Former Chairwoman of the Federal Reserve, Janet Yellen, appeared on the Brookings Institution podcast “Dollar & Sense” to discuss monetary policy, currencies, and manipulation.
On the topic of manipulation, Yellen explained that currency values are controversial in trade discussions, due to the effect that exchange rates have on import and export prices, flows and a country’s trade balance.
Yellen defines currency manipulation as policies (particularly direct intervention in foreign exchange markets) that are deliberately intended to alter currency values to affect a country’s competitive position and its trade flows.
However, the reality is that currency manipulation is still difficult to define, as Yellen states it’s generally agreed that countries should be allowed to use monetary and fiscal policy to achieve domestic policy goals, such as full employment.
Although, it’s due to these shifts in domestic policy that the US was often accused of initiating currency wars. For example, the US was heavily criticised in 2010 by emerging markets of flooding the world with liquidity when they announced the second round of quantitative easing.
Changes in exchange rates can be particularly problematic for countries with debt denominated in US dollars rather than their own currency, as it increases the burden of the debt. It can also have a significant impact on things like the rate of inflation and commodity prices, which could affect monetary policy in foreign countries and impact imports and exports.
Emerging markets were worried that capital outflows from the US into emerging markets could create problems in the future. Yellen, however, was not worried about this, as a strong US economy experiencing strong growth promotes stronger growth throughout the rest of the world.
Emerging markets once again voiced concerns over the Federal Reserve’s policy normalisation, as it would cause capital outflows and depreciation of their currencies. In 2013 we saw the ‘taper tantrum’ when the pace of QE purchases was slowing, leading to US rates rising and huge capital outflows from emerging markets.
The US is not the only country that has been criticised for manipulation. Up until 2015, the Chinese yuan had been pegged to the US dollar. However, since mid 2014 the US dollar began appreciating against a number of currencies and pushed up the value of the yuan. In the summer of 2015, China decided to offset part of that by devaluing its currency, leading to a period of global disruption in the financial markets.
More recently, in 2015 and 2016, Japan has seen problems with deflation and it looked like they would undertake direct intervention to push down the yen, which caused tension with the US.
Listen to the full podcast: