What is the impact of ultra-low monetary conditions in developed countries on Asia? Some economists, including Ben Bernanke, chairman of the US Federal Reserve Bank, have blamed Asian countries, particularly China, for consuming too little and saving too much, which has led the US to, willy-nilly, run up huge current account deficits.
Others have attributed the global imbalances—the huge current account surpluses in China and the corresponding deficits in the US—on the artificially low value of the Chinese currency.
But the fact remains that these global imbalances have been accompanied by low interest rates in the US, which has led to a huge expansion of global liquidity.
This paper attempts to understand how these low interest rates in the West have affected emerging and developed economies in Asia. It explores the linkages between the global and domestic monetary gaps— defined as the gap between the actual real rate and the neutral real rate—and their effects on output growth, inflation and net saving rates for Asian countries.
The authors use data from 20 Asian countries for the period 1980-2008. They find that ultra-low real interest rates in the West have led not only to increased output growth in emerging Asia, but also to high inflation and large current account surpluses.
The authors find that loose monetary policy in advanced economies is partly responsible for the widening savings-investment gap in Asia. This is because expansionary monetary policy leads to capital flows to emerging economies, which can be used to finance investment. Moreover, world output growth, again partly the result of accommodative monetary policies, leads to higher exports from emerging economies, and therefore, higher output.
The authors find, however, that easy monetary policy in advanced nations increases output more than it does investment in emerging economies. It, therefore, reduces the investment rate. With the savings rate remaining as before, the result is that the net savings rate (savings rate minus investment rate) rises. Bernanke calls this excess of savings over investment the savings glut, but the authors show that its main reason is the expansionary monetary policy in the West.
Other findings include: International reserve holdings tend to reduce domestic investment for all Asian country groups, possibly reflecting excess accumulation of reserves at the expense of lower investment, and financial integration tends to stimulate savings and investment in the advanced economies of Asia but not for emerging Asia.
Finally, the authors find what they call a feedback loop between the monetary policy of advanced economies and the impact on emerging nations in Asia. They say low interest rates lead to funds flowing out to emerging Asia, and the first line of defence when dealing with these capital inflows by policymakers in emerging economies has been to intervene in the currency markets. They prefer to intervene rather than let their currencies appreciate.
These interventions have led to the build-up of international reserves, which fuel vast quantities of dollars into international capital markets and lead to low returns on US securities. This in turn leads to low real interest rates in the US, completing the feedback loop.
The authors say the easy global monetary condition is partly responsible for the current account surplus in Asia and “unwinding the global monetary gap will help reduce global imbalances”. In other words, it’s only once the West starts raising real interest rates that we’ll see an end to global imbalances.
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