It is interesting to read an article [1] titled “What Happened to the Great Divergence” by Lael Brainard, a member of Board of Governors of the Federal Reserve System. The article was written in February 2016, several weeks before the March FOMC policy meeting. The author argued that there appeared to be less monetary policy divergences between major economies than originally thought by most people.
I appreciate his suggestion that there are limits in policy divergences on condition basis and on reality basis. First the underlying economic conditions, specific the inflation and inflation expectation in the major economies, including the U. S., European and Japan, are more or less similar, they are all soft and below their targets. However, they see great differences in closing resource gaps, with euro zone having significant resource slacks compared with the U. S. and Japan.
Second, realistically, the benefits of the monetary policy divergences are damped by “rapid and strong transmission of foreign shocks across borders”. This was true when the Fed decided to raise the interest rate for the first time in a decade in December 2015, the currencies in the emerging markets were weakened significantly and the large capitals were moved away from those countries. The strength of the U. S. dollar actually pressured exports from the U. S. and the profitability of the cross border corporations in the U. S. The global economic slowdown and the financial market drop-down in early 2016 eventfully forced the Fed to deviate from the course of monetary policy normalization that many people predicted in December 2015.
I think monetary policy divergences will stay and be extended. The differences will be distinguished not by tightening from the Fed, rather as I pointed out in my last note [2], by forcing “some of the central banks, such as the ECB and the Bank of Japan, to reduce interest rates deeper into negative”.
References:
[1] What happened to the great divergence, remark by Lael Brainard, at “2016 Monetary Policy Forum”, February 2016.
[2] Kevin economy note on March 17, 2016.