what lies beyond price stability? - bank negara malaysia · limited tolerance, especially for er...

1BANK NEGARA MALAYSIACENTRAL BANK OF MALAYSIA

1

BNM Monetary Policy ConferenceMonetary Policy 2.0?

Sasana Kijang, Kuala Lumpur, 24th July 2017

What Lies Beyond Price Stability?

Sukudhew SinghCentral Bank of Malaysia

BANK NEGARA MALAYSIACENTRAL BANK OF MALAYSIA

Views expressed are my own and do not necessarily reflect those of Bank Negara Malaysia


2

The economic welfare of all sectors of society.

Price stability is one important component of that objective, but it is not the only component.

Monetary policy has different effects on:

Savers and borrowers.

Those who own financial assets and those who don’t.

Property speculators and pensioners.

Extreme monetary policy stances exaggerate these asymmetric effects on the welfare of different sectors of society.

Having too high or too low interest rates over a long period are themselves a source of financial instability increased inequality

What lies beyond price stability?


3

Monetary policy frameworks?

The way central banks carry out their mandates?

…or both?

What can be improved?


4

Unconventional monetary policies? But the MP frameworks used today are the same as those that spawned the financial crisis.

Policy frameworks with 2-year horizons have been extended to multiples of that horizon

After almost a decade of financial repression and despite strenuous efforts, central banks are still having trouble achieving their desired inflation rates.

Price stability is important but is it the only thing that is important?

What is the point of getting inflation up if wages do not rise?

What does it say about the frameworks when interest rates are used for exchange rate outcomes?

Questions about current frameworks from post-crisis experience


5

Should the zero lower bound on nominal interest rates be interpreted as a target – something to be achieved, breached or circumvented? Or should it be a warning?

QE: How much liquidity does an economy need? And beyond a point, does more liquidity necessarily make the economy run better or faster?

What do central banks achieve when a significant portion of the liquidity they inject “leaks out” to other countries in search of higher yields?

Questions about current frameworks from post-crisis experience…(continued)


6

Policymakers will focus only on what they are being held accountable for.

This makes them unable/reluctant to see the negative longer term consequence of them single-mindedly pursuing their policy objective.

Pre-crisis: AE Central banks failed to see the financial stability consequences of having too low policy rates (lulled by the great moderation).

Post-crisis: Failed to see that very low interest rates may not only not achieve the outcome they desire but may also create vulnerabilities that could undermine future growth.

Questions about the way some central banks have carried out their mandates in the post-crisis period


7

60

65

70

75

80

85

90

95

100

-7

-6

-5

-4

-3

-2

-1

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Current account (LHS)

Household debt (RHS)

Too much focus on a single economic variable? Does it contribute to economic resilience?

-6

-4

-2

0

2

4

6

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

GDP

Inflation

Annual growth, %USA Inflation and GDP (2005 -2010)

USA Current Account and Household Debt (2005 -2010) Percentage of GDP, %Percentage of GDP, %


8

Monetary policy that is too easy for too long?

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

%

Source: IMF, Author’s calculations, Bloomberg

US Policy Rate

(Actual and Taylor Rule estimate)

Taylor Rule estimate of the Fed Funds Rate

Fed Funds Policy Rate


9

Global economic integration has made global factors an increasingly important determinant of domestic price and economic conditions

Financial integration has globalized monetary policy

Financial globalization has weakened the national transmission of monetary policy…

… but strengthened the global transmission of monetary policy

Financial globalization has globalized financial cycles

Inflation targeting & similar frameworks have failed to capture the realities of the operating environment


10

Policy makers have highlighted problems created by capital flows and exchange rates for their policy autonomy

Sources: * Effectiveness of Capital Control in Selected Emerging Markets in the 2000s, Chikako Baba et al (2011)** Bloomberg, Wall Street Journal, Financial Times, central bank websites

Policy Complications CountriesEconomic Conditions/ Policy

ConsiderationsQuotations

Raised policy rates during boom period and faced more capital inflows

BrazilExperiencing economic boom in the early 2000s

"Brazil faced the problem of more capital inflows due to strong fundamentals and relatively high interest rate differentials with advanced economies when they raised the interest rate in the period of boom in the early 2000s"*

ColumbiaExperiencing economic boom in 2006

"With the fiscal stance remaining neutral, the monetary tightening resulted in a significant hike in the policy interest rate to control the boom, thus attracting even more capital inflows"*

Reluctant to raise interest rates as would lead to larger inflows and appreciation

IndonesiaExperiencing economic boom in 2011

“Indonesia has resisted raising interest rates, fearing higher rates would attract even more investors, putting pressure on its currency to rise." (Source: Bloomberg)

In the face of safehaven flows, cut rates to negative levels in order to stem inflows and appreciation, amidst potential imbalances in some sectors

SwitzerlandEconomy is in excess capacity and facing deflationary pressure

"A number of factors have prompted increased demand for safe investments. The introduction of negative interest rates makes it less attractive to hold Swiss franc investments, and thereby supports the minimum exchange rate" (Source: December 2014 Monetary Policy Statement)

Denmark

Fixed exchange rate regime; concerns about housing market developments andsustained period of very low interest rates

"Denmark introduced negative rates to stem massive inflows from investors looking for a safe haven outside the eurozone that was causing the krone to strengthen; Negative interest rates must be considered as something extraordinary, not a new permanent state of affairs.” (Source: Speech by Governor 25 March 2015)


11

Normal times: Floating exchange rate + Intervention & Sterilisation provide some degree of policy independence

Not too many “normal times” over the last decade

Prolonged ER misalignment can turn the exchange rate from being a shock absorber into a shock propagator

Floating ERs guarantee policy autonomy only if you have a limitless capacity to tolerate significant ER volatility

Even the big developed economies have shown that they have limited tolerance, especially for ER appreciation

Tolerance of ER volatility also depends on economic structure –higher for commodity exporters than for exporters of manufactured goods (or being part of GVC)

Floating exchange rates cannot guarantee policy autonomy


12

Link between domestic measures of slack and inflation has been weak for almost two decades

Link between global measures of slack and domestic inflation has increased

Globalisation has made markets more contestable, eroding the pricing power of both firms and workers

Between 1990-2015, the global labour force increased by 1.6 billion workers due to the opening up of economies like China and EMEs.

Global value chains have made inflation more global across countries the more a country in engaged in GVCs, the greater the influence of global slack on domestic inflation

“The globalisation tailwinds that helped central banks to bring inflation under control pre-crisis became headwinds when central banks tried to push inflation up post-crisis.”

The increased influence of global factors may have reduced the ability of central banks to fine-tune inflation

BIS: Increased influence of technology and globalisation on domestic inflation


13

Extended periods of low interest rates encourage risky behaviour across the system — with risks popping up in different parts of the economy.

Managing these risks would be difficult and could end up being the central banking equivalent of the “Whack-A-Mole” game.

There has been much discussions about whether monetary policy should be “leaning against the wind.”

The issue is even more fundamental than that. Monetary policy should not be actively creating financial stability risks in the first place, no matter what the neutral rate is saying.

Since the financial crisis, at least 3 central banks have assumed a leading role in financial stability: BOE, ECB & Norges Bank

Monetary Policy and Financial Stability:Monetary policy sets the baseline conditions for risk-taking


14

The policy environment has become more complex:

Divergence between economic and financial cycle

Destabilizing changes in exchange rates

Global developments are increasingly important in determining domestic economic and financial outcomes

We do not have a good understanding of the determinants of inflation.

Policymakers have no control over the sources of many of these risks

Limits to relying on interest rates alone

May not be effective when demand is weak

Sustained periods of high or low interest rates can lead to financial imbalances that undermine the future growth prospects of the economy

Complex multi-faceted risks to macroeconomic and financial stability


15

Asymmetry in incentives of the reserve currency economies and those that are not.

Incentives for reserve currency central banks focus on what they are held directly accountable for – domestic outcomes.

No incentive to do anything about the “spillovers” of their policies.

Non-reserve currency economies are impacted by policies of large economies but have no leverage to change situation.

Institutions like G-20 are nothing more than “talk-shops” diverging interests undermine ability to undertake concerted action to deal with global problems.

International collaboration & policy coordination?Nice idea but it is not happening!


16

A number of frameworks have been proposed to address the shortcomings of IT

Dual Mandate1

Nominal Growth

Targeting1

Price-Level Targeting1

Dynamics of the economy

Financial imbalances

Not constrained by zero-lower bound

Financial Stability

Oriented MP3

Inflation Targeting 2.02

Capital flows and exchange rate

Likely UnlikelyPotential

1Andersson, BjÖrn and Claussen, Carl A (2017), ‘Alternatives to Inflation Targeting’ , Sveriges Riksbank Economic Review 2017:12Céspedes, Luis Felipe, Chang, Roberto and Velasco, Andrés (2014) ‘Is Inflation Targeting Still on Target? The Recent Experience of Latin America’, Journal of International Finance, Volume 17 Issue 2, pp 185-208 3Borio, Claudio (2016) ‘Towards a Financial Stability-Oriented Monetary Policy Framework’ , Presentation at the Conference on the occasion of the 200th anniversary of the Central Bank of the Republic of Austria’ , Vienna, Austria


17

Multi-faceted risks require a holistic policy eco-system

Monetary Policy

Micro & Macro-prudential policies

Capital Flows Management Measures

Fiscal Policy

Building Buffers

• Too low interest rates are bad

• Too low for too long are worse

• Well-regulated FIs

• Sound risk management

• Sector/risk specific measures

• Price-based deterrents

• Quantity-based in crisis

• Taxes to mitigate risks

• Expenditure to offset negative shocks

• Structural Reforms

• Sufficient FX reserves

• Strong fiscal position

• Healthy current A/C balance


18

Overdependence on monetary panacea.

Despite often noting the role of structural reforms and fiscal policy, the aggressive monetary policy response by the major central banks seems to indicate that there was a strong belief among these central banks that low inflation was indeed amenable to a monetary cure.

How else would one rationalize their actions?

By doing more, central banks have made it easier for others to do less…

…with the expected less than optimal outcomes.

Post-crisis conduct of monetary policy in the major developed economies


19

Significantly affected by the global flood of reserve currencies

Most central banks – including the inflation targeting ones – adopted a broad range of policies to address the risks

This included relying on a multiplicity of tools because large external flows made it difficult to rely on interest rates alone.

Generally, greater apprehension among policymakers about consequences of pushing interest rates too low.

Monetary policy working together with other policies has a higher likelihood of good outcomes.

In contrast, many small open Asian economies…


20

Complex and multi-faceted risks that current monetary policy frameworks are ill-designed to handle

Implications for monetary policy and the way monetary policy is conducted:

Consider broader implications on welfare and inequality

Adopting a longer policy horizon and being more cognizant of the risks and perverse incentives – understand that sometimes doing less is more.

Monetary policy must not actively create financial risks over sustained periods.

The objectives of monetary policy may need to be more holistic and less precisely defined in terms of a single price objective.

National collaboration: A broader range of policy tools need to be used collaboratively to holistically manage risks and minimize the possibility that excessive reliance on any single policy will create additional risks.

Beyond price stability. To summarise…


21

Monetary policy mandates:

the stability of the currency of Australia;

the maintenance of full employment in Australia; and

the economic prosperity and welfare of the people of Australia.

Governor Philip Lowe: Allow the RBA to adopt a more balanced policy stance that considers longer term implications than if it were tied to a single price stability mandate.

Reserve Bank of Australia

what lies beyond price stability? - bank negara malaysia · limited tolerance, especially for er...

Documents