Emerging Market Volatility: Lessons From The Taper Tantrum (IMF)

October 2014

KEYWORDS: Emerging Markets


Ratna Sahay, Vivek Arora, Thanos Arvanitis, Hamid Faruqee, Papa N'Diaye,
Tommaso Mancini-Griffoli

  • IMF


A surge in volatility overtook global financial markets in the summer of 2013 following the markets’
reassessment of the prospects that the U.S. Federal Reserve would wind down its bond-buying
program and tighten monetary policy. The brunt was felt acutely by emerging markets (EMs). While
changes in advanced-country monetary policy, or even signals of such changes, can reverberate in the
rest of the world, the strength of the markets’ reaction took most by surprise. Asset prices and
currencies tumbled, and questions about the growth prospects of EMs continued to intensify amidst
heightened uncertainty.
The shift in market sentiment vis-à-vis EMs came on the heels of a prolonged period of monetary
easing in advanced economies, which was essential for preventing an even worse outcome at the
start of the global financial crisis (IMF 2013a), and during which emerging economies experienced
large inflows of foreign capital. During 2009–12, EMs received close to half of global flows, and while
inflows were concentrated in eight to 10 large EMs, several small EMs also attracted large volumes
relative to their size. In several cases, the inflows were accompanied by a rapid expansion of credit,
fueling an overheating of domestic economies and setting the conditions for a buildup of
vulnerabilities. This challenged policymaking, with some EMs raising concerns about the unwelcome
side effects of monetary policy in advanced countries. Indeed, a substantial part of the flows could not
be explained by EMs’ economic fundamentals.
The reactions of markets during the summer of 2013 following talks by the Fed about prospects for
gradually unwinding its unconventional monetary policy were unusual both in terms of the size and
breadth of the outflows, although the magnitude of adjustment varied significantly across countries.
Why did markets react the way they did and what are the policy lessons from this episode? This paper
tries to synthesize recent research on this issue.

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