Normative Narratives

Economic Outlook: Quantitative Easing, Monetary Policy Coordination, and the IMF

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I was going to write a  conflict watch about the chemical gas attack in Syria, but as different actors are aligning with their interest and using mostly circumstantial evidence (Russia / Assad Regime: rebels did it, why would we launch chem weapons while U.N inspectors here?; Opposition / Western governments: Assad did it, emboldened by lack of international intervention after previous chem attacks, Assad subsequently shelled area so time would pass, now UN inspectors cannot get reliable results), I will refrain from speculating on these troubling events until more information emerges.

Continuing the narrative that has come to the forefront since G-20 finance talks in Moscow and the focus surrounding extra-territorial consequences of loose monetary policy at the Fed’s annual Jackson Hole meeting, policy coordination between central banks and new policy responses by IMF are needed to ensure as smooth as possible a transition from Q.E. to Fed monetary policy tightening (exactly when this will occur is uncertain, I am of the mind that it will be later rather than sooner).

Original articles:

Reuters:

Central banks should coordinate to avoid unwanted side effects as they exit from ultra-easy monetary policies that have left the world awash in cheap money, top policymakers were told on Saturday.

“The main challenge will be to manage the consequences of monetary policies, and their evolutions, on cross-border liquidity movements,” Jean-Pierre Landau concluded in a paper he presented to an audience that included top central bankers from advanced as well as emerging market economies.

The Fed’s bond buying, or so-called quantitative easing, has been at the heart of its aggressive efforts to revive U.S. economic growth after it cut interest rates to nearly zero in 2008. Interest rates in Europe and Japan are also ultra-low.

However, the purchases have spurred massive capital inflows into faster growing emerging economies, which are now suffering as investors anticipate an end to the easy money.

But he lamented that the necessary coordination on monetary policy was unlikely, and warned of the potential for the “fragmentation” of global capital markets.

Stocks and currencies plunged in India, IndonesiaBrazil and Turkey this week as investors fretted over a looming reduction in the U.S. Federal Reserve’s monthly bond purchases.

Landau acknowledged that central bankers dislike the idea of coordinating monetary policy because their job is to focus on domestic goals. But they worked well together during the 2007-2009 financial crisis, when the Fed, European Central Bank, Bank of Japan and other central banks coordinated rate cuts and currency swap lines.

As cross-border liquidity pressures build, they will find it productive to do so again, although cooperation is more likely through regulatory and financial structures aimed at preventing excessive leverage or harmful asset bubbles, he said.

In an ideal world, the cooperation would extend to monetary policy because policies in major economies such as the United States can have an international impact that amplifies their magnitude with domestic implications, Landau argued.

“The system itself is producing more accommodative monetary conditions than warranted by the situation,” he said. “In a reverse environment, when monetary policies need tightening, the effects could be symmetrical and complicate the exit from non-conventional measures.”

In addition, much could be gained through an international “lender of last resort,” which would remove the motive for some nations to maintain massive foreign exchange reserves, he added.

“All countries have a common interest in finding ways to disconnect reserve accumulation from exchange-rate management,” Landau said. “The need for national reserves could be reduced if credible mechanisms exist to provide for the supply of official liquidity on a multilateral basis.”

Economix:

The stimulus campaigns of the Federal Reserve and the central banks of Europe and Japan, by depressing domestic interest rates, have helped to push trillions of dollars into developing markets in recent years.

The question of what central banks are supposed to do about it dominated the formal agenda here at the Kansas City Fed’s annual monetary policy conference.

The answers were surprisingly mellow. The rest of the world would like the Fed to explain its plans clearly, and then to travel slowly. Bankers from developing nations said they might need to impose some restrictions on the outflow of capital, but expressed little concern over the potential for serious economic disruptions.

Christine Lagarde, the managing director of the International Monetary Fund, struck the same sanguine tone in a Friday speech, declaring that “Central banks handled entry well, and we see no reason why they should not handle exit equally well.”

She added that the fund – and by extension, the major economies – accepted that some developing countries might need to impose some financial controls. “In some circumstances, capital flow management measures have been useful,” she said.

This is not the way that policymakers used to talk. The big countries and the I.M.F. spent the last few decades pushing for the liberalization of financial markets. They argued that developing nations were creating their own problems by failing to take the painful steps necessary to moderate capital inflows, notably by allowing their currencies to appreciate. And they showed no tolerance for capital controls.

The argument for global monetary policy coordination– mainly that in today’s globalized world, where unfathomable amounts of money can and do flow at the click of a mouse, that a large countries monetary policy choices have a direct impact on other countries–has already been explored in depth.One of the most important developments in monetary policy over the last generation is the conclusion that central banks can increase the power of their actions by talking about their goals, thereby shaping the expectations of investors.” Managing expectations and policy coordination are logically related and present a synergy point for global monetary policy coherence. 

Central banks historically have served a dual mandate, to manage unemployment and inflation. A 3rd (secondary) mandate has emerged since the Great Recession; to manage the extra-territorial effects of monetary policy decisions.

Two other interesting points are raised in these articles; the issue of capital controls and flexible credit lines.

Capital Controls:

International  capital investments are necessary for helping least developed countries (LDCs) escape poverty traps / expedite their development process. However, the mobility and liquidity of capital in today’s digital and globalized age make capital flows intrinsically volatile–capital controls help temper this volatility. IMF managing director Christie Lagarde has endorsed the use of capital controls in certain instances, which represents a complete 180 from the IMFs “Washington Consensus” policies of the 1980s and 90s. When money is “cheap” (as it is now), it flows to places that offer a higher rate of return (i.e. developing countries). Capital controls provide a buffer from capital flight when monetary policy tightens (which is inevitably as the global economy recovers), which can otherwise have devastating standard of living / human rights implications.

Capital flight may lead to less investment / higher “risk premium” (investors will not like the idea of not having complete control over their investment), but it is surely should be a countries own decision what investments it allows in its country and under what conditions, considering the destabilizing nature of unchecked financial inflows. If speculative money does not wish to come into a country, that may be in that countries best long term interests anyways. The failure of “Washington Consensus” policies, culminating in global financial contagion during the Great Recession, has led the international financial community (headed by the IMF) to reverse it’s previous stance on capital controls.

Flexible Credit Lines:

Jean Pierre-Landau alluded to flexible credit lines with this comment;

In addition, much could be gained through an international “lender of last resort,” which would remove the motive for some nations to maintain massive foreign exchange reserves, he added.

“All countries have a common interest in finding ways to disconnect reserve accumulation from exchange-rate management,” Landau said. “The need for national reserves could be reduced if credible mechanisms exist to provide for the supply of official liquidity on a multilateral basis.”

Flexible Credit Lines are available to countries through the IMF if they meet certain preconditions (a shift by the IMF from imposing constitutionality on loans to having countries reach certain thresholds for eligibility, but after that providing assistance without conditions that can sometimes undermine development (see “Washington Consensus”). Countries gain access to funding by the IMF at an agreed upon rate (which is fairly low). By having this IMF insurance policies, countries are able to pursue policies in their best long-term interests (for example capital controls, or fiscal investments in public goods), as opposed to the short-term interests of speculative investors.

The existence of a FCL eases concerns of financial actors. The overall experience with FCL countries (to date Mexico, Columbia, and Poland, evidence suggests that Ireland will be next) has been overwhelmingly positive. These countries have been able to borrow at a lower risk premium without ever having to access FCL money–no FCL country has ever had to draw on FCL funds. The efficacy of FCLs is only amplified against the backdrop of the European Debt Crisis.

I am a strong advocate of both FCLs and capital controls for developing countries. Both policies are fully consistent with a human rights based approach to sustainable human development. Both policies can temper the destabilizing effects of capital inflows, giving governments the capital, policy, and fiscal space needed to respond to crisis situations. It is encouraging to see high level policy makers are of the same mind when it comes to monetary policy coordination, FCLs, and capital controls.

I invite my readers to view a PPT presentation (FCL Final) I did last year on FCLs. The study shows graphically the experiences of Mexico, Columbia and Poland before, during, and after the Great Recession (these three countries all performed very well compared to comparable countries). It concludes by arguing for “scaling-up” of FCLs by offering them to more countries as a potential development tool.

 

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