Muhammad bin Ibrahim: Monetary policy autonomy - intricacies,
instruments and independence
Luncheon address by Mr Muhammad bin Ibrahim, Governor of the Central Bank of Malaysia
(Bank Negara Malaysia), at Bank Negara Malaysia's Monetary Policy Conference 2017 "Monetary
Policy Autonomy: Intricacies, Instruments and Independence", Kuala Lumpur, 24 July 2017.
* * *
Monetary policy was thought to be a relatively simple and straightforward business. It was widely
concluded that all that the central bank needed to do was conduct monetary policy in a way
consistent with the inflation-target and ensure that employment levels are satisfactory. Life
should have been easy for central banks. The holy grail of monetary policy was achieved.
Central banks had finally understood how monetary policy should best be conducted. This was
one of the primary explanations for the Great Moderation - the period of prolonged
macroeconomic stability that preceded the 2007-2008 Global Financial Crisis.
Today, the situation is markedly different. Conducting monetary policy is anything but easy. For
the advanced economies, despite almost 10 years of easy monetary policy, inflation is still
persistently below target and economic recovery remains slow and fragile. The latest enigma is
strong growth devoid of inflationary pressure.
For open economies, especially in emerging markets, we are left to manage the spillovers of
extraordinary policy measures implemented in the advanced economies. These spillovers have
had tremendous implications on emerging market central banks through macroeconomic and
financial instability, financial and foreign exchange market volatility, and more importantly, the
ability and autonomy of central banks in the region to conduct monetary policy.
So much attention has been focused on the advanced economies - the growth recovery, policy
trajectory and political uncertainty. Not enough has been discussed on the countries at the
receiving end of these uncertainties, and the difficult circumstances under which emerging
market central banks have had to operate in recent years. This will be the focus of my remarks
today.
I intend to describe a few reasons on why it has been a real challenge for emerging market
central banks to conduct monetary policy in recent years than in the period prior to the global
financial crisis. I will then discuss the policy thinking and tools from the perspective of an open
economy when facing the challenges that emanate from global policy-spillovers. Lastly, I will
share my view on the importance of having utmost autonomy in policy-making and suggest what
we and the global community can possibly do to improve independence in policy decisions.
Global developments since the crisis have added extra layers of complexity in
policymaking
For most emerging economies, structural changes in the economy over the past two decades
such as diversification of sources of growth, wider set of policy tools and deeper domestic
financial markets have all contributed to greater independence in the formulation of monetary
policy. Nevertheless, the transmission of global monetary conditions to emerging economies is
unavoidable given the open nature of the economies and the increasingly open and
interconnected financial markets.
To fully appreciate the changes in the global landscape since the Global Financial Crisis and the
challenges and risks they entail, let me suggest five important developments that emerging
market economies have been facing in conducting domestic monetary policy.
First, global financial markets are more interconnected than before. Financial openness in
the Emerging Asia, as measured by the sum of assets and liabilities in the international
investment position to GDP, has grown from around 800% of GDP to now more than 1000%
of GDP. Emerging Asia cannot escape the vagaries of the financial markets around the
globe.
Second, global capital flows have increased in size and volatility. Cumulative non-resident
capital flows to the region have reached USD2.1 trillion in 2016, compared to only USD400
billion in the period prior to the Global Financial Crisis. More importantly, capital flows have
also become more fickle than before. Debt flows now contribute to 66% of capital flows.
These flows are short-term in nature and carry higher propensity of reversals. Emerging
markets had never experienced such phenomena before.
Third, the volume of global foreign exchange trading has grown by more than four times in
the last 15 years alone. The global foreign exchange market has become bigger, more
complex and increasingly disconnected with economic realities. Today, exchange rate
overshooting is the norm rather than the exception. Emerging economies' trade volume
relative to the global market is, at best, minuscule.
Fourth, non-resident participation has increased tremendously in most emerging markets.
Non-resident holdings of Government bonds in Uruguay for example. In a little over a year,
non-resident holdings surged from 2% to 45% of the outstanding bonds in May 2013. Closer
to home, non-resident holdings of Malaysia and Thailand Government bonds increased from
10.2% and 2.5% in 2009 to 32.2% and 14.1% in 2016 respectively . These non-resident
investors tend to be driven more by global rather than domestic factors, motivated by the
search for yields. As participation becomes too high, it brought heightened risks to domestic
markets through the distortion in asset prices. The disproportionate influence of NR
investors further amplified the disconnect between domestic interest rates and economic
fundamentals.
Fifth, asset prices in emerging economies are increasingly correlated with global factors,
exposing emerging markets to shocks in the advanced economies. Stock market indices
and long-term bond yields in emerging markets have shown strong co-movement with the
indices and bond yields in the advanced economies, particularly the United States. This has
led to signs of weaker monetary control. The increasingly correlated yields between
advanced economies and emerging market economies have weakened the transmission
from policy rate to domestic yields.
Given this new landscape, policymakers in highly open economies are often caught in a "catch
22" situation. Raising interest rates to manage rising inflation and the central bank may stoke
capital inflows and further currency appreciation. Cutting interest rates to manage economic
slowdown, only to find that it worsens capital reversals, exchange rate depreciation, and
potentially reignite financial imbalances that policymakers have tried so hard to tame.
These are some amongst the many challenges to any policymaker, which brings me to my next
point - the importance of policy pragmatism.
The importance of policy pragmatism
Our own experience suggests that in dealing with multifaceted challenges, a broad array of policy
instruments is critical. The idea is that no single policy tool should be overburdened. The region's
experience theorises that despite great strides in achieving price stability and sustainable growth
since the Asian Financial Crisis, an open economy with sizeable financial market invites volatile
capital flows that adds layers of complexity in policy-making. We have expanded our policy toolkit
to include micro and macroprudential as well as financial market stability measures. This
additional arsenal of policy tools has helped to maintain the effectiveness of monetary policy and
safeguard domestic financial and macro stability.
But having a broad policy toolkit is not enough. It may be tempting for us to treat these challenges
as linear strings of events in order to cope with the complexity. But breaking the challenges into
digestible fragments of their own and tackling them in isolation using our various policy tools
seem a futile attempt. Given the closely interdependent and constantly evolving nature of the
challenges, solving one part of them may amplify the risks in others. In this environment, it is
imperative for policymaking to also be agile and pragmatic.
One aspect of pragmatism is the need to be bold and timely in introducing new policy tools, even
unconventional ones when it becomes necessary. When a new crisis occurs, it is likely that the
factors causing it are unprecedented. It goes without saying, that the solutions required to
remedy the problem requires new measures as well. Using conventional and 'consensus
thinking' are unlikely to be an effective remedy.
Policy-making is also increasingly characterised by shorter time horizon. With the rapid
developments in the financial markets, the window of opportunity and effectiveness for policy has
shrunk considerably. Gone are the days when policy-making can take months to formulate and
implement, let alone years. As financial markets evolve, the shelf-lives of policies have also
become shorter as policies can become ineffective very quickly. Such an uncertain environment
necessitates the deployment of new and untested policies.
The "audacity of pessimism" - as Mervyn King calls it - a situation when policymakers start
scrambling to address problems only when things have gone terribly wrong - may prove too little
too late to salvage the situation. Constant, holistic and courageous assessments of implemented
policies are therefore crucial in ensuring that policies remain relevant.
Another area of policy pragmatism that seldom gets discussed is the ability and conviction in
reversing policies when deemed appropriate. In my years as a central banker, there seems to be
an unspoken rule among global policymakers that certain policy paths are one-way, no-return
endeavours. Any policy reversals are seen as a backward move that is time inconsistent, which
could risk a permanent damage on trust, reputations and credibility of the central bank.
For me, this mindset is not tenable and counterproductive. It is imperative to realise that under
extreme circumstances, a reversal of policies may be beneficial and in fact, necessary for the
greater good and wellbeing of the society. Sometimes, taking a step backward may be the best
way forward.
A case in point is in the area of liberalisation. While we have benefitted from an open market, and
are strongly committed to the principles of this approach, we believe that countries should be
cautious in its adoption, giving due consideration to the various trade-offs and preconditions.
There might be a situation where a 'short moratorium' for further liberalisation becomes
necessary. As with everything else, a balanced approach is always the preferred and wiser
option. Liberalisation is not a 'cure all' for economic development. It is not a panacea for
economic sustainability either. Liberalisation requires patience and sequenced planning. Greater
openness needs to be phased in and be consistent with the readiness of the domestic market.
Should expanded relaxation of policy become a source of financial instability, policymakers must
be decisive and have the boldness to change course. This brings me to my final point of my
remarks today.
Policy autonomy
It is now widely accepted that a broad policy toolkit and pragmatic policymaking are paramount in
dealing with multiple challenges. Unconventional and unprecedented policies are no more
heresy. This shift in mindset is a very welcome change. If only this mindset had persisted during
the AFC, our experience in the region would have been much more positive. Experience also
suggests that policy autonomy is critical in deploying measures in an environment with no
precedent. Especially when the essence of the problems is domestic in nature, compounded by
the specificity of each economy's operating and legal environment, political and social structures.
Policy prescriptions will be least effective when it is not 'owned' by the domestic policy maker or
when it is not independent of external influence and coercion or when policy being administered
is more a reflection of 'consensus economic' thinking.
External influence can be viewed from two aspects. External developments that transcend
national boundaries; and external players that may directly or indirectly suppress domestic
autonomy. The former has been greatly discussed, where financial liberalisation and
globalisation have worsened the trade-offs for monetary policy to achieve its multiple domestic
objectives. Some consensus has also been reached on the ways to regain autonomy, in the
form of broad policy toolkit to prevent overburdening of any single policy instrument, the
buildingup of buffers and instituting the necessary structural reforms that serve to fortify the economy.
What is less represented, but in no way less relevant, is the potential for external players to
suppress national autonomy. Let me elaborate.
Despite great strides in global integration bringing the benefits of reduced inter-country
disparities, differences still exist. As much as we can categorise economies based on common
characteristics, be it by geography, or by level of development, no two countries are identical.
Even if countries may seem similar, their reaction to a certain phenomenon, in all likelihood, will
not be the same.
This reminded me of the doctor-patient relationship, grounded by the classical "Principle of
Biomedical Ethics" that emphasises respect for the patients' autonomy. A doctor may well know
all the treatment options available, and would prefer some over others, but it is ultimately the
wishes of the patient that needs to be considered. The doctor, rather than vehemently working
against the patient, should upon exploration of options and sharing of information, wholeheartedly
respect and support the decision of the patient. Underlying this bilateral covenant is the crucial
recognition of the shared humanity of doctors and patients.
In a similar manner, we can all agree that as policymakers and regulators, macroeconomic and
financial stability is a shared goal. We have been very grateful for the wealth of information and
quality of debate that multilateral institutions bring to the table, which have immensely aided our
decision-making process. However, individual countries should not be starved of policy
autonomy to manage challenges. Domestic policymakers have greater understanding of the
local economic and financial conditions, with the necessary experience in dealing with
countryspecific circumstances. In this regard, multilateral institutions must respect that individual
countries, as independent institutions, have made the tough but necessary choices after careful
and deliberate considerations.
Multilateral institutions possess great breadth of cross-country information to dispense
prescription for its member countries. But there is no such thing as a 'one-pill-cures-all' remedy.
Instead, tailored policy responses are essential given the unique and diverse nature of emerging
economies. As the world becomes increasingly more integrated and harmonised, we welcome
the value of global coordination and interaction if it adds to the betterment of society at large. But
where peculiarities exist, member institutions ought to be given the space to exercise their
autonomy.
We must also avoid the rush towards greater cross-country standardisation that impinge on
policy flexibility or where policies are judged based on pre-subscribed narrow definitions, theories
and concepts rather than the actual outcomes. The never-ending debate on the categorisation of
policies as capital flow management measures or macro prudential policies is one such
contention. In an increasingly integrated and complex environment, the impact of shocks varies
between countries. The policy would also vary. Even if policies are similar, the outcomes might
be different. The work of multilateral institutions becomes even more difficult and complex. For
instance, any mis-categorisation of policy could prematurely reverse the effectiveness of that
policy, given the impact it might have on investor perception and sentiment. Beyond the
potentially arbitrary labelling, the efficacy and desirability of a given policy should be judged solely
by its outcome and its effectiveness in correcting market failures and imbalances. Only then can
policies be evaluated intelligently, fairly and measurably.
Today I have talked about how it has become more difficult for central bankers in open
economies to conduct monetary policy. I attempted to highlight that in order to manage these
difficult challenges, there needs to be sufficient pragmatism and agility by central bankers. Most
importantly, policymakers have to be given sufficient space and autonomy to address rising
challenges to our respective economies.
I am reminded by John Baldoni's article on "The Secret to Team Collaboration: Individuality". The
author warned about the risks of confusing between collectivism and collaboration. Collectivism
leads to confined "group-think" and decisions; collaboration on the other hand breeds innovation.
While collectivists do work towards a single goal, they ignore alternate paths to achieve that
purpose. Collaborators, however, while similarly focused on a single purpose, arrive at their
goals by incorporating different points of view and creative solutions. In short, collectivists value
ideology over results. Collaborators are pragmatists that look for alternative ways to get things
done.
As we move forward and fight for greater policy autonomy, we might be tempted to think that
integration and collaboration come at the expense of individuality and domestic autonomy. In my
opinion, it is the exact opposite. Collaboration thrives with individuality and autonomy. This is not
wishful thinking. With the right instruments and tools, and considerable agility, policy autonomy is
not only attainable; it can be the perfect catalyst for powerful collaboration as we move forward.
Let us collaborate rather than be restrained by collectivism.