Must-Read: Steve Cecchetti and Kermit Schoenholtz: Spillovers, Spillbacks and Policy Coordination
Must-Read: The very sharp indeed Steve Cecchetti and Kermit Schoenholtz on how, contrary to the models of the early 1980s–and, I fear, the view of the world still held by the FOMC–U.S. monetary tightening is not expansionary for the rest of the world:
Spillovers, Spillbacks and Policy Coordination: “Reserve Bank of India Governor Raghuram Rajan’s recent plea for increased coordination is merely the latest protest by emerging-market economy (EME) policymakers about the spillovers from advanced-economy (AE) monetary policy…:
…We are still at the early stages of understanding all of this…. Perhaps the real question is whether AE policymakers have underestimated not only the spillovers, but the potential for spillbacks… are insufficiently attentive to the financial stability risks that their policies may cause—not just domestically, but globally…..
The leverage of some intermediaries rises markedly when the accommodation is sustained…. After two years of policy easing… the leverage of the median bank rises from 10.2 to 12.5. For insurance companies, leverage rises from 6.5 to 7.4…. The impact on leverage abroad from an easing of U.S. monetary policy is a multiple of the impact of easing by the home-country central bank! For example, non-U.S. bank leverage jumps from a baseline of 15.8 to 23.6….
The dollar’s position in the global economy is special…. This Global Dollar system… magnifies the impact of changes in Federal Reserve policy on the behavior of intermediaries around the world…. [Global] inancial stability depends on the stability of dollar funding. This, in turn, means that the Federal Reserve has an obligation that other central banks do not have: namely, to prevent a collapse of dollar intermediation globally. In the end, this is very clearly in the U.S. interest because the spillbacks from global financial instability will almost surely be large.