The Challenges Posed by the Withdrawal of the Stimulus in the US

The uncertainties around U.S. economic recovery are forcing our political leaders and authorities to be cautious with financial policy.

Since the end of 2008, the U.S. Federal Reserve has embarked on three massive buying programs of public and private bonds as a way of combating the effects of the financial crisis. Buying public bonds had important implications for the financial markets, with steep drops in interest rates, a global devaluation of the dollar and higher prices of raw materials creating a particularly favorable climate for the economies that export those products.

This climate changed significantly in May of this year, when the president of the Fed stated that, in the case of economic recovery, the Fed would have to normalize the balance, first by softening and then reversing its policy. Higher dollar interest rates in recent months (nearly 150 basis points on a 10-year Treasury bond) reflected the expectation that the Fed’s announced plans would soon come into effect. In the case of emerging markets, against a backdrop of high capital outflows, the impact was particularly negative. Investment funds have withdrawn almost $66 billion since the end of May, equal to 10 percent of the total shares issued. Similarly, the cost of finance in developing countries moved away from the U.S. Treasury interest rate by 75 basis points, shares fell by six percent in local currency, and currencies depreciated by around five percent.

The idea of future deterioration in the external climate surrounding emerging countries was partially reverted last week, after the Fed indefinitely postponed the slowing of bond-buying. This calming message, together with the markets’ expectation of an imminent monetary adjustment, has allowed part of the value lost in emerging countries’ shares to be recovered, including those that are traded on the Chilean Stock Exchange. Strong market fluctuations and predicted changes in the course of U.S. monetary policy, however, confirm that this policy is of great importance in shaping the external climate for emerging economies, such as that of Chile.

Though the precise date of the withdrawal of monetary stimulus in the U.S. is uncertain, the consolidation of its economic recovery makes it very probable that monetary stimulus will soon come to an end. This prospect, positive for the United States and therefore the global economy, but challenging for the Chilean economy, requires our authorities and political leaders to have a cautious attitude in their proposals and policies. In particular, the government must lead the effort in moderating local expectations that cling to an unduly optimistic future climate, meaning that all pressure to spend excessively in the 2014 budget must be controlled. For their part, the ongoing presidential campaigns must take all the uncertainties in the external climate into account, being careful not to promise resources in excess of what is reasonably affordable in a difficult period like the one predicted.