A Cautionary History of US Monetary Tightening

It may have had something to do with the near total lack of response of long term interest rates to monetary tightening. If central banks are tightening and long term rates aren t rising, one needs some explanation.

The fourth of the channels, the exchange rate, has already been functioning. The prospect of US monetary tightening coincides with moves by the European Central Bank and the Bank of Japan toward enhanced monetary stimulus.

On rates, it reiterated that some tightening of monetary policy would be needed to cool inflation and by a somewhat greater extent than markets expect.

Yet widespread concerns persist. The International Monetary Fund for example, has argued that any rate hike by the Fed would need an effective monetary policy communication strategy a polite way of saying that any monetary tightening in the US and other advanced economies would be premature.

The price stability mandate has been trumped by concerns about growth. The fear is that tightening monetary policy to bear down on inflation could snuff out the faltering economic recovery.

Duisenberg recognized this linkage and held firm. The ECB s paltry rate hike in December, together with the supine promise of no plans for further monetary tightening, demonstrates that Trichet is no Duisenberg.

For example, some inflation targeting central banks have reacted to increases in prices of imported commodities by tightening monetary policy and thereby increasing the value of the currency. But adverse movements in the terms of trade must be accommodated they cannot be fought with monetary policy.

The Fed will almost certainly start raising rates in December, but monetary tightening will be much slower than in previous economic cycles, and it will be motivated by concerns about financial stability, not inflation. As a result, fears bordering on panic in some emerging markets about the impact of Fed tightening on global economic conditions will probably prove unjustified.

To be sure, a country s domestic economic circumstances, and the tools available to policymakers, should guide policy. And, though monetary tightening may well be advisable in some economies, it might be inappropriate in others.

Will Fed Tightening Choke Emerging Markets?

That brings us to monetary policy, the importance of which as a determinant of commodity prices is often forgotten. Monetary tightening is widely anticipated in the US, with the Federal Reserve having ended quantitative easing in October and likely to raise short term interest rates sometime in the coming year.

Many a recession has been catalyzed or amplified by monetary tightening cycles former US Federal Reserve Chairman Alan Greenspan was christened the maestro in the 1990s, because he managed to slow inflation and maintain strong growth simultaneously. The idea that controlled tightening is easier in a more centrally planned economy, where policymakers must rely on far noisier market signals, is highly questionable.

Meanwhile, given the fragility and interconnectedness of the global economy, tightening monetary policy in the US could have negative impacts abroad (with consequent blowback at home), especially given the instability in China and economic malaise in Europe.

This episode showed that the renminbi is under significant depreciation pressure, which is likely to intensify as the PBOC, amid weak GDP growth, loosens monetary policy (particularly as the US Federal Reserve is gradually tightening its monetary policy). Add to that efforts to liberalize the capital account and internationalize the renminbi, and some exchange rate volatility can be expected.

Yet the IMF imposed even tougher conditions on Asia than it has on Greece, including fiscal austerity, monetary tightening, and financial restructuring. Some of these requirements were clearly unnecessary, as evidenced by Malaysia, which recovered quickly from the crisis without IMF assistance.

If food inflation recedes further, and the headline inflation rate starts to converge on the 3 core (non food) rate, the result will be the equivalent of passive monetary tightening in real (inflation adjusted) terms precisely what the inflation prone Chinese economy needs.

What would most benefit commercial banks is not an immediate increase in interest rates, but a monetary policy that contributes to ensuring that the economy is capable of supporting higher interest rates in the future. If history is any guide, tightening monetary policy in the near term will only lead to further economic turbulence, followed by a rapid retreat to low interest rates.

Between 1993 and 1994, Greenspan once again reined in monetary policy, only to be surprised by the impact that small amounts of tightening could have on the prices of long term assets and companies borrowing costs. Fortunately, he was willing to reverse his decision and cut the tightening cycle short (over the protests of many on the policy setting Federal Open Markets Committee) a move that prevented the US economy from slipping back into recession.

Neither Greenspan nor his successor, Ben Bernanke, understood how fragile the housing market and the financial system had become after a long period of under regulation. These twin mistakes deregulation, followed by misguided monetary policy tightening continue to gnaw at the US economy today.

The models used by all of the forecasting organizations dramatically underestimated the fiscal multiplier the impact of changes in government spending on output. Second, they overestimated the extent to which quantitative easing (QE) by the monetary authorities that is, printing money could counterbalance fiscal tightening.

In China s last protracted bout of deflation, from 1998 to 2002, persistent declines in prices were the result of monetary and fiscal tightening that began in 1993, compounded by the lack of exit mechanisms for failed enterprises. After peaking at 24 in 1994, inflation began to decline in 1995.

The second risk is that, even based on current growth expectations, investors may have gotten ahead of themselves in anticipating monetary policy tightening. The Fed will raise interest rates when it senses that the economy is nearing full capacity and that inflation wage inflation, in particular is accelerating.

But most have suffered from the opposite syndrome excessive reliance on capital inflows, which, by spurring domestic credit and consumption, generate temporary growth. But recipient economies are vulnerable to financial market sentiment and sudden capital flight as happened recently when investors anticipated monetary policy tightening in the United States.

Disappointing first quarter growth data have already led foreign investors to have second thoughts about keeping money in China. A Grexit could prove to be the last straw, and would surely lead to a tightening in domestic monetary conditions at a very precarious point in the economic cycle.

But when and how the Fed will begin tightening monetary policy remains unclear. What is certain is that, in making its decision, the Fed will not consider its policy s spillover effects on the rest of the world, leaving affected countries policymakers and central bankers to deal with the fallout.

Finally, there is a long history of underground lending and borrowing in some of China s east coast region, especially in Wenzhou. Whenever monetary tightening causes bank credit to shrink, small and medium size private enterprises are prepared to borrow at suicidally high interest rates from relatives or loan sharks.

They defied their Lord's messenger, so He seized them with an ever tightening grip.

They defied their Lord's messenger, so He seized them with an ever tightening grip.

Then, between 1988 and 1990, another round of monetary tightening under Alan Greenspan ravaged the balance sheets of the country s savings and loan associations, which were overleveraged, undercapitalized, and already struggling to survive. To prevent the subsequent recession from worsening, the federal government was forced to bail out insolvent institutions.

A leaflet on marine litter, entitled Tightening the noose , was also published recently by UNEP.

So the most important way to control inflation while regaining the monetary and credit policy autonomy needed to control inflation is to allow currencies in these economies to appreciate significantly. Unfortunately, the need for currency appreciation and monetary tightening in overheated emerging markets comes at a time when the housing bust, credit crunch, and high oil prices are leading to a sharp slowdown in advanced economies and outright recession in some of them.

The UN report observes that national economic policies and existing multilateral settings are not designed to mitigate effectively the risk of a global slowdown or to address global imbalances. In Europe and Japan, for example, monetary and fiscal policies have been tightening in response to domestic concerns, further slowing the world economy.

Monetary tightening, administrative measures introduced by various municipal governments to stem the run up in the housing market, and the waning effect of the government s 4 trillion ( 642.3 billion) stimulus package resulted in a gradual economic slowdown. While inflation should have eased in early 2011, rising food prices and commodity prices thwarted expectations.

And now I'm tightening lashes, shaped in hide as if around a ribcage, shaped like five bowstrings.

And they disobeyed the messenger of their Lord, therefor did He grip them with a tightening grip.

And they disobeyed the messenger of their Lord, therefor did He grip them with a tightening grip.

I have believed for some months that the Fed should start tightening monetary policy to reduce the risks of financial instability caused by the behavior of investors and lenders in response to the prolonged period of exceptionally low interest rates since the 2008 financial crisis. Events in China are no reason for further delay.

Whether or not the critics are right, one thing is clear with the Fed lagging other global central banks in the monetary tightening cycle, and with rating agencies contemplating a downgrade of America s credit score, the US dollar s purchasing power has sunk to an all time low against the currencies of America s trading partners.

These policies have raised capital costs, with monetary tightening, in particular, taking a large toll on local governments and real estate developers. Because slower growth forces them to borrow new money to pay their maturing debts, interest rates are bid up, and businesses in the real economy are crowded out, creating a further drag on growth.

This year, the emerging economies are worried about a tightening of global monetary policy, not the policy loosening that three years ago fueled talk of currency wars. As the Fed tapers its purchases of long term assets, including US treasury securities, it is a perfect time for the ECB to step in and buy some itself.

LONDON The US Federal Reserve is almost certain to start raising interest rates when the policy setting Federal Open Markets Committee next meets, on December 16. How worried should businesses, investors, and policymakers around the world be about the end of near zero interest rates and the start of the first monetary tightening cycle since 2004 2008?

Monetary Mystification

We therefore express concern and reject the new measures recently implemented by the US government aimed at tightening the embargo.

There was no incompatibility between tightening controls over the nuclear fuel cycle and expanding the use of peaceful nuclear technology.