U.S. Monetary Policy and Its Effects on Latin America

IMF Blog, January 16, 2014

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The Fed’s stance remains "still-loose" because "U.S. inflation is too low, the output gap too large, and the labor market too weak."
Even during tapering, "the Fed’s stance will remain highly loose."
The "10-year Treasury rate, adjusted for core inflation, is about 230 basis points below its 30-year average" and the "inflation-adjusted Fed funds rate is 320 basis points below."
These rates "are likely to remain below their 30-year average for at least the next two to three years."

Loose U.S. monetary conditions have tangible benefits:
- "A stance that supports growth and financial stability in the world’s largest economy is good for the region" given links to the United States.
- Continued U.S. growth is "positive for commodities demand, both directly from the U.S. and via other countries that benefit from U.S. growth."
International financing conditions for Latin America remain favorable: "the average yield on sovereign debt is still about 250 basis points below its 16-year average."
Favorable conditions have enabled governments and businesses to refinance liabilities, finance infrastructure and other investment at historically low rates, and allowed several countries to issue for the first time in international markets.
Risks: the normalization of U.S. monetary policy "will be complicated and volatile" (volatility since May 2013).

"Continue to take advantage of loose financial conditions by refinancing debt at low rates and increasing maturities," while "avoiding a significant expansion of domestic spending fueled by cheap credit."
"Start adjusting for the exit," which "might entail rising long-term dollar interest rates, weakening regional currencies, lower flows of capital to the region (and in some cases, maybe outflows), with pressure in local financial markets."
- These changes will "increase debt service and tighten financing costs, thus affecting investment and growth."
- The adjustment "might not unfold smoothly—we might see big swings in markets."
To prepare for volatility:
- "Make sure that banks, governments, businesses and households have solid balance sheets."
- "Strengthen liquidity conditions in local markets" in light of "some signs of illiquidity in local currency bond markets" and "asset price volatility" observed during stress episodes.
Use buffers prudently: "the exit process will take time, it is important to use buffers wisely and keep one’s powder dry."

Countries with weaker macroeconomic fundamentals "tend to see more abrupt changes in capital flows and asset prices."
Since 2009 the region has experienced "a relaxation in fiscal policy, widening current account deficits and slowing growth," increasing vulnerability during tighter external conditions.
Positive developments relative to the past:
- "Policies are better, banks are stronger, buffers are larger, the region is not excessively dependent on portfolio inflows, and the generalized adoption of flexible exchange rates makes a huge difference."
- More than two-thirds of inflows have been accumulated as international reserves by central banks or as external assets by the private sector.
- During 2009-12, "central banks in the region increased their reserve holdings by $304 billion and the private sector accumulated $266 billion in foreign assets (FDI and portfolio assets)."
The task: "making sure that this resilience is sufficient to handle a lot of volatility, and sufficient across a range of countries."

While the exit may be "a bumpy ride," Latin America is "better prepared than 10 or 20 years ago."
The author argues that the Fed’s tapering and eventual normalization of interest rates should be welcomed because they signal an improving U.S. economic outlook, which "will be good news for Latin America" and "a step down the road toward putting the global financial crisis behind us once and for all."

Source: Alejandro Werner, January 16, 2014 — U.S. Monetary Policy and Its Effects on Latin America

Implicações da política monetária dos EUA para América Latina
- Implicações da política monetária dos EUA para América Latina (Markdown version)
- Implicações da política monetária dos EUA para América Latina (PDF)