Former Federal Reserve Vice Chairman Donald Kohn said officials in emerging market nations are correct in voicing apprehension about the flow of capital into their economies.
“Emerging market economies are right to be concerned about the use and the character of these inflows and what will happen when they’re reversed,” Kohn said today during a panel at the Brookings Institution in Washington.
Emerging market nations, while leading the world out of the worst recession in six decades, have complained that near-zero borrowing costs and monetary easing in advanced nations are channeling capital to their higher-yielding markets, threatening to spur asset bubbles.
Nations have adopted different ways to manage the risk, with South Korea embracing a tax on foreigners’ investments in its bonds and Indonesia favoring a lock-up period for overseas purchases of bills. India has raised its policy rates six times this year.
“The U.S. in the 2000s is a good example of what you shouldn’t do with inflows of capital,” Kohn said. The capital funded “unsustainable credit” while fueling a rise in consumption and in residential construction. It also “financed the build-up of debt in the government sector so we didn’t have as much space to move when the crisis came,” he said.
Kohn said the Fed’s decision last month to buy $600 billion in Treasury securities didn’t mean the central bank intends to benefit the U.S. at the expense of other countries through favorable exchange rates. The Fed asset-purchase plan is designed to keep interest rates low and spur growth, causing some concern that capital will flow into other countries’ economies.
“There was no intention just to shift our problem to the rest of the world,” Kohn said. “The intention was to get a stronger U.S. economy through a number of channels.”
Kohn, 68, retired Sept. 1 after serving as the top monetary policy strategist for former Fed Chairman Alan Greenspan and as Chairman Ben S. Bernanke’s chief lieutenant, guiding central bank efforts to stem the financial crisis, including unprecedented emergency credit programs.
Kohn joined the Brookings Institution, a research organization, as a senior fellow after leaving the Fed.
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