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Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Mario Bergara
IEA-BCU Roundtable on “Capital Flows,Capital Controls and Monetary Policy”
December 7th, 2013
Anemic growth/Recession
Advancedeconomies
Differential situation in advanced and emerging economies
Emergingeconomies
Monetary expansionQuantatitive easings
Defensive strategiesMarket intervention
Reserve accumulation
Reasonable growth
Fiscal problems Stronger fiscal positions
Debt issues Sustainable debt
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Implications of volatile capital flows formacroeconomic and financial stability
Growthdifferentials
Volatile exchange rates in emerging markets
Uncertainty and volatility in the global environment
Interest ratedifferentials
Differentialexpectations onexchange rates
Liquidityconditions and
marketsentiment
Risks of asset price bubblesand bank lending boom
Risks of capital flowstop or reversal
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Price stability: monetary policy
Contributes to financial stability due to a better framework for risk management by financial agents
Financial stability: micro-macro regulation and supervision of the financial system
Contributes to price stability and to enhance transmission channels of monetary policy
The financial crisis has shown that macroeconomic stability proved insufficient to preserve financial stability, which is crucial for the effectiveness of monetary policy
Central Bank concerns: price and financial stability
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
It has been necessary to put in place a set of macroprudential instruments to limit the exposure of the financial system to systemic risks
They typically impose efficiency costs on financial intermediation, which nevertheless are lower than the benefits from preserving financial stability
Central Banks in emerging economies have used reserve requirements and caps on foreign exchange positions to limit potential imbalances derived by surges in short-term capital inflows
Lately, Central Banks have used instruments such as additional capital requirements, counter-cyclical provisioning, and additional liquidity requirements to reduce systemic risks and enhance financial resilience
Nevertheless, the quantitative effect of macroprudential measures is difficult to establish and their effectiveness is challenged
Financial stability in the context of macroeconomic stability
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
The exchange rate flexibility acts as an automatic buffer to cushion against external shocks and contribute to provide an adequate incentive structure in the economy
Foreign exchange market intervention has been done in order to reduce excessive volatility and currency appreciation in the current (circumstantial) financial environment, but not against long term fundamentals
Costly sterilized market intervention has been done by balancing with other goals, such as low inflation and long term competitiveness
The impact and effectiveness of policy options
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
A consistent set of policies must balance different objectives, such as low inflation, competitiveness and financial stability
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Monetary policy based on a trinity:Exchange rate flexibilityInflation targetMonetary policy rule: contingency plan specifying the circumstances under which policy instruments are changed
“Taylor rule” are designed for economies with:Fully developed long-term bond marketsForeign exchange market with a high degree of capital mobility
Market structural conditions in emerging markets may require modifications of the typical policy rule recommended for economies with developed financial markets
With uncertainty and difficulties in measuring the natural interest rate, policy makers might want to give greater consideration to policy rules with monetary aggregates
The design and implementation of monetary policy: Taylor (2000)
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Policy rule as a guideline for monetary policy decisions, but discretion is also needed
Other objectives can be addressed as long as they are not inconsistent with the inflation target in the long run
A flexible exchange rate policy does not mean that the exchange rate plays no important role in the policy rule and in the transmission mechanisms: country’s size, openness, capital mobility and FX market development matter
In sum, monetary policy rules in emerging economies might require modified considerations on:
The choice of instrument (monetary aggregates)The variables in the rule (greater role for exchange rate)The size of response of the instrument to economic events (to deal with less developed financial markets)
The design and implementation of monetary policy: Taylor (2000)
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Capital flows to emerging markets are strongly motivated by the seek of profitability and liquid assets: this motivation declines when returns of liquid assets in developed economies are expected to rise
Capital flows intensifies with more volatility, because liquidity is endogenous: more used assets are more liquid
An asset is liquid if the market considers it as liquid: thus, liquidity is not a fundamental and can disappear
Dilemmas for Central Banks: in developed countries, they reduced interest rates to zero and then they opted for QE (monetary aggregates), purchasing assets of unknown quality
Incentives for capital flows to emerging economies and high yield bonds, inducing FX market interventions
The interest rate might become ineffective as an instrument when is too high and threatens fiscal sustainability
The design and implementation of monetary policy: Calvo (2013)
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
The complementary roles of micro and macro perspectives
The macroprudential perspective contributes with more instruments to deal with short term capital flows, without affecting macroeconomic and financial stability
Capital controls or capital flows management?
Both approaches help to make agents to internalize externalities in both static and dynamic dimensions of financial stability
Regulation should be determined by the assessment of risks, avoiding arbitrage incentives: micro and macro-systemic risks have to be taken into consideration
Macroprudential Framework vs.Microprudential Framework?
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
The lack of a macro-systemic approach was clear, but was the micro-prudential regulation working properly?
Failure of the regulatory approach and of the organizational design of public intervention in financial marketsThe decentralized governance failed as well as the “light supervision” approachSupervision and regulation was poor and the organization of the Financial Safety Net was inaccurate in some places and chaotic in others
A possible (dangerous) lesson from the crisis: “Everything was right except that the macro-prudential approach was lacking.”
The discussion about the governance of macro-prudential policies might be “smuggling” a debate about the failure of the decentralized regulation and the need to move towards a more centralized fashion
We need to get back to the conceptual determinants of the optimal Financial Safety/Stability Net: conflict of objectives, incentive structures, accountability, coordination and organizational design
Current discussion influenced by situation in developed countries
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
Monetary Policy
Lender of Last Resort
Prudential
Regulator and
Supervisor
Deposit Insurer
and Resolution
Agency
Coordination and contribution for all agenciesto comply with their respective mandates
From Financial Safety Net to Financial Stability Net
Ministry of Finance/
Treasury
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
The normalization of global financial conditions are not bad news for emerging markets: the cost of financing is not everything
Since a large share of the US dollars circulate outside the US, they are collecting segnoriage all across the universe: we are all paying the financial crisis
Emerging countries should not expect the Federal Reserve to introduce the international impact of its decisions into its objective function
Even the “softer” road will be bumpy: communication is as crucial as implementation
This will be a new test for emerging economies to navigate on troubled waters
A soft road to normalization?
Monetary Policy in anMonetary Policy in anUncertain and Volatile WorldUncertain and Volatile World
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