The emerging economies, and especially their stock markets, were leaders after the global economic bottom in 2009. Their stock indexes rose much more than developed economy indexes. Most analysts said those economies would have permanently higher growth rates and that their stock returns would be higher than developed market stocks. All that changed over the last couple of years, and it changed dramatically after Ben Bernanke said in May that the Fed might soon reduce its bond buying.
What happened? One thing that happened is that developed economy central bank monetary stimulus caused a lot of money to flow into emerging economies. It distorted their markets and economies. The mere threat of reducing the stimulus had an immediate effect on those markets. The biggest effect was a major withdrawal of capital by investors from developed markets. Two professors dived into the numbers and came up with this explanation of what happened and why. It makes clear that we have a global economy. Markets and economies are more closely correlated than they have been.
These results provides some intuition for how it was that the same countries could complain about quantitative easing while it was underway – QE had large, disconcerting impacts on local markets – and then also complain about tapering talk. Since their asset prices had been allowed to run up sharply and their current accounts had been allowed to widen relatively dramatically in the earlier period, talk of tapering now had a relatively large negative impact on local markets.
We interpret changes in real exchange rates and current account deficits as picking up the impact – positive, negative or neutral – of macroprudential policy broadly defined. Recall that we control for the stance of fiscal policy (since fiscal tightening can also limit the appreciation of asset prices in a period when capital is flowing in). In addition, we control for the intensity of capital controls in the prior period; these, similarly, do not appear to have exerted a consistently significant impact on the effects of tapering. Nor does their inclusion alter the estimated effect of the change in the real exchange rate.
Evidently, neither capital controls, nor fiscal tightening, nor even a combination of the two, sufficed to dampen the effects of financial inflows. Instead, a broader array of macroprudential policies which moderate the upward pressure on the exchange rate and the widening of the current-account deficit – limits on the rate of growth of bank lending, loan-to-value regulation for the mortgage market, and similar measures – may have made a difference, and may therefore be called for in the future.