The Fed’s Quantitative Easing (QE) program, consisting of the purchasing of Treasuries and bank debt and flooding the markets with capital and keeping interest rates and the value of the dollar low, has helped bolster both the US and global economy through the economic downturn. By freeing up reserves of banks, the Fed gave banks more funds eligible for loans, and in an effort to loan these excess funds out, banks would lower interest rates and make capital more available to the economy. This, in turn, would weaken the dollar with a looser money supply, and more small businesses and individuals would have access to money, spurring growth and spending. Finally, in regards to international repercussions, QE has led to excess liquidity and capital inflows into emerging market economies such as the BRIC nations, and this has resulted in rapid unwarranted economic and price growth that came without restructuring issues with their respective economies.
With QE3, the phase-out plan in which the Fed aims to reduce its monthly purchasing operations, has many investors cautious about the economy; with the government-led support phasing out and with many economic indicators such as unemployment (when the labor force participation rate is factored in) still relatively poor, even hints of QE3 have sent the markets into a frenzy both in the United States and in emerging markets. Currencies of countries such as India have spiraled, with the US-to-rupee conversion rate falling to less than 1:63, and concerns of lower future market growth have sent equity markets downward consistently as Ben Bernanke and others at the Fed have commented on QE3. The question remains of how to begin exiting QE without harming both the US and global economy.
The United States can avoid financial and economic stability by clearly delineating timelines, expectations, and steps with QE3. Investors, unsure of any future actions by the Fed, have been able to jump into the market sporadically, and have had equally inconsistent reactions upon statements by the Fed. Through early and middle 2013, Fed statements left investors unsure of when tapering would begin, and Bernanke notably delivered a calming speech assuring investors tapering would not end anytime soon in July of 2013. However, investors have responded favorably when expectations are clearly outlined and in check with general public opinion, as was evidenced when the Fed finally announced the start of QE3 in September. The market had begun to expect QE3 with many statements from the Fed throughout the year, and with this announcement coming as no surprise, the stock market actually posted a significant gain on the day of the announcement, which was a large surprise. The Fed should continue to delineate the progress of QE3 with easily measurable and transparent metrics. Should the Fed continue to make steady, well-announced and fairly anticipated progressions in QE3, investors should continue to respond well and markets should not face extreme volatility, as suggested by the Efficient Market Hypothesis (EMH) by Professor Eugene Fama, wherein the market has already priced in all available information; if the market can anticipate all tapering progressions with reasonable certainty, the United States should be able to avoid financial and economic instability.
In regards to trading partners, the situation is much more difficult to address. Several trading partners in emerging markets have large current account deficits (notably India), and quantitative easing has helped ease the pain of spending that outweighs earnings with plentiful capital inflows. Instead of undergoing rigorous economic reforms during the global economic recession post-2008, these economies were able to benefit from free-flowing capital coming from the United States; with Quantitative Easing, the Fed kept interest rates close to the zero bound, but made capital very available by insuring bank assets. Investors thus looking for a place to invest money turned to foreign markets with higher yields, and these capital inflows balanced out excess spending and current account deficits in nations such as India. Now, as tapering progresses and rates rise in the US and as the bond-purchasing program by the Fed declines, investors will find investing in these emerging markets less attractive than in recent years, and this will make the pain of large current account deficits more apparent. Furthermore, currency values will greatly deplete; the rupee, for example, has fallen from approximately 45 rupees to the dollar to under 60 rupees to the dollar. Thus emerges the issue where QE3, even if acceptable to the US, will hinder the growth of trading partners, especially in emerging markets.
Many questions have emerged as to who is at fault for this predicament for many of the United States’ trading partners. Do the partners take the blame for their current account deficits and currency issues? Or does the blame lie with the United States for creating such an issue for partners in the first place? But, regardless of who is to blame, the United States needs to find a way to engage in Quantitative Easing without harming the economies or growth of trading partners. One possible solution is partnering with these partners in understanding their economies and helping them overcome their current account deficits, which make them particularly vulnerable to tapering. Another potential solution can be deferring some of the funds from QE each month towards buying bonds or investing in other indirect ways in emerging markets, thus dampening the burden of decreased capital inflows from US investors who have sought higher yields in the past few years. Finally, helping partners working on protective measures, such as those instated by Governor Rajan to keep the rupee from falling drastically lower than 60 rupees to the dollar (i.e. buying the dollar in the spot market and selling in the forward market), can be seen as a solution, if somewhat temporary. The key will be economic reform and creation of economic balance in trading partners, and measures that the US institutes that dampens the impact of tapering will serve to help partners avoid economic instability.