OECD warns of EM bubble as Fed confirms $600 billion QE

Monetary easing in advanced economies may create emerging market bubbles, the Organisation for Economic Development and Cooperation (OECD) has warned, as America’s Federal Reserve embarked on a second round of quantitative easing (QE2) worth $600 billion (£373 billion).

The OECD’s latest Economic Outlook and Requirements for Economic Policy report was released just hours before yesterday’s Fed announcement and ahead of the G20 Summit in Seoul next week.

The OECD warns capital including QE money might flow from developed to emerging markets, which can create asset bubbles and put more pressure on exchange rates.

“Unilateral interventions in foreign exchange markets and the resulting volatility could prompt protectionist responses”

“The recent unilateral interventions in foreign exchange markets and the resulting volatility could prompt protectionist responses,” the OECD says. Instead, the OECD recommends reaching a common understanding on how global imbalances can be reduced.

“Indeed, exchange rate adjustment cannot do the whole job of rebalancing,” the OECD says.

“Structural reforms, such as the strengthening of social safety nets and the development of financial markets in emerging economies, should be employed to reduce their  savings and dependence on financial markets in advanced economies.” (article continues below)

Structural reforms, as the OECD sees it, could include the liberalisation of product markets and the reduction of high taxes in the labour market. Those could help to recover the output losses associated with the crisis and fix public finances.

As in previous reports, the OECD once again highlights that public deficits have reached “unsustainable levels” as countries are dealing with the aftermath of the crisis.

“Simply stabilising debt relative to GDP in most countries will require a historical consolidation effort of anywhere from 6 to 9% of GDP,” says Angel Gurría, the OECD secretary general. “But in fact even more is needed to bring debt back to sustainable levels.”

The imbalances between growth in developing and developed markets have exacerbated tensions in public debt levels and monetary policy. Ultra-loose policy is seen as more damaging  to emerging markets but convenient for the developed world.

OECD economies on average are predicted to grow between 2.5% and 3% this year and between 2% and 2.5% next year.

In contrast, many emerging markets are still growing at a robust rate. While this is likely to continue, it seems inevitable that the overall rate will slow down in line with the rest of the world.

If global economic growth turns out to be weaker than expected, or deflation persists, central banks could delay the normalisation of interest rates.