Most commentary about the catalyst for these moves has focused on the shift in expectations with respect to U.S. monetary policy – and, in particular, to uncertainty about the timing and implications of Fed tapering. This focus seems generally right to me, although other factors also played a role. From one perspective, the unconventional nature of recent U.S. monetary policy adds little that is fundamentally new to the challenges that face EMEs. These policies simply represent a way of easing that was necessitated by hitting the zero lower bound on the federal funds rate. Central bankers have managed differences across countries in cyclical positions and policy stances many times in the past. This time should not be fundamentally different. But, from another perspective, we have less experience operating with unconventional monetary policy, and this creates more potential uncertainties. These uncertainties put a premium on keen listening skills on our part and clear communication among central bankers as well as between central bankers and market participants. In my view, an important fact is that our large scale asset purchase programs affect the size of term risk premia globally. This new set of monetary policies affects financial asset prices in a different way compared to changes in short-term interest rates, and we should be humble regarding what we claim to understand about this distinction. Looking ahead, it seems likely that markets will remain focused on vulnerabilities that they might have ignored prior to the taper tantrum in 2013.
While raising interest rates is often portrayed as a difficult task for central bankers, in fact, given the events since the onset of the financial crisis, it would be a development to be truly excited about. Raising interest rates would signal that the U.S. economy is finally getting healthier, and that the Fed is getting closer to achieving its dual mandate objectives of maximum employment and price stability. That would be very good news, even if it were to cause a bump or two in financial markets. Global implications of U.S. monetary policy normalization Let me now turn to the implication of U.S. policy normalization for foreign economies. Like other central banks, our monetary policy mandate has a domestic focus. Our monetary policy actions, though, often have global implications that feed back into the U.S. economy and financial markets, and we need to always keep this in mind. For most of us, the market volatility that we saw in the spring and summer of 2013 during the so-called “taper tantrum” still remains fresh in our minds. EME financial markets were hit the hardest, with declines in equity prices, a widening in sovereign debt spreads and a sharp increase in foreign exchange rate volatility. In the U.S., we saw a spike in Treasury yields, with the 10-year rate rising by more than 100 basis points from early May before peaking in early September.