Question

The impact of the Fed’s tapering and interest rate policies on the risk of sudden capital outflows from emerging market countries.

Answer 1

The task of the Fed is to control monetary policy in the US. It does so through the use of interest rate changes and open market operations. Now if the Fed reduces interest rates then this will reduce the inflow of capital from abroad as countries find it less attractive to invest in the US. This worsens the capital account balance in the country. An increase in the interest rates encourages greater investment within the US. Thus as interest rates are reduced emerging markets invest less in the US. As interest rates are increased, emerging markets increase capital infusion into the US.