Turmoil in US Financial Market Roils East Asia — World Bank

The task of macroeconomic management in this environment will not be an easy one, although policy- makers in most East Asian countries will be able to confront the problems from a relatively strong position.

Current account surpluses and large foreign reserves provide a buffer that will enable economies to accommodate volatility in international capital flows without forcing the kinds of sudden large adjustments in domestic demand that became inevitable during the 1997–98 financial crises. Fiscal positions generally also have become stronger over recent years, creating the scope for more stimulative fiscal policies should an unexpected fall-off in private sector domestic make them desirable.

The role of monetary policy is likely to be especially challenging. In principle, the rise in headline inflation caused by higher international commodity prices should be temporary, reflecting a change in relative prices that, by itself, does not call for action by the central bank. However, monetary policy will need to remain vigilant to ensure that the rise in fuel, food, and other commodity prices does not set off an inflationary spiral leading to rising core inflation rates, especially in economies already showing signs of domestic over-heating and excessively rapid credit growth. Continued movements toward greater exchange rate flexibility will provide countries greater flexibility in using monetary policies to meet inflation challenges.

Countries also face difficult challenges in addressing the harmful distributional effects of higher food and fuel prices on the living standards of the poor. Well-targeted cash transfer schemes may be helpful, although they need to be considered within the context of the country’s overall fiscal position.