Monetary Policy in an
Uncertain and Volatile World
Mario Bergara
IEA-BCU Roundtable on “Capital Flows,
Capital Controls and Monetary Policy”
December 7th, 2013
Monetary Policy in an
Uncertain and Volatile World
Differential situation in advanced and emerging economies
Advanced
economies
Emerging
economies
Anemic growth/Recession
Reasonable growth
Fiscal problems
Stronger fiscal positions
Debt issues
Sustainable debt
Monetary expansion
Quantatitive easings
Defensive strategies
Market intervention
Reserve accumulation
Monetary Policy in an
Uncertain and Volatile World
Uncertainty and volatility in the global environment
Growth
differentials
Interest rate
differentials
Differential
expectations on
exchange rates
Liquidity
conditions and
market
sentiment
Implications of volatile capital flows for
macroeconomic and financial stability
Volatile exchange rates in emerging markets
Risks of asset price bubbles
and bank lending boom
Risks of capital flow
stop or reversal
Monetary Policy in an
Uncertain and Volatile World
Central Bank concerns: price and financial stability
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
Monetary Policy in an
Uncertain and Volatile World
Financial stability in the context of macroeconomic stability
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
Monetary Policy in an
Uncertain and Volatile World
The impact and effectiveness of policy options
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
Monetary Policy in an
Uncertain and Volatile World
A consistent set of policies must balance different objectives,
such as low inflation, competitiveness and financial stability
Monetary Policy in an
Uncertain and Volatile World
The design and implementation of monetary policy: Taylor (2000)
Monetary policy based on a trinity:
Exchange rate flexibility
Inflation target
Monetary 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 markets
Foreign 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
Monetary Policy in an
Uncertain and Volatile World
The design and implementation of monetary policy: Taylor (2000)
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)
Monetary Policy in an
Uncertain and Volatile World
The design and implementation of monetary policy: Calvo (2013)
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
Monetary Policy in an
Uncertain 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 an
Uncertain and Volatile World
Current discussion influenced by situation in developed countries
The lack of a macro-systemic approach was clear, but was the microprudential regulation working properly?
Failure of the regulatory approach and of the organizational design of public
intervention in financial markets
The decentralized governance failed as well as the “light supervision” approach
Supervision 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
Monetary Policy in an
Uncertain and Volatile World
From Financial Safety Net to Financial Stability Net
Prudential
Monetary Policy
Regulator and
Lender of Last
Resort
Supervisor
Deposit Insurer
and Resolution
Ministry of
Finance/
Agency
Treasury
Coordination and contribution for all agencies
to comply with their respective mandates
Monetary Policy in an
Uncertain and Volatile World
A soft road to normalization?
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
Monetary Policy in an
Uncertain and Volatile World
Mario Bergara
IEA-BCU Roundtable on “Capital Flows,
Capital Controls and Monetary Policy”
December 7th, 2013