For some, currency wars may not be fun or easy to win

By Howard Schneider JACKSON HOLE, Wyo. (Reuters) - It's a maxim for private investors: Don't fight the Fed.

Reuters August 24, 2019 00:11:25 IST
For some, currency wars may not be fun or easy to win

For some currency wars may not be fun or easy to win

By Howard Schneider

JACKSON HOLE, Wyo. (Reuters) - It's a maxim for private investors: Don't fight the Fed.

The lesson may apply to central banks in developing nations as well, according to new research presented on Friday that concluded using monetary policy to fight a currency war may ultimately lead to self-inflicted wounds.

For developing nations at least, when a central bank like the Fed acts and global capital flows shift, the interest rates needed to keep the local currency from changing value are likely to throw monetary policy out of line with what the local economy needs. Borrowing costs at that point become either too tight and court a slowdown, or too loose and court inflation or excessive borrowing.

"Domestic monetary policy transmission is imperfect and as a consequence, emerging markets' monetary policy actions designed to limit exchange rate volatility can be counterproductive," Sebnem Kalemli-Ozcan, a University of Maryland economics professor, wrote in a paper presented at the Fed's annual central banking conference in Jackson Hole, Wyoming.

Her research speaks to a growing concern among some economists that, in a global economy that may be both slowing and becoming more volatile as a result of U.S. trade and tariff policy, countries may be tempted to use their central banks to influence the value of their currencies and gain a trade advantage.

Though the practice may be officially frowned upon by organizations like the Group of 20 nations, U.S. President Donald Trump has accused an array of nations of engaging in it, and has said the Fed should follow suit to weaken the dollar.

That sort of breakout "currency war" is just what the world doesn't need, the International Monetary Fund cautioned on Tuesday.

"One should not put too much stock in the view that easing monetary policy can weaken a country's currency enough to bring a lasting improvement in its trade balance," IMF officials including chief economist Gita Gopinath wrote.

LOSING BATTLE

Fed interest rate hikes through last year touched off stress in a number of countries whose currencies slid in value, for example by making it more expensive for companies to keep up with loans that had to be repaid in dollars.

Kalemli-Ozcan's paper suggested any effort to use monetary policy to buffer the currency may be a losing battle. Policy moves by the Fed in particular, the study found, shift the perceived risks of investing in other countries, making local monetary policy less effective - with the changes needed to influence currency markets made all the larger as a result.

That shift in risk perceptions does not occur to the same degree in advanced economies, she found.

The lesson may not apply equally to all countries. China, for example, can use its vast store of foreign reserves to manage the value of its currency, and not have to rely as heavily on the central bank to help with interest rate moves.

In places like Kalemli-Ozcan's native Turkey, by contrast, the Fed's policy tightening last year contributed to a slide in the Turkish lira that the central bank tried to offset with local rate hikes.

That did little to fix the economy's underlying problems, and it ended in a political crisis as well when the head of the central bank was fired in July.

(Reporting by Howard Schneider; Editing by Paul Simao)

This story has not been edited by Firstpost staff and is generated by auto-feed.

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