Revisiting the Taper Tantrum: A Case for International Monetary Policy Coordination

In the backdrop of the 2007-2008 financial crisis, central banks came to acquire a prominent role in alleviating the immediate and medium term effects of the crisis on the domestic economy. In all systemic countries (US, UK, EU and Japan) central banks were confounded with a slowing economy, rising unemployment and fading market confidence, while fiscal measures proved to be inadequate and unwholesome. Thus, on the monetary front, central banks were forced to take up the mantle and responded both promptly and extensively in the financial markets. Short-term interest rates which were already low, were further lowered to the zero lower bound level, thus exhausting instruments of conventional monetary intervention. Central banks, thereafter, turned to unconventional balance-sheet based monetary policies (UMP) with an aim to depress long-term interest rates that included a combination of large-scale purchases of long-term treasury bills and other private securities, expansive lending programmes, and forward guidance on interest rate policy.

The effects of UMPs however, has been both mixed and varied. While the jury is still out on whether such policies have had any impact on the real economy, growth and aggregate demand, studies have shown that UMPs have been effective in achieving its immediate financial market goals. Specifically, UMPs have been found to have influenced the lowering of long-term bond yields and in restoring monetary policy transmission channels.

The use of UMPs has however, produced significant spillovers effects onto other economies through the capital accounts and exchange rate channels. Increased liquidity and excessive capital flows into emerging markets were reflected though exchange rates appreciations, asset price increases and strengthening of the local currency. Thus, accusations of a new age of ‘currency wars’ and ‘competitive devaluations’ as extreme forms of ‘policy spillovers’ have been levelled against advanced market economies, in recent episodes with renewed vigour.

In this context, I argue that there is an urgent need to rethink our position on monetary policy coordination in the international realm. The scope for coordination as means to achieve optimal global monetary outcomes necessarily entails a more careful and considered discourse on the promises and perils of such coordination. Recent economic literature has been consistently highlighting the gains from monetary policy coordination and it is imperative that central banks study and internalise the negative externalities of their monetary actions. In the paper, I briefly consider both, the impediments to coordination and the mechanism through which coordination could be achieved in the international sphere.

Kanad Bagchi is a research fellow at Max Planck Institute for Comparative Public Law and International Law, Heidelberg and graduated from Oxford University in 2016 (M.Sc. Law and Finance). His areas of interest lie at the intersection of law and monetary policy.

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