensitivity to risk perceptions will complicate the task of exit and necessitate very close and constant dialogue and cooperation between central banks," said Landau, now a professor at Princeton.
But he lamented that the necessary coordination on monetary policy was unlikely, and warned of the potential for the "fragmentation" of global capital markets.
Stocks and currencies plunged in India, Indonesia, Brazil and Turkey this week as investors fretted over a looming reduction in the U.S. Federal Reserve's monthly bond purchases.
Turkish Central Bank Governor Erdem Basci was attending the conference, although his Brazilian counterpart, Alexandre Tombini, canceled to stay home and deal with the crisis.
The Fed's bond buying, or so-called quantitative easing, has been at the heart of its aggressive efforts to revive U.S. economic growth after it cut interest rates to nearly zero in 2008. Interest rates in Europe and Japan are also ultra-low.
However, the purchases have spurred massive capital inflows into faster growing emerging economies, which are now suffering as investors anticipate an end to the easy money.
Landau acknowledged that central bankers dislike the idea of coordinating monetary policy because their job is to focus on domestic goals. But they worked well together during the 2007-2009 financial crisis, when the Fed, European Central Bank, Bank of Japan and other central banks coordinated rate cuts and currency swap lines.
As cross-border liquidity pressures build, they will find it productive to do so again, although cooperation is more likely through regulatory and financial structures aimed at preventing excessive leverage or harmful asset bubbles, he said.
In an ideal world, the cooperation would extend to monetary policy because policies in major economies such as the United States can have an international impact that amplifies their magnitude with domestic implications, Landau argued.
"The system itself is producing more accommodative monetary conditions than warranted by the situation," he said. "In a reverse environment, when monetary policies need tightening, the effects could be symmetrical and complicate the exit from non-conventional measures."
In addition, much could be gained through an international "lender of last resort," which would remove the motive for some nations to maintain massive foreign exchange reserves, he added.
"All countries have a common interest in finding ways to disconnect reserve accumulation from exchange-rate management," Landau said. "The need for national reserves could be reduced if credible mechanisms exist to provide for the supply of official liquidity on a multilateral basis."
That said, he freely admitted that this goal will be very hard to reach. Such an international agreement ultimately puts taxpayers in one country on the hook to bale out debtors in another, which would very hard to sell politically.
"It is hard to imagine that any government could bring the necessary fiscal backing to issuance of potentially unlimited liabilities to non-residents in times of crisis," Landau said.
As a result, the outlook for global capital markets is not encouraging, Landau said, warning of a "segmentation" between nations with surplus capital and others that will suffer from a dearth of investment due to a lack of access to capital.
"The most likely scenario is that of progressive fragmentation of the international financial system," he added.