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Where will global financial stability go, amid Fed rate hike spillovers?

25 July, 2022
Beijing China
International and Chinese experts joined a CFA Institute and Global Asset Management Forum roundtable to discuss inflation and the Fed's policy objectives, the spillover effect of interest rate hikes, and global financial stability

CFA Institute, the global association of investment management professionals, and the Global Asset Management Forum (GAMF), recently co-hosted a close-door virtual roundtable discussion on "The Impact of Fed Rate Hike and Systemic Financial Risk Prevention". The panel of experts included Lou Jiwei, Chairman of GAMF and former Minister of Finance of China, Hu Xiaolian, former Chairman of the Export-Import Bank of China and former Deputy Governor of the People's Bank of China, Wang Zhaoxing, Counselor of the State Council and former Vice Chairman of the China Banking and Insurance Regulatory Commission, Wang Yiming, Member of the Monetary Policy Committee and former Deputy Director of the Development Research Center of the State Council, Donald Kohn, former Vice Chairman of the Federal Reserve, Simon Johnson, former Chief Economist of the International Monetary Fund and co-chair of the CFA Institute Systemic Risk Council, and Margaret Franklin, President and CEO of CFA Institute. The session was chaired by Zhou Hao, Dean of the Business School of Southern University of Science and Technology, and Chair Professor of the PBC School of Finance of Tsinghua University.

Topics discussed by the panel of experts included:

Global inflation and the pace of Fed rate hikes

  • The Fed has considered setting the inflation target at 3% to 4% from an academic point of view. But, given Congress' requirements for price stability and the American people's aversion to the concept of inflation, the inflation target is set at 2%. However, to achieve a soft landing for the economy, the Fed may extend the time period to achieve this target.

 

  • Given the US dollar’s role as a reserve currency for international trade and finance, it is not enough for the Fed to limit its policy framework to the US. The Fed needs to fully consider global economic and financial stability when implementing its monetary policy.

Spillover effects of Fed rate hikes

  • As developing economies are mainly faced with the pressure of sharp increases in food and energy prices, the policies of these economies need to consider how to control price increases as soon as possible. For developed economies, such as the US and EU, it is necessary to avoid wages and prices from spiraling upward. In mainland China, the price increases are not so serious. At present, there is still room to employ China's independent monetary policy, and the spillover effect of the Fed's rate hikes are generally manageable.

 

  • This round of Fed rate hikes may have a bigger-than-expected impact on emerging markets that lack policy space. Specifically, emerging markets face risks from local currency depreciation, capital outflow, and the sharp rise in the prices of imported food and energy. The Fed rate hikes will exacerbate capital outflows and the risk of debt defaults in emerging markets.

Challenges to global financial stability and suggested recommendations

  • The situation facing global financial stability is very complex, and the challenges are even more severe. There are six characteristics: coexistence of high debt and high inflation, coexistence of high inflation and weak growth, coexistence of high costs and weak demand, supply chain and transport chain disruption, coexistence of weakness in the real economy and price bubbles, and the coexistence of varying economic cycles and the misalignment of different monetary policies. These factors combined, may have a huge impact on financial stability, and may even lead to a serious global financial crisis.

 

  • To further improve policy cooperation of monetary authorities, major economies should enhance forward-looking and transparent monetary policies, and improve the predictability of policies and their impact. For emerging economies, the supervision of capital flows and the monitoring of debt risks should be strengthened. If necessary, effective capital control measures should be implemented to stabilize domestic finance and exchange rates. Monetary authorities should jointly maintain the normal operation of the international financial system. Communication and coordination among monetary authorities of major economies should also be strengthened, along with financial regulatory authorities.

 

  • To help alleviate the risk of debt defaults in emerging markets, international financial organizations and creditors should work together to properly manage the debt-related issues of emerging economies, with, for example, a package of policy measures through international organizations, such as the Financial Stability Board, the Bank for International Settlements, and the Basel Committee on Banking Supervision. International financial organizations can play a role in driving capital to invest in emerging economies.