As we consider the decision of policy rate normalization, we are mindful of possible spillovers to other economies, including emerging market and developing economies. In an interconnected world, fulfilling the Federal Reserve's objectives under its dual mandate requires that we pay close attention to how our own actions affect other countries and how developments abroad, in turn, spill back into U.S. economic conditions.

...
In order to minimize the likelihood of surprises and thus avoid creating unnecessary market and policy volatility, we are striving to communicate our policy strategy clearly and transparently. Beyond communicating our intentions, we also emphasize that monetary policy normalization in the United States will occur in the context of a strengthening U.S. economy, which should benefit the emerging market and developing economies.

Still, one feature of the era after the first increase of the federal funds rate will, in all likelihood, be higher U.S. and global interest rates compared with their extraordinarily low levels of recent years. The increase in global interest rates could cause investors to adjust their portfolios, triggering capital outflows from emerging market and developing economies.

...
Once we begin to remove policy accommodation, the Committee's assessment is that economic conditions will likely warrant raising the federal funds rate only gradually. Thus, we expect that the target federal funds rate will remain for some time below levels viewed as normal in the longer run. But that is only a forecast, and monetary policy will, in practice, be determined by the data--primarily data on inflation and unemployment.

I expect the financial system to continue to involve a mix of capital markets and institutions, but with a wider array of institutions falling under regulatory supervision. Furthermore, I take it as given that there will continue to be large international institutions with operations in many countries, that is to say, regulatory jurisdictions around the globe.

Looking ahead, I see an ongoing role for securitization and the originate-to-distribute model. Securitization markets have shrunk dramatically over the last year and a half and in some cases have shut down altogether. I expect these markets to return, perhaps in simpler form and with more accountability.

Recent analysis of the size and sources of spillovers between the United States, the euro area, Japan, and other industrial countries finds a central role for international trade. But spillovers also occur through commodity prices and through financial variables such as short- and long-term interest rates and equity prices.⁷ For example, when liquidity conditions tighten in one country, globally active banks may attempt to pull liquidity from overseas affiliates, reducing the liquidity consequences at home but simultaneously transmitting the shock abroad.⁸ What is particularly interesting is that in some cases, financial linkages might now be more important for transmission than the traditional trade linkages. 

China has officially recognized the need to increase its domestic spending and scale back its reliance on exports.  Measures that could help achieve these goals include further reforms of the financial sector; increased government spending on infrastructure, environmental improvement, and the social safety net; and currency appreciation. 

We need to be more attentive to the risk that specific aspects of our system, regulations or other constraints, create a greater disincentive to locate a financial business here, or to invest here, or to raise capital here, than would have been the case five or ten years ago. We need to take a careful look at how we regulate financial activity in a world where capital is more mobile, and the structure of the financial system has diverged substantially from the system for which our regulatory framework was designed.

The policy responses to the challenges that come with economic and financial integration principally involve choices for governments at the national level.  International cooperation can in some circumstances help provide a more supportive environment, but there are no feasible changes to the architecture of the international financial system that offer the prospect of a durably stable external economic and financial environment for nations, large or small.  Fundamentally, the only realistic choice for policymakers is to equip their economies with the flexibility to cope more successfully in this increasingly integrated global economy.  And this means preparing for a world of more rather than less flexibility in exchange rate regimes. 

Recent research suggests another possibility, which is that U.S. monetary policy actions may have significant effects on foreign yields and asset prices as well as on domestic financial prices. For example, changes in U.S. short-term interest rates seem to exert a substantial influence on euro area bond yields and appear to have a strong effect on foreign equity indexes as well.  In contrast, the effects of foreign short-term rates on U.S. asset prices appear to be relatively weaker. These cross-border effects of policy, and their asymmetric nature, are somewhat puzzling. One would expect a more symmetric relationship between the United States and the euro area, for example, as the two regions are of comparable economic size. It will be interesting to see if these relationships persist.

Cross-border flows of real and financial capital have also increased dramatically—a reflection of the recent notable reduction in the degree of home bias in capital markets.

Although economic globalization has come a long way, in one particular dimension--finance--it is very far from complete...

We have seen that the repression of the financial system is a great obstacle to economic growth and the reduction of poverty in poorer countries...

Government is often the primary source of financial repression in developing countries. Strong property rights, a crucial element in financial development, severely constrain a government's ability to expropriate land, factories, or ideas whenever it wants to profit from them.

We need to continue to adapt our approach to the imperatives of a much more integrated global financial system. Global integration, of course, gives us all a greater stake in the quality of supervision outside our borders. This pragmatic interest will lead us to spend progressively more resources and attention on the international dimension of our work.

We need to find ways to accelerate the pace at which the regulatory framework evolves to meet new challenges. The increase in the pace of change in financial innovation and in market structure requires greater agility among supervisors and regulators. Without this agility we risk lagging too far behind changes in the frontier of risk. This does not mean that each innovation needs to be met with a regulatory response. That would be an unfortunate and surely counterproductive impulse to encourage in regulation.

We do not yet live in a world of perfect capital mobility, one in which savings move across borders to their most productive use without constraint in the form of capital controls or without distortions affecting the behavior of private actors. Recognizing this is important to understanding both why the U.S. imbalance has grown as large as it has and, perhaps, more importantly why it has been financed with such apparent ease despite obvious concerns about its sustainability.

We can also take steps to ensure that increased financial market integration does not lead to financial instability.  In this regard, it is particularly important to help developing and emerging market economies create strong and resilient banking systems so that they do not become a source of systemic instability.

A...challenge worth noting relates to how we handle systemic financial crises and the liquidity needs they can produce. Firms that operate across borders normally manage their liquidity market by market, and liquidity in any one market and in any one currency normally is not readily transferable to where it may be needed. This can limit access to liquidity where it’s needed most, and can also complicate the capacity of central banks to respond quickly and effectively to a liquidity problem of financial institutions it supervises.

Integration gives us each a greater stake in the quality of financial supervision outside our borders. This is true not just to ensure a more level competitive playing field for institutions that operate across borders. It’s necessary to provide a stronger framework of protection for depositors and investors with claims on foreign financial institutions and to reduce our respective vulnerabilities to a failure of such an institution.