Laura Tyson has a nice piece in Project Syndicate this morning about typhoon season for emerging market economies.
With increasing signs the North Atlantic central banks will tighten over the next several years, forward-looking financial markets are incorporating that tightening into their pricing of emerging-market assets today.
This means emerging-market central banks have three options:
So why are there problems? Why isn't this third option--maintaining full but not overfull employment by shifting resources out of interest-sensitive investment and wealth-based consumption-producing sectors and into exports a no-brainer?
The fear for India and elsewhere appears to be the expectations of future nominal currency values vis-à-vis the dollar are not well-anchored. Thus letting the rupee drop now does not restore confidence by making foreign exchange specullators expect the next bounce of the rupee will be upward in value. Rather, it destroys confidence by leading them to expect the unleashing of a domestic exchange-rate inflationary spiral Rakshasha.
The fear is, as Rudy Dornbush used to put it, that India and other emerging markets are right now not North Atlantic but rather South American economies.
I do not envy Raghu Rajan his current job at all…