What Yellen Didn’t Say

In her first major speech on monetary policy since taking the helm at the U.S. Federal Reserve in February, Janet Yellen said that she’ll be watching the labor market and inflation and keeping an eye out for any other surprises that might derail the U.S. economic recovery as she considers how long to keep interest rates close to zero.

Yellen’s focus on unemployment and inflation comes as no surprise, but she also highlighted the need to keep tabs on other economic factors that might not be reflected in those numbers.

“Because the course of the economy is uncertain, monetary policymakers need to carefully watch for signs that it is diverging from the baseline outlook,” Yellen said in a speech Wednesday at the Economic Club of New York.

Yellen said that she assumed in her “baseline outlook” that it would take two more years to close the gap between the current unemployment rate of 6.7 percent and the Fed’s target of 5.2 to 5.6 percent. But she also said that the real picture of the labor market could be even more dire because those numbers might not reflect all the people who can’t find enough work or who have given up looking. “The share of the workforce that is working part time but would prefer to work full time remains quite high by historical standards,” she said.

But one thing Yellen didn’t mention: the effects her actions might have on other countries.

Central bankers are not charged with running the global economy, only their domestic spheres, but a growing number of leaders of smaller economies are arguing that developed countries should pay more attention to the international consequences of their policy decisions.

India’s central bank governor, Raghuram Rajan, said that large countries should “become more sensitive to spillovers” of their policies, at a speech last week at the Brookings Institution.

At issue is the Fed’s decision to “taper” its stimulus program for the U.S. economy, which has had adverse effects on emerging markets around the world. To spur the sluggish U.S. economy after the financial crisis, the Fed started buying bonds from banks, effectively pushing money into the U.S. financial system to hold down borrowing costs and to try to get banks to lend and, in turn, businesses and individuals to spend. But the money didn’t all stay inside American borders. Because U.S. interest rates were low and the economy hadn’t yet recovered, people looked for investments overseas that would return more money for each dollar they put in.

“This money was chasing returns all over the place, including in countries like Brazil,” Alexandre Tombini, Brazil’s central bank chief, said Friday at a lunch hosted by Foreign Policy. This made emerging market economies suddenly much more attractive because they were growing and because the riskier investments came with higher returns. “At that time we were, sort of, arguing for the source countries to also take measures to make sure that this liquidity was serving their own jurisdictions not sort of spilling over into the rest of the world.” Some countries were wary of the money flowing from the United States into their smaller economies because it pushed up the value of their currencies and made it cheaper to borrow money, which can create bubbles and encourage companies, and countries, to take on more debt than they can afford.

In January, the Fed started scaling back its purchases of bonds, which is expected to take until October. When former Fed Chairman Ben Bernanke announced the move last summer, he caused the tide to shift. People saw the U.S. as a better place to invest again because they anticipated that interest rates would soon rise. Investors moving their money out of smaller countries in order to shift it to the U.S. caused problems for smaller economies across the globe, from Turkey to Indonesia. Brazil, for instance, has been struggling with slow growth and high inflation that has pushed the price of staples like tomatoes so high that restaurants are dropping dishes that contain the expensive fruit from their menus. Though some economists argue domestic policies within these countries are at least partly to blame, the shift has prompted criticism of the U.S. Fed.

“When the advanced economies were really at the depth of the crisis, it was the emerging markets that helped stabilize, that helped create some balance to the global outlook,” South African central bank Governor Gill Marcus told Bloomberg in February. “The challenge here is if the advanced economies say OK, you are on your own, the scale of the emerging markets is such that it’s going to impact on this fragile recovery.”

But it’s not just the “tapering” that emerging markets have to worry about. Once the Fed has stopped the bond-buying program, it will at some point start raising interest rates. All eyes are on when that might happen because it could spur more people to move their money back to the United States, further exacerbating the problems of weaker economies.

“Once the Fed starts tightening policy that will perhaps trigger a second temper tantrum like we saw last year,” said TD Securities analyst Millan Mulraine, referring to the nickname that observers gave to this market phenomenon. Investors’ change of heart about emerging markets after Bernanke’s announcement that the Fed would start tapering off the bond-buying program was later dubbed a “taper tantrum.”

Analysts expect the first possible interest rate hike to come in mid-2015, but Yellen emphasized that the Fed’s plan would have to respond to changing circumstances, including any signs the U.S. economic recovery is faltering.

“A vital aspect of effective monetary policymaking,” she said, is to “monitor the economy for signs that events are unfolding in a materially different manner than expected and adjust policy in response in a systematic manner,” Yellen said.

That may be the silver lining for emerging markets — the decision to raise rates will be dependent on an improving domestic economy and that could be good for everyone.

“The U.S. economy ultimately will be a driver for the rest of the world,” said Mulraine.