The well-known Mundell-Fleming "trilemma" states that it is
not possible to have all three of the following things: free
capital mobility, a fixed exchange rate, and the ability to
pursue an independent monetary policy. The trilemma does not
say that a flexible exchange rate will always fully insulate
domestic economic conditions from external shocks.1 And,
indeed, that is not the case. We have seen that integration of
global capital markets can make for difficult trade-offs for
some economies, whether they have fixed or floating exchange
Since the Fed is the central bank of the world's largest
economy and issuer of the world's most widely used reserve
currency, it is to be expected that the Fed's policy actions
will spill over to other economies. Changes in US interest
rates after Fed policy actions lead to corresponding changes in
the value of the dollar. And because of the dollar's widespread
use around the world, these changes in the dollar affect
financial conditions abroad. Fed policy-related movements in US
bond yields also tend to spill over to bond yields abroad. Such
spillovers are to be expected in a world of highly integrated
financial markets.2 Bond yields and equity prices
around the world typically move together fairly closely.
But the influence of US monetary policy on global financial
conditions should not be overstated. The Federal Reserve is not
the only central bank whose actions affect global financial
markets. In fact, the United States is the recipient as well as
the originator of monetary policy spillovers. For example,
changes in German yields after European Central Bank policy
decisions also pass through to US yields.3 More
broadly, it is notable that although the Fed has raised its
target interest rate six times since December 2015 and has
begun to shrink its balance sheet, overall US domestic
financial conditions have gotten looser, in part due to
improving global conditions and central bank policy abroad.
Much of the discussion of the spillovers of US monetary
policy focuses on their effects on financial conditions in
emerging market economies (EMEs). Some observers have
attributed the movements in international capital flowing to
EMEs since the Global Financial Crisis primarily to monetary
stimulus by the Fed and other advanced-economy central
banks.4 The data do not seem to me to fit this
narrative particularly well. Capital flows to EMEs were already
very strong before the Global Financial Crisis, when the
federal funds rate was comparatively high. The subsequent surge
in capital flows in 2009, as the crisis was abating, largely
reflects a rebound from the capital flow interruption during
the crisis itself, though highly accommodative monetary
policies in advanced economies doubtless also played a role.
Moreover, capital flows to EMEs started to ease after 2011, a
period when the Federal Reserve continued to add accommodation
and reduce yields through increases in its balance sheet. And,
more recently, capital flows to EMEs have picked up again
despite the fact that the Fed has been removing accommodation
If US monetary policy is not the major determinant, what
other factors have been driving EME capital flows? One
prominent factor has been growth differentials between EMEs and
advanced economies. Capital inflows to EMEs picked up
post-crisis, in line with the widening of this growth
differential, while the slowdown in inflows after 2011
coincides with its narrowing. Another related determinant has
been commodity prices. The pickup in both global growth and
commodity prices over the past couple of years explains a good
part of the recent recovery of capital flows to
Monetary stimulus by the Fed and other advanced-economy
central banks played a relatively limited role in the surge of
capital flows to EMEs in recent years. There is good reason to
think that the normalisation of monetary policies in advanced
economies should continue to prove manageable for EMEs. Fed
policy normalisation has proceeded without disruption to
financial markets, and market participants' expectations for
policy seem reasonably well aligned with policymakers'
expectations in the Summary of Economic Projections, suggesting
that markets should not be surprised by our actions if the
economy evolves in line with expectations.
It also bears emphasising that the EMEs themselves have made
considerable progress in reducing vulnerabilities since the
crisis-prone 1980s and 1990s. Many EMEs have substantially
improved their fiscal and monetary policy frameworks while
adopting more flexible exchange rates, a policy that recent
research shows provides better insulation from external
financial shocks.6 Corporate debt at risk –
the debt of firms with limited debt service capacity –
has been rising in EMEs7. But this rise has been
relatively limited outside of China and has begun to reverse as
stronger global growth has pushed up earnings.
All that said, I do not dismiss the prospective risks
emanating from global policy normalisation. Some investors and
institutions may not be well positioned for a rise in interest
rates, even one that markets broadly anticipate. And, of
course, future economic conditions may surprise us, as they
Moreover, the linkages among monetary policy, asset prices,
and the mood of global financial markets are not fully
understood. Some observers have argued that US monetary policy
also influences capital flows through its effects on global
risk sentiment, with looser policy leading to more positive
sentiment in markets and tighter policy depressing
sentiment.8 While those channels may well operate,
research at both the Fed and the IMF suggests that actions by
major central banks account for only a relatively small
fraction of global financial volatility and capital flow
Nevertheless, risk sentiment will bear close watching as
normalisation proceeds around the world. What can the Federal
Reserve do to foster continued financial stability and economic
growth as normalization proceeds? We will communicate our
policy strategy as clearly and transparently as possible to
help align expectations and avoid market disruptions. And we
will continue to help build resilience in the financial system
and support global efforts to do the same.
This article has been adapted from a speech given by
Chairman Jerome H Powell at "Challenges for Monetary Policy and
the GFSN in an Evolving Global Economy" Eighth High-Level
Conference on the International Monetary System sponsored by
the International Monetary Fund and Swiss National Bank,
Zurich, Switzerland, May 08 2018. The full and original text
with accompanying data can be freely accessed at
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presented at "Eighteenth Jacques Polak Annual Research
Conference: The Global Financial Cycle," sponsored by the
International Monetary Fund, Washington, November 2-3.
Ahmed, Shaghil, and Andrei Zlate (2014). "Capital Flows to
Emerging Market Economies: A Brave New World?" Journal of
International Money and Finance, vol. 48 (November), pp.
Bems, Rudolfs, Luis Catao, Zsoka Koczan, Weicheng Lian, and
Marcos Poplawski-Ribeiro (2016). "Understanding the Slowdown in
Capital Flows to Emerging Markets," chapter 2 in World Economic
Outlook: Too Slow for Too Long. Washington: International
Monetary Fund, April, pp. 63-99.
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(2017). "Taper Tantrums: QE, Its Aftermath, and Emerging Market
Capital Flows," NBER Working Paper Series 23474. Cambridge,
Mass.: National Bureau of Economic Research, June.
Clark, John, Nathan Converse, Brahima Coulibaly, and Steve
Kamin (2016). "Emerging Market Capital Flows and U.S. Monetary
Policy," IFDP Notes. Washington: Board of Governors of the
Federal Reserve System, October 18.
Curcuru, Stephanie, Michiel De Pooter, and George Eckerd
(2018). "Measuring Monetary Policy Spillovers between U.S. and
German Bond Yields (PDF)," International Finance Discussion
Papers 1226. Washington: Board of Governors of the Federal
Reserve System, April.
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Road Ahead," chapter 1 in Global Financial Stability Report: A
Bumpy Road Ahead. Washington: IMF, April, pp. 1-55.
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- See, for example, Klein and Shambaugh (2013) and
- See, for example, Adrian and others (2017) and the
IMF's most recent Global Financial Stability Report (2018)
for discussion of the transmission of global risk shocks to
domestic macroeconomic conditions.
- Curcuru, De Pooter, and Eckerd (2018) find that about
half of the movement in German bund yields in a window
following ECB monetary policy announcements spills over to
U.S. Treasury yields, roughly the same magnitude as the
spillover of movements in U.S Treasury yields to German
bund yields following Federal Reserve policy
- See, for example, Wheatley and Garnham (2010) and Rajan
- Studies looking at the determinants of EME capital
flows include Chari and others (2017), Clark and others
(2016), Bems and others (2016), Koepke (2015), Ahmed and
Zlate (2014), Fratzscher (2012), and Ghosh and others
(2012). These papers generally conclude that many factors,
including both "pull" and "push," affect EME capital
- See, for example, Obstfeld, Ostry, and Qureshi (2017).
The results in IMF (2017) also indicate that while global
financial conditions explain a significant portion of
countries' domestic financial conditions, domestic monetary
policy changes also play an important role in economies
with flexible exchange rates.
- The interest coverage ratio (ICR) is the ratio of
earnings before interest, tax, depreciation, and
amortization to interest expense. A value of 2 or less is
typically associated with an increased likelihood of
distress. For example, just before the Asian financial
crisis, firms in Korea, Thailand, and Indonesia had an
average ICR of 2; see Pomerleano (1998).
- For more on evolution of EME debt at risk and
vulnerabilities, see Powell (2017).
- Rey (2015); Miranda-Agrippino and Rey (2015).
- For example, Londono and Wilson (2018) find that U.S.
monetary policy variables account for only roughly 10
percent of the six-month ahead forecast error variance of
the VIX. In fact, in their study, non-U.S. global factors
(non-U.S industrial production, a global Economic Policy
Uncertainty Index, and the expected probability of
recessions outside of the United States) explain nearly as
much of the VIX forecast error variance as U.S. monetary
policy and other U.S. variables combined. In addition,
Cerutti, Claessens, and Rose (2017) find that directly
observed variables in "center" countries (including
VIX), as well as unobserved common dynamic factors
extracted from actual capital flows, together rarely
explain more than one-fourth of the variation in most types
of capital flows.