For instance, it is estimated that about two‐thirds of the outstanding stock of 10‐year treasuries is in private hands.6 It would not be surprising that those private bondholders would become wary of the possible price impact of a reduced demand for these assets by the Fed, and decide to anticipate this move. Dealing with such a situation would be challenging for any authority. In sum, the baseline scenario is one of a gradual reversal with some temporary financial turbulence taking place as markets take notice of the new policy stance. However, a tail event of heightened and persistent financial volatility cannot be written off. Although there is some research estimating the impact of the implementation of QE on key interest rates in the US, it is likely that the impact of the removal of QE will not be the flipside image of its implementation. Let me turn now to the last determinant of the impact of a reversal: what countries do in the meantime. Recent events have shown us that even a gradual normalization of global monetary conditions may not be welcome news for all countries. For various reasons, these conditions have bred more vulnerability in some countries than in others. Those countries that have been running large current‐account deficits, where these deficits have been financed mainly with debt, where fiscal positions are weak, and where capital inflows have bred large expansions in credit, may have already become too dependent on abundant and cheap international funding.
Nonetheless, identifying the role of pull versus push factors poses problems akin to those of separating supply and demand. There is still room for research that finds clever identification strategies to settle this question. Under most conditions, a situation of abundant capital inflows and low global interest rates is good for developing countries. Theory tells us that, in the absence of frictions, international capital flows not only contribute to expand a country’s productive capacity, but also allow their citizens to share risk with the rest of the world. However, the presence of pecuniary externalities, of inefficient fluctuations in credit standards, or of other types of financial frictions may lead to perverse situations where these inflows result in excessive credit growth, risk taking, or misallocation of capital. An important amount of recent research has been devoted to understanding how an economy may borrow in excess and miss‐allocate credit.3 Of course, if we believe that these frictions are present and strong, first‐best policy actions should aim to undo them. But this may not be feasible, either because we are unsure about the presence, type, or magnitude of the frictions involved, or because first best policies cannot be implemented in the timeframe required. In such a situation, policymakers may have to resort to second best policies. We will address some of the roles of financial frictions in the transmission of foreign shocks in the presentation by Javier García‐Cicco this afternoon.