The Fed risks a substantial policy mistake if, as markets
expect, it begins to
taper its asset-purchase programme in September, warns
Carmen Reinhart economics professor at Harvard and
one of the worlds leading experts on debt cycles
citing the stubborn disrepair of US household and fiscal
balance sheets, and headwinds to growth.
|Carmen Reinhart, economics professor
Minutes from the Feds meeting in July showed broad
support for the winding down of its $85 billion of monthly
asset purchases, first signalled by
Fed chairman Ben Bernanke in May, while the US unemployment
rate fell to 7.4% in July, the lowest level since December
In an interview with Euromoney, Reinhart warns: We
still have a great degree of deleveraging to endure in the US,
and the issues around the world, particularly in Europe, are
far from resolved.
Asked about the relative emphasis of employment versus price
stability in the Feds dual mandate, Reinhart says these
objectives were nowhere near conflict. At
some point the Feds policy mandate will force it to
consider a trade-off but I dont see that yet, she
says. Cyclically right now, where is the
The faster-than-expected tapering timetable has re-priced
global risk premia with the benchmark 10-year Treasury
note nearing 3% in recent trades triggering outflows
from fixed-income funds, with emerging market (EM) currencies,
local credit and equities also bearing the brunt.
Earlier this year,
dovish sell-side analysts told Euromoney they expected to
see a steady steepening of the US yield curve, with the 10-year
note hitting 2.9% to 3.0% by end of 2014, based on an
improvement in the US unemployment rate to below 6.5%.
Reinhart says the prospect of tightening US liquidity
conditions poses a debt-sustainability challenge. The Fed
probably signalled more to the markets than it intended [in
recent meetings], she says. The communication was
Right now, a withdrawal of stimulus would be
premature. Where you have weak inflation and poor unemployment,
even though we have seen better economic news recently, you
have a tepid recovery.
And in the area where the Fed has chosen to help, such
as the housing, there has been a bit of a recovery but the Case-Shiller index [a benchmark gauge for
US house prices] is still below its peak, so we are not there
in terms of recovery.
Asked whether the Fed should take into account the prospect
financial bubbles, triggered by its loose stance, in its
policy calculations, Reinhart says there is no precedent of the
US central bank conceiving of its mandate outside the
objectives of employment and price stability.
Because of the recent crisis, people are
understandably more bubble-conscious than before, she
says. There is a consensus that the Fed should continue
to focus on growth and employment as its target, and it does
not have a history of pricking bubbles. I dont see why
this should be changed.
Janet Yellen, and Larry Summers, a veteran economist, have
emerged as the leading contenders for leadership of the Fed
when Bernankes term comes to an end on January 31,
Asked to comment on the leadership debate, Reinhart says:
They are both highly qualified people. I dont think
we are going to see the same kind of need to respond to crises
like we did in 2008, where there was a re-awakening of the idea
that developed markets, not just emerging markets, could
Reinhart co-author with Kenneth Rogoff, former IMF
chief economist, of an influential and contentious paper that
concluded a public debt-to-GDP ratio over 90% is historically
correlated with slowing long-term growth adds: The
ideal qualities would be someone who is open to the idea of
helping the deleveraging process.
The Fed has been doing fiscal policy a role
that it did not pursue before the crisis. We dont need
anyone to reinvent the wheel we just need the Fed chair
to think creatively on policy tools that deal with deleveraging
and other issues such as reserve requirements.
Asked about the
impact of tighter US monetary conditions on EMs, Reinhart -
whose work on the impact of credit-flow bonanzas on EMs is
influential in policy circles says: Emerging
markets enjoyed a raft of global factors that now are very hard
to replicate: low interest rates and high commodity prices,
tied to the strength of
This nurtured a mistaken view that emerging markets
had entered a brave new world.
She sounded the alarm on elevated real-estate valuations in
many EMs, Chinas disorderly shift to a
consumption-driven model, which threatens commodity exporters,
the prospect of continued outflows from EMs with deteriorating
current accounts, and the fact that, from Hong Kong to
Brazil, credit growth has vastly outpaced nominal GDP
expansion since 2008.
Reinhart adds: During boom cycles, there is always
some form of indiscriminate lending. You dont need
foreign debt to create a banking crisis just take a look