PARTICIPANTS
Michael Boskin, David Brady, John Cochrane, Steven Davis, Paul Gregory, Steve Haber, Bob Hall, Nick Hope, Arvind Krishnamurthy, Stephen Langlois, Hanno Lustig, David Mauler, John Raisian, Josh Rauh, Ken Scott, George Shultz, John Taylor, Yevgeniy Teryoshin

ISSUES DISCUSSED
Agustín Carstens, Governor of the Bank of Mexico, presented on the topic “Challenges for Emerging Economies’ Central Banks in the Face of Quantitative Easing in Advanced Economies.”

Carstens first described the challenges that central banks in emerging market economies (EMEs) face due to quantitative easing (QE). He showed how they have had to set the policy rate based on other factors besides the output gap and deviations from the local inflation target. Because of increased financial globalization and international transmission of shocks, policy makers are forced to consider external factors. In effect, EME central banks have had to deviate from traditional Taylor-type rule with a term –such as federal funds rate—accounting for monetary conditions in advanced economies.

Carstens argued that this need to consider external conditions in EME policymaking arises currently from the imminent normalization of global conditions following massive unconventional monetary policy (UMP) in advanced economies. As the UMP unwinds and portfolio rebalancing occurs, EME central banks must ensure a smooth adjustment process and avoid de-anchored inflation expectations associated with overshooting exchange rates and a destabilized nominal system.

Carstens noted a sharp increase in volatility of EME capital flows as a possible unintended consequence of extensive UMP. Massive capital inflows into EMEs caused real exchange rate appreciation and the danger of potential sudden capital flow reversals. Capital flows are particularly problematic given the current lack of liquidity, in part generated by recent financial regulation.

Concluding, Carstens touched on specific actions by the Bank of Mexico in dealing with these challenges.