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Parting Shot: Armed resistance

Mar 1, 2013

Battling the effects of quantitative easing is one of the biggest challenges facing emerging markets. But capital controls are no solution, says Chile’s finance minister Felipe Larraín

A lot of the discussion on quantitative easing (QE) has been about the yen, the dollar and the euro. But let’s not forget emerging markets. Economies that are otherwise performing well are suffering the effects. It is hitting Latin America, maybe disproportionately so, because we have floating, market-based rates.

Resisting QE is one of our main challenges. One might argue that appreciation is a good thing, but it puts pressure on the export sector, particularly on agriculture and industry.

As an economy gets wealthier, its exchange rate should appreciate. The rate at which that should occur is the rate that would capture the differences of productivity improvements in the economy. But that is more a long-term phenomenon.

Exchange rates are moving more according to short-term increases in the monetary base. This is what happens when interest rates are at the floor and countries resort to QE.

If one country does QE, other countries with similar issues will follow. I understand the plight of Japan. It suffered an earthquake and an economic downturn and has been stagnant for two decades. But we must remember that QE was never a part of the normal toolkit, at least relative to how much it has now been used.

I’m not being naïve here. I don’t pretend that the US, Japan and Europe will conduct their monetary policy based on the plight of emerging economies. Of course not. But it is one of the main challenges emerging market policymakers are facing today. Our industries are losing competitiveness because of currency appreciation.

Still, all the blame should not be placed only on the economies that are pursuing QE. Other countries lack market based exchange rates. Take China. If you let the Chinese currency float, I have very little doubt what would happen: it would appreciate. However, we are the ones facing appreciation pressures – on the Chilean peso, on the Peruvian sol, on the Colombian peso, on the Mexican peso, on the Brazilian real.

I am skeptical of the effects of additional rounds of QE for the economies pursuing it. It will not solve the fundamental problems: you may think that QE is a good pill to ease your headache, but it won’t get rid of what’s causing the headache.

We know from history what the end result of currency wars is: countries raise tariffs. The incentives for protectionism come from these kinds of policies. They also trigger other measures like capital controls.

The first policy response is to have a responsible, moderate increase in government spending, ideally below the rate of GDP growth. The second is managing government debt. If you have a lot of dollar and foreign currency revenues, if you don’t want to just sell that foreign currency, then you issue government debt locally.

The third approach is central bank intervention. This is beyond the realm of the finance ministries. I talk to the central bank regularly. It is very important that economic authorities coordinate. But we respect their autonomy. They have their policy tools and we have ours.

Another option is macro-prudential measures. We haven’t precluded using them we just haven’t used them so far. Then there are capital controls. A last resort for countries is just plain protectionism.

We have said repeatedly that taxing foreign capital is not an avenue we would like to pursue. We have not considered it yet.

Capital controls mainly change the composition of capital but they don’t stem the absolute flows. They also have some secondary effects and it is highly doubtful that they will have an effect on the exchange rate. Also, people always find ways to circumvent them.

The approach I am taking is a practical one. It is based on research on the effects of capital controls. We have a lot of experience with capital controls in Latin America. You can never say never, but I’m very skeptical about their effects. LF

Felipe Larraín is Chile’s finance minister. He was interviewed by Taimur Ahmad. 

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