REMARKS BY MR. JAVIER GUZMÁN CALAFELL, DEPUTY GOVERNOR AT THE
BANCO DE MÉXICO, AT THE POLICY PANEL ON "REFORMULATING
MONETARY POLICY IN EMERGING MARKETS AND THE NEED FOR
MACROECONOMIC POLICY COORDINATION". CONFERENCE ON GLOBAL
ENVIRONMENT AND POLICY CHALLENGES IN EMERGING MARKETS
ORGANIZED BY THE CENTRAL BANK OF THE REPUBLIC OF TURKEY. Antalya,
Turkey, December 2, 2017.1
Largely as a result of the difficulties faced following the outburst of the Global
Financial Crisis, macroeconomic policy coordination has gained increasing
relevance in recent years. This has two dimensions. Domestically, a context
characterized by stubbornly low rates of inflation and deflationary risks,
anemic economic growth or outright contraction, as well as monetary policies
constrained by the zero lower bound on interest rates, particularly in the
advanced economies, underline the need to jointly activate different policy
levers in order to effectively overcome such a situation.2 In a second
dimension, the growing and increasingly complex interlinkages in the world
economy brought about by the ongoing process of economic and financial
globalization have increased the potential for spillovers and boomerang
effects of domestic policy measures in the major economies, thus highlighting
the importance of coordinating actions at the international level under certain
circumstances, for instance, in the presence of global shocks
While the above arguments apply fundamentally to advanced economies,
clearly, the importance of an adequate coordination of macroeconomic
policies is nowadays more pressing for emerging market economies (EMEs) as
well. In fact, the challenges resulting from globalization can be even more
acute for these countries. It is also worth noting that the policy response in
advanced economies to the Global Financial Crisis has sharply increased the
volatility of capital flows to EMEs, with episodes of large inflows alternating
with bouts of outflows. Simultaneously, the crisis has reduced the global
growth potential, fostered anti-globalization sentiment and, in general,
substantially increased uncertainty.
In light of the above, the following remarks will focus on the domestic
dimension of policy coordination in EMEs, including measures beyond the
strictly macroeconomic realm.
The advantages of a coordinated and balanced approach to policy rest on a
number of merits. Among these, it is worth noting the potential to exploit the
synergies of multiple policies acting simultaneously.3 In addition, reliance on a
multi-pronged strategy reduces the likelihood of an over-burden of policy
instruments when these are used in isolation,4 while the possibly adverse
effects on the overall performance of the economy arising from the
implementation of some policies may be compensated by action in other
fronts.
Seen from the perspective of monetary policy, which are the key areas for
coordination that deserve to be underlined?
A first one is exchange rate policy. In theory, flexible rate regimes allow
countries the implementation of a fully autonomous monetary policy. In
addition, they are widely regarded as an efficient mechanism for the
adjustment of the economy to external shocks. Nonetheless, as volatile flows
of capital across borders have led to acute swings in exchange rates, doubts
have emerged as to the degree to which such frameworks isolate economies
from developments abroad. In particular, sharp fluctuations of the exchange
rate can have significant effects on the real economy, domestic prices and the
financial sector, especially in EMEs. Of course, this does not imply that floating
rates should be discarded in favor of alternative regimes. Instead, the issue is
how to increase the efficiency of floating exchange rates during episodes of
disruptive volatility. A frequently noted option is the temporary use of
complementary intervention mechanisms to support the adequate
functioning of currency markets.5
Fiscal policy is a second crucial area of coordination for monetary policy. The
erosion of space following the Global Financial Crisis, in combination with the
end of the commodities boom that preceded it, has to a large extent
constrained the role of fiscal policy in many emerging market economies. In
light of the extant evidence, both theoretical and empirical, suggesting the
pernicious effects that weak fiscal positions can have on the overall
performance of the economy, for instance through an adverse impact on
expected inflation, interest rates and the exchange rate,6 it should not come
as a surprise that the typical policy response in these countries has sought to
favor the rebuilding of fiscal strength even under conditions of weakness in
economic activity.7 In fact, the potentially compensating effects on the latter
deriving from the strengthened credibility of the macroeconomic policy
framework and the lessened upward pressure on current and expected
interest rates further justify this as a sensible course of action. However, the
usefulness of fiscal policy measures to counter negative shocks to our
economies should not be disregarded, particularly in a context of solidly
anchored fiscal accounts.
The active implementation of measures directly oriented to the financial
sector represent a third fundamental component of a coordinated policy
package. In particular, as the experience of the recent and previous episodes
demonstrates, a healthy financial system is of paramount importance for the
efficient transmission of monetary policy to the rest of the economy. In fact,
failure to set in motion the measures needed to reestablish the well-
functioning of the financial sector in case of disruptions would imply a heavy
burden on monetary policy. Furthermore, the margins of maneuver for the
latter, e.g. the possibility to increase interest rates in the face of inflationary
pressures, may be constrained under situations of fragility in the former.
On the other hand, the build-up of financial imbalances and vulnerabilities that
might ensue following a relaxation of the monetary policy stance, especially if
sustained over a prolonged period of time, can effectively be countered by
targeted micro- and macroprudential measures. Conversely, situations that
require a tighter monetary policy stance, but for which a more nuanced effect
on the real economy is desired, may call for a simultaneous relaxation of
prudential measures that perk up economic activity via easier lending
conditions, provided the health and stability of the financial system remain
within safe margins.8
Lastly, although generally operating over a longer-term horizon, structural
reform should also be a strategic part of policy coordination in emerging
market economies. By providing incentives to improve the overall functioning
of domestic input and product markets, increasing their competitiveness and
strengthening the institutions within which they operate, policies that
overhaul structural aspects of the economy foster efficiency gains that
increase its productive potential.
Thus, a successful implementation of structural reform can ultimately result in
strengthened buffers in other areas of policy as, for instance, an expanding
productive capacity may offset the potentially adverse impact of restrictive
fiscal and monetary policies on economic activity; increased competition and
efficiency resulting from structural reform alleviate inflationary pressures; and
possibly higher fiscal revenues in a context of faster economic growth, both
actual and potential, reduce the level of public debt relative to the economy's
GDP.
Naturally, the implementation of structural adjustment policies faces a
number of challenges and some resistance is likely to arise, mostly as a result
of the redistributive effects, both across time and across sectors, inherently
imbedded in them. Thus, it will frequently be important to place actions in this
realm within the context of a broader-ranging plan that contemplates
countering, and coordinated, measures in other fronts. For instance, fiscal and
monetary easing may reduce the short-term output costs associated to the
economy's process of adjustment in the aftermath of structural reform, while
the enhancement of the social safety net and the enactment of other targeted
programs may alleviate the costs of transition.
Let me turn now to Mexico's experience regarding the role of policy efforts in
the above-mentioned areas in overcoming the macroeconomic challenges
faced in recent years.
Inflationary pressures in Mexico have increased significantly since early 2017,
owing to a sharp depreciation of the peso and a number of supply shocks.
Thus, the rate of growth of the headline consumer price index rose from 3.36
percent in December 2016 to 6.59 percent in the first half of November of this
year. The Banco de México's response to these developments has been
aggressive, as the reference rate has risen by 400 basis points over the course
of the two years since December 2015, to a level of 7.0 percent at present.
While the task is not finished yet, the results thus far can be deemed as
satisfactory, since inflation is expected to decline sharply in 2018 and long-
term inflation expectations have remained stable. Furthermore,
macroeconomic stability has been preserved, in the context of a sharp decline
in oil prices, stints of uncertainty in international financial markets, the
increase in interest rates in the United States, and the results of last year's
electoral process in that country. At the same time, economic activity has
shown resilience to shocks thus allowing a moderate rate of growth.
However, it is important to note that the above developments have also
benefitted from a balanced recourse to monetary and other policy
instruments. In particular:
1. Given the high volatility of the exchange rate, a number of measures
have been implemented to ensure adequate conditions of operation in
the foreign exchange market. In particular, the Foreign Exchange
Commission has introduced a mechanism for the hedging of foreign
exchange risks of up to US$20 billion, that does not imply the use of
international reserves. This strategy is consistent with a flexible
exchange rate regime that plays a key role as a shock absorber, allows
market forces to determine the equilibrium real rate, and rests on the
premise that the value of the currency is supported mainly by economic
fundamentals.
2. Challenges for the implementation of monetary policy in Mexico were
compounded, particularly in 2014 and 2015, by concern regarding the
country's fiscal position, in view of the marked increase in public sector's
debt. However, the fiscal authorities have embarked on a consolidation
strategy, a policy shift that is yielding a primary surplus and a drop in
public sector indebtedness relative to the economy's output this year
for the first time in a decade. This indicator is, according to the latest
projections, expected to continue trending downwards in the
foreseeable future. However, it is also true that public finances still face
significant challenges over the long term that will need to be addressed
in due course.
3. Thanks in large part to the continued efforts undertaken over several
decades, which have gathered momentum since the Global Financial
Crisis, Mexico's financial system is profitable, liquid and well-capitalized,
and supported by moderate levels of private sector debt, including
households, and the absence of evident risks of a systemic nature. Far
from representing an obstacle to its implementation, the health of our
financial system has proven to be a most valuable asset for Mexico's
monetary policy, as it has allowed an efficient operation of transmission
mechanisms, and a sharp increase in interest rates without significant
adverse side effects on banks or other financial institutions.
4. Structural reform policies spanning through a wide array of sectors have
made important strides over the last few years. Although it may still be
too early to draw conclusive assessments of the efforts undertaken, as
most of these changes are still in their implementation phase, a number
of positive results are already evident. Of particular importance for
monetary policy are the beneficial effects that increased competition
across a number of key markets, and especially in telecommunications,
has had on the evolution of domestic prices, both directly and indirectly.
The structural reform of the Mexican economy is a long-term endeavor
that will take several years to fully materialize, whose potential is
conditional on its correct implementation, and which needs to be
complemented by efforts in other areas. But it is certainly reassuring
that the process has, to a significant extent, lived up to the expectations
it has generated.
All in all, a policy approach encompassing multiple instruments has
undoubtedly ameliorated the magnitude of the challenges for monetary policy
in Mexico. However, as is natural to expect, it has not fully eradicated them.
At the current juncture, the Mexican economy is facing a deceleration of
economic activity, a rapid although expected to decline rate of price growth,
and a situation of higher-than-usual uncertainty deriving from a number of
factors, of both domestic and external origins, with the normalization of
monetary policy in the United States, the renegotiation of NAFTA and
presidential elections in 2018, among them. In virtue of the potentially
opposing implications that the realization of alternative scenarios may have
for the conduct of monetary policy, it will be essential to adhere to an
approach emphasizing prudence and timely action, and the continued support
of policy measures in other areas.