To be sure, progress has not been uniform across EMEs, and more work remains in some countries to further strengthen institutional structures. Vulnerabilities remain in several important EMEs, and some have been hit by a sharp adverse turn in their terms of trade due to the recent fall in global commodity prices. Still, the fundamental improvements I’ve cited leave many EMEs better positioned than in the past to weather those times in the cycle when the external environment turns more challenging. Second, during previous Fed tightening cycles EME economic performance has generally been good. During the last three U.S. tightening cycles, EME industrial production growth has been between 7½ and 10 percent over the 12-months from the start of Fed tightening, while EME export volumes have risen 10 to 15 percent. The likely explanation for this favorable record is that Fed tightening generally occurs during periods of strong U.S. economic performance. Recent research from the IMF bears out this hypothesis, finding that higher U.S. interest rates associated with stronger U.S. growth represent a net positive for EMEs. 1 Financial performance of EMEs has been more diverse across Fed policy cycles. The strongest contrast is between the tightening cycle that began in 2004, and the one beginning a decade earlier, in 1994. EME asset prices strengthened considerably during the 2004 cycle, but weakened considerably during the earlier cycle.
Relatively quickly, however, market pressures turned more focused, tightening more severely for countries with clear fundamental vulnerabilities: large current account deficits, a heavy reliance on portfolio inflows and high inflation rates. Markets then responded favorably as EME authorities shifted toward clearer, more consistent policies focused on inflation objectives and external sustainability, and away from policies with conflicting and sometimes competing objectives. A smooth adjustment to Fed normalization this cycle will be more likely if market participants retain this discriminating perspective. None of this is to suggest that the road ahead will necessarily be an easy one. Market participants may focus on vulnerabilities that they might have ignored prior to the taper  1  See “Spillovers from Unwinding Monetary Support in Advanced Economies,” 2014 Spillover Report, Chapter 2. See also, “On the Receiving End: External Financial Conditions and Emerging Market Growth Before, During and After the Global Financial Crisis,” World Economic Outlook, April 2013, Chapter 4. BIS central bankers’ speeches  5  tantrum in 2013, placing an added premium on strong fundamentals, policy coherence and predictability. There will likely be no one right answer for EMEs in managing the trade-offs that come with the changed environment, and the adjustment could sometimes be difficult. With respect to these risks, central banks in general, and the Fed in particular, play an important role. We seek to be good global stewards. As you know, we’ve taken a number of steps to increase transparency and to improve the clarity of our communications.