Fallout from Fed tightening will be worse than 1994, warns ECB policymaker

BRUSSELS — The spillover effects of the U.S. central bank unwinding its policy stimulus risk being greater now than in 1994, and that episode highlights the importance of clearly communicating exit strategies from expansionary policies, an ECB policymaker said.

The Federal Reserve is expected to start slowly reducing its bond purchases when it meets later this month, beginning to unwind a policy that has helped foster recovery in the world’s largest economy and buoyed financial markets.

“In early 1994, when the U.S. recovery gained strength, the Fed started a tightening cycle and bond markets crashed not only in the U.S. but also around the world,” European Central Bank Executive Board member Joerg Asmussen said on Tuesday.

“If spillovers were large in 1994, we can expect them to be even larger today in an even more deeply interconnected world,” he added in the text of a speech for delivery in Brussels.

While economists believe the Fed could still announce a tapering of its monthly bond purchases at its Sept. 17-18 policy meeting, they believe weak jobs growth data increased chances of a delay.

Even if the Fed were to begin reducing its stimulus it would still have a highly expansionary monetary policy with interest rates nailed down near zero.

Two lessons could be drawn from the 1994 episode, Asmussen said: firstly, clarity on central banks’ “reaction functions” — how they respond to shifts in economic data — is crucial, and secondly, inflation expectations must be well-anchored.

Full article: Fallout from Fed tightening will be worse than 1994, warns ECB policymaker (Financial Post)

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