agustin carstens : emerging market economies – challenges and how to move forward speech by mr agustin carstens, governor of the bank of mexico, at the economic club of new york, new york city, 28 march 2014. * * * it is a pleasure and privilege to have the opportunity to address such a distinguished audience, in this venerable fora that is over 100 years old. i thank roger ferguson for having invited me and bill dudley for his kind words of introduction. the topic i would like to develop relates to the challenges that emerging market economies ( emes ) are facing today and in the near future, and at the same time i will attempt to delineate a path on how should they respond and move forward. at the outset i would like to recognize that there is substantial heterogeneity among emes, and by doing this type of grouping i run the risk of making sweeping generalizations that may be unfair to some countries. at the same time, it is undeniable that emes, mexico included, face common challenges derived from our participation and interaction in the global economy. this in fact is recognized by financial markets, which oftentimes consider emes ’ assets as an asset class by itself, opening the possibility of contagion among countries. allow me first to go back a few years to provide appropriate background. it is fair to say that in 2007 – 2008, when the global financial crisis erupted, emes were by and large well prepared. after many countries in this grouping suffered sequential crisis in the seventies, eighties and nineties, with huge economic, social and political costs, we learnt important lessons. these led to the adoption of key policy actions, of which i would like to highlight the following : – the establishment of flexible exchange rate regimes ; – the enhancement of the degree of autonomy of central banks, with primary mandate of price stability. these led to a wide adoption of inflation targeting and probably more important for a number of countries, to the end of fiscal dominance ; – consciousness about the relevance of fiscal discipline and the preservation of public debt sustainability ; – deeper trade liberalization ; – keeping up to speed in financial sector supervision and regulation, which has produced well - capitalized banking systems. the result of this behavior was that most emes did not have any major economic imbalances in 2008. previous to the global financial crisis, emes were not in the radar screen of vulnerable economies. in support of this claim, let me say that in october

central banks, i would say that the main challenge for emes boils down to how to stimulate growth without compromising financial stability, facing at the same time an external environment plagued with uncertainties. the question then is, how to move forward? one option would be to try to engineer some form of international coordinated policy response, bringing on board both emes and advanced economies. but at this stage, this option does not seem to be feasible. as the late anna schwartz used to say : “ international policy coordination is a fair weather phenomena ”. right now we don ’ t have “ fair weather ”, and i am not referring to new york city. since 2008 we have had some policy coordination, mostly among central banks and financial sector authorities, but primarily to tackle specific vulnerabilities in global financial markets. the bottom - line is that emes should take policies in advanced economies as given. the governments of these economies have to deal with their own problems, which are not negligible. if they succeed, the world will be better off. so emes have to find their own way out. in my mind, a three - pillar approach should be followed. first pillar. strong macrofundamentals and policy settings are of the essence. basically there is no room for poor fundamentals. in particular, it is very important for emes to limit financial needs to what is feasible under stress scenarios. this calls for moderate fiscal policies and to use aggregate demand management to avoid large current account deficits. monetary policy should concentrate in keeping inflation under control, since this is a prerequisite for the flexible exchange rate to be able to perform as a shock absorber. the domestic financial markets should be monitored with a hawkeye ; early adoption of the enhanced regulatory regime produced under the auspices of the fsb and the basel committee should be pursed. on macroprudential policies, they might work under specific circumstances, but they are not substitutes for core policy actions. second pillar. external sector resilience under stress scenarios should be a policy objective. this is very important to avoid capital reallocations resulting in bad equilibria in financial markets. so to start with a strong balance of payments is needed. flexibility in interest and exchange rates, anchored by strong fundamentals, should be part of the adjustment process. but, given the sheer size of capital inflows to emes so far, this might not be sufficient. so to count with large international reserves and