Agustín Carstens: Challenges for emerging economies in the face of
unconventional monetary policies in advanced economies
Text of the Stavros Niarchos Foundation Lecture by Mr Agustín Carstens, Governor of the
Bank of Mexico, at the Peterson Institute for International Economics, Washington DC,
20 April 2015.
* * *
All the opinions are the responsibility of the author, and do not necessarily reflect the views of Banco de México.
Thanks to Manuel Ramos Francia, Ana María Aguilar, Alfredo Sordo and Gabriel Cuadra for useful discussions
and support.
It is a real pleasure and honor to have the opportunity to deliver the 15th Stavros Niarchos
Foundation Lecture at the Peterson Institute for International Economics (PIIE). In particular,
I wish to express my gratitude to Adam Posen for the invitation. I am sure that all of you
present here tonight would agree with me that the PIIE has been since its creation a forum of
excellence for the analysis and debate of issues related to international finance, trade, the
international monetary system, and more, with a clear emphasis on exploring and identifying
policy options. The contribution of the Institute has been particularly valuable since 2008,
when the Global Financial Crisis (GFC) erupted in the United States, rapidly spread to most
of the rest of advanced economies, and eventually affected the world as a whole.
* * *
Even though the most critical aspects of the GFC have been overcome - in particular the
possibility of extreme tail-risk events that would have been disastrous had they
materialized -, the process of recovery has been extremely slow, and it still is vulnerable to
setbacks. World economic growth continues to be sluggish, and a huge deficit in employment
creation persist. Nevertheless, the quest for financial stability has shown more promising
results, underpinned by a comprehensive Financial Sector Reform steered by the Financial
Stability Board (FSB).
But the aspect that worries me the most about the process of recovery of the world economy
is the fact that it still depends heavily on the monetary policy stances in main advanced
economies (AEs) that are not sustainable over the medium and long term. Let me explain.
Relatively soon after the beginning of the crisis, it became clear that the feasibility in most
AEs of stimulating growth through fiscal policy came to an end, as debt-to-GDP ratios grew
very fast. Thus, the only stabilization policy instrument left was monetary policy, and
therefore the main AEs central banks have adopted, at different times, speeds and with
varied modalities, unprecentented expansionary monetary policies. The Federal Reserve
System led the way, followed by the Bank of England, the Bank of Japan and the European
Central Bank (ECB), the latter two motivated also by the growing risk of deflation. These
policies have engineered sharp declines in interest rates across the yield curve. The zero
lower bound in the policy reference rates became binding in all the above-mentioned cases
(Figure 1). In addition, forward guidance for the policy rates and quantitative easing (QE)
have been adopted. As a result, the balance sheets of AEs central banks have increased
sharply (Figure 2).
Figure 1
Advanced Economies: Central Bank Target Rate
%
16
14
12
10
U.K.
8
6
U.S.
4
Eurozone
2
Japan
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bloomberg.
Figure 2
Advanced Economies: Assets in the Balance of Central Banks
% of GDP
70%
60%
Bank of Japan
50%
40%
European Central Bank
Federal Reserve
30%
20%
Bank of England
10%
0%
Jul-11
Oct-08 Jun-12 Apr-14
Dec-06 Sep-09
Nov-07 Aug-10
May-13
The overall objective of unconventional monetary policies (UMP) in these AEs has been to
stimulate growth and employment, while inducing the convergence of inflation to each
countries ́ objective. Inflation in most AEs has fallen below their objective, mostly as a result
of widespread unemployment, large output gaps, reduction in commodities prices, in
particular of oil, and more recently in the United States, due to a sharp effective appreciation
of the US dollar.
I believe that given the magnitude of the GFC and the policy options available, the UMP have
been essential and they have worked well so far. Economic recovery in the United States
and in the United Kingdom, and to a lesser extent in Japan, have taken hold, and recent
figures in the Eurozone have been promising. Inflation expectations and core inflation have
been moving towards the respective central banks' objectives.
Nonetheless, my perception is that it is too early to declare victory. To begin with, we still
have to see if the unwinding of those policies can proceed in an orderly fashion, once their
immediate objectives are met. Once we reach that state of affairs, the unwinding of UMP will
be unavoidable, given that otherwise they would feed into inflation, and induce higher than
warranted interest rates and financial instability. This is the reason why I consider that UMP
are not sustainable over the medium and long term. To assess the risks associated with the
unwinding of those policies, we have to identify the unintended consequences that they have
caused.
The transmission of extraordinary monetary stimulus to higher economic growth was meant
to work primarily by enticing more risk taking by economic agents. In the case of consumers,
and in particular as a response to quantitative easing (asset purchase programs by central
banks), lower interest rates and wealth effects would stimulate their expenditure. Another
important channel that would operate was that lower interest rates, term spreads and credit
spreads that would result from QE would stimulate real risk taking by firms, that is, QE would
induce higher corporate investment. But investment has only partially recovered from the
sharp fall in the recession of 2009 - the median decline from a group of AEs and emerging
markets economies (EMEs) has been around 2 1⁄2 percentage points of GDP. Meanwhile,
there has been massive investments in financial instruments of all sorts, both in local and
external markets, in what has been called "the search for yield", which has created
considerable spillover effects of UMP. The crux of the matter is that it seems that "financial
risk-taking" has been by far more responsive to UMP than "real risk-taking".
Several consequences have resulted from the above. Initially resources were directed to
bonds and stock markets in AEs, but as the search for yield led to stretched valuations
(Figure 3), investments in high-yield corporate, and EMEs sovereign and corporate debt
exploded. These responses led in turn to wider credit and term spreads compressions,
record high-yield debt issuance and deteriorating underwriting standards.
Advanced Economies: 10-Year Interest Rates
%
14
12
10
U.K.
8
U.S.
6
Eurozone
4
Japan
2
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Bloomberg.
Most of these investments have been intermediated by non-bank financial institutions, such
as asset management companies, hedge funds and pension and insurance companies.
A novel feature of this episode of capital inflows to EMEs has been the fact that a large
portion of them have taken place as purchases of government bonds denominated in the
domestic currency by non-resident investors (Figure 4). This is an important feature, since it
eliminates the "Original Sin Syndrome"1 that haunted EMEs for several decades.
Non-Resident Holdings in Local Currency Government Bonds
Percentage
10 27
9 23
8 19
Non-resident holdings
in government bonds as
7 15
percentage of local
debt outstanding
6 11
Average 5-year interest
5 7
rate SWAP for selected
emerging markets
4 3
08 09 10 10 11 12 13 14 15
Jul-
Oct-
Apr- Feb-
Dec- Aug-
Mar-
May- May-
Source: Ministries of finance, central banks and other national authorities.
Note: Non-resident holdings of the following countries: Mexico, Peru, Colombia, Brazil, Indonesia, Malaysia,
Thailand, Poland, Turkey, Israel, Russia, Hungary, South Africa and South Korea (since December 2009).
Massive capital inflows into EMEs persisted for a while, fueled primarily by carry trades
explained by ex ante uncovered interest rates arbitrage opportunities (Figure 5). The flows
promoted by the excess global liquidity created a sense of exuberance, which in turn
generated mispricing in some assets in many EMEs, meaningful real exchange rate
appreciations and opened the door for potential sudden capital flow reversals. These factors
caused concerns among many countries, in particular about the potential of capital flows to:
a) induce a sharp decline in exports, given the resulting real exchange rate appreciation;
b) produce asset bubbles created by rapid credit expansion, which in turn could result in
financial instability; and c) eventually observing capital outflows, which also could be a
source of financial instability. Most EMEs resorted to at least one of the following defensive
policy measures: (i) the accumulation of international reserves; and/or (ii) the adoption of
macroprudential policies.
Carry to Risk
Index
1.25
Brazil
1.00
Turkey
0.75
South Africa
0.50
0.25
Mexico
0.00
Poland
-0.25
Colombia
-0.50
Jan-06
Apr-07 Apr-11 Apr-15
Aug-08 Dec-09 Aug-12 Dec-13
Note: Carry to Risk is calculated based on the implied spread between local rate and foreign rate in FX
forwards with three-month maturity. This spread is adjusted using the implied volatility in FX options with
three-month maturity.
Source: Central Bank of Mexico using information from Bloomberg.
The accumulation of international reserves by EMEs is a phenomenon interesting to analyze
12th
in detail. Almost two years ago, as he delivered the Stavros Niarchos Foundation Lecture,
Fred Bergsten2 said that "the transmission of all monetary policy occurs to some extent
through the exchange markets". He is absolutely right. Given the sheer size of quantitative
easing in the United States, coupled with the one implemented so far in Japan, it is not
surprising that EMEs domestic currencies suffered sharp appreciations in response. This is
the main reason that some analysts and policymakers have labeled QE as "competitive
easing". In a way, the aggressive accumulation of international reserves by EMEs all the way
to late 2013 (Figure 6) is at least partially the other side of the coin to "competitive easing".
As a matter of fact we might as well call it "competitive reserve accumulation". In most of
the cases, I would agree with this practice, given the blunt distorting effects that QE had
on EMEs. The size of capital flows to this subset of countries was much larger per unit of
time than the capacity of such countries to absorb them without suffering substantial
distortions.
International Reserves
Billions of dollars
14,000
Emerging and Developing Asia
Sub-Saharan Africa
Emerging and Developing Europe Advanced Economies
12,000
Commonwealth of Independent States
10,000
Latin America & the Caribbean
Middle East, North Africa
8,000
6,000
4,000
2,000
0
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1
2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Elaborated by Banco de Mexico using information from International Financial Statistics Database.
International Monetary Fund (IMF).
*Advanced Economies.- Canada, Germany, France, Italy, Spain, Japan, United States & United Kingdom.
Commonwealth of Independent States.- Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan,
Moldova, Russia, Tajikistan, Turkmenistan, Uzbekistan & Ukraine.
Emerging and Developing Asia.- Bangladesh, Bhutan, Brunei Darussalam, Cambodia, China, Fiji, India,
Indonesia, Kiribati, Lao P.D.R., Malaysia, Maldives, Marshall Islands, Micronesia, Mongolia, Myanmar,
Nepal, Palau, Papua New Guinea, Philippines, Samoa, Solomon Islands, Sri Lanka, Thailand, Timor-Leste,
Tonga, Tuvalu, Vanuatu, and Vietnam.
Emerging and Developing Europe.- Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Kosovo,
Lithuania, FYR Macedonia, Montenegro, Poland, Romania, Serbia, and Turkey.
Latin America & Caribbean.- Antigua and Barbuda, Argentina, The Bahamas, Barbados, Belize, Bolivia,
Brazil, Chile, Colombia, Costa Rica, Dominica, Dominican Republic, Ecuador, El Salvador, Grenada,
Guatemala, Guyana, Haiti, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, St. Kitts and
Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, Trinidad and Tobago, Uruguay, and Venezuela.
Middle East & North Africa.- Afghanistan, Algeria, Bahrain, Djibouti, Egypt, Iran, Iraq, Jordan, Kuwait,
Lebanon, Libya, Mauritania, Morocco, Oman, Pakistan, Qatar, Saudi Arabia, Sudan, Syria, Tunisia, United
Arab Emirates, and Yemen.
Sub-Saharan Africa.- Countries in the continent that lie south of the Sahara Desert (such as South Africa).
Therefore, for most EMEs it has been appropriate to throw some "gravel under the wheels"
via international reserve accumulation to mitigate some of the negative externalities that
could take place as a result of the sharp real exchange rate appreciation. Even the contained
appreciation has had real effects, starting with a deterioration of the trade balance, and going
all the way to substantially handicapping some sectors in a variety of countries, such as
manufacturing in Brazil. We have several other recent examples in this regard.
Another important reason to accumulate reserves in the face of QE is that it might avoid
financial instability in the future. As QE will be temporary, countries should prepare
themselves for the reversals of capital, and one way to do so is by accumulating reserves
and by building other backstops (Figure 7). In addition, rapid capital inflows could be used in
the recipient economy in such a way that asset price bubbles or rich valuations could result;
this is of particular concern if such flows are intermediated by the banking system of the
recipient country and they lead to a real estate bubble, which, as we well know, usually are
the source of major crisis. The avoidance of this scenario through reserve accumulation has
been an effective prudential instrument.
Figure 7
Net Non-resident Holdings of Emerging Markets' Government Bonds
Percentage of International Reserves
45
40
35
30
25
20
15
Jul-08 Jul-13
Jan-14
Oct-10 Jun-12
Feb-09 Apr-11
Dec-07 Aug-09 Dec-12 Aug-14
Mar-10 Nov-11 Mar-15
Source: Ministries of finance, central banks and other national authorities.
Note: Average percentage of foreign holdings on local bonds for the following countries: Mexico, Brazil,
Indonesia, Malaysia, Thailand, Poland, Turkey, Israel, Hungary and South Korea (since December 2009).
Of course, in some cases macroprudential measures applied through the banking system
(like loan to value or income to debt limits, and the imposition of higher reserve
requirements), could deliver the same results, and several EMEs have followed this path.
Nevertheless, macroprudential policies are far less effective when capital flows are not
channeled through the banking system, as has been the case with recent cross-border flows
to many EMEs, where market-based financing has been the norm.
As time passed, a gradual deterioration in some EMEs macrofundamentals, in combination
with some major events in AEs that periodically switched the risk-on to off, and vice versa,
(such as the problems with Greece and other countries in the periphery of the Eurozone, the
possibility of a fiscal cliff in the United States, the "whatever it takes" statement by Mario
Draghi3) have made capital flows to EMEs increasingly volatile (Figure 8).
Figure 8
Emerging Economies: Capital Flows (Debt and Equity)
Weekly Billion USD
15
10
5
0
-5
-10
-15
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: Emerging Portfolio Fund Research.
In April/May 2013 the first serious reality check for EMEs arrived. At that time, the global
financial cycle was more clearly transmitted to EMEs, triggered mostly by the start of the
discussion of monetary policy normalization in the United States, that is the "taper talk". This,
together with the correction in commodity prices that has followed the economic slowdown in
China and in most AEs, invited a reevaluation of EMEs' prospects.
The turbulence in EMEs' financial markets that followed was not homogeneous. The most
severe turbulence occured in countries with the weakest fundamentals, mostly judged by the
size of their current account and fiscal deficits. In these cases, sharp depreciations in local
currencies took place, together with disproportionate increases in interest rates, and
plummeting stock markets. National authorities reacted by intervening in the foreign
exchange markets, facilitating the reduction of duration in investors ́ portfolios, and more
importantly, by tightening fiscal and monetary policies. In contrast, many other EMEs
managed to sail through this episode by reinforcing their policy stance, and allowing the
exchange and interest rates to make the adjustments, without any market interventions. We
could say that many EMEs came out strengthened from this period of volatility.
Financial markets were surprisingly calm in late 2013 and the first half of 2014. The tapering
of securities purchases by the Federal Reserve started in January 2014 and proceeded
without unforeseen consequences. At the same time, the Federal Open Market Committee
(FOMC) enhanced the clarity of its forward guidance, creating the expectations of policy rate
adjustments until 2015. In the euro area, major concerns became evident about sluggish
economic growth and massive unemployment, together with inflation rates substantially
below the ECB target. This generated the expectation of significant additional monetary
policy easing by the ECB. Owing to these events, together with the reactivation of the search
for yield, credit spreads compressed and their dispersion fell to unusually low levels, volatility
in all asset classes was supressed and capital flows seemed to recover.
But market conditions started to change considerably for the worse at the beginning of the
second half of 2014. Again, events in the United States and the Eurozone were important
triggers. As the QE tapering was coming to an end in the United States, widespread
speculation about potential dates and modalities of the policy rate lift-off from the zero lower
bound became destabilizing, leading to higher US rates. At the same time, both the Bank of
Japan and the ECB took sequential steps towards additional monetary easing. Worth noting
was the fact that in January of 2015 the ECB initiated a fully-fledged QE program. The
combination of the expectation of the normalization of US monetary policy, with additional
easing in the Eurozone and Japan, have established conditions for euro and yen carry
trades, as the US offers higher yields and an appreciating currency, while low rates make the
euro and the yen attractive funding currencies. This process feeds into itself, as the flows
that it triggers have reinforced the appreciation of the US dollar. Thus it is not surprising that
the US dollar effective appreciation in the 9-month span from July, 2014 to today has been
the largest since 1973 (Figure 9).
Figure 9
USD Appreciation over a 9-month Period1/ and Days it Took
to Reach the Highest Level
Percentage, days
30%
Actual: 25.77%
Financial crisis 2008-2009: 23.98%
25%
20%
Maximum
gain
15%
in
a
10%
9-moth
5%
period
0%
0 30 60 90 120 150 180 210 240 270
Calendar days to realize the gain
1/ The USD appreciation was computed using the DXY Index.
Source: Banco de Mexico's own calculations using data from Bloomberg.
When the United States implemented QE, cross border flows increased to many EMEs. But
now, with the Eurozone and Japanese QE combined with the expectation of an imminent
Fed tightening, together with stronger economic growth in the US even with respect to many
EMEs, flows are going towards the United States, implying tighter external financial
conditions for EMEs.
In addition, also since mid-2014 we have witness a sharp decrease in commodity prices,
especially in oil, which reflects protracted low growth in the world economy, the appreciation
of the US dollar and particular circumstances in specific markets. So what we have seen
recently in EMEs are capital outflows (Figure 10) and continued exchange rate depreciation
(Figure 11), caused to a large extent by the strengthening of the dollar and the sharp
collapse in commodity prices (Figure 12).4
Figure 10
Emerging Economies: Accumulated Capital Flows to Emerging Markets
(Debt and Equity)1/
Billion USD
140
2010
120
2012
100
80
60
2009
40
20
2014
0-20
2011
2013
2015
-40
-60
2008
-80
1 4 7
10 13 16 19 22 25 28 31 34 37 40 43 46 49 52
Weeks
1/ The sample includes funds used to sell or buy equity and bonds from emerging markets registered in
advanced economies. Flows exclude changes in market value of portfolios and changes in foreign
exchange rates.
Source: Emerging Portfolio Fund Research.
Figure 11
Latam FX Depreciation and Broad USD Appreciation
Index 31-Dec-14 =100
80 115
85 110
DXY
90 105
95 100
100 95
105 90
Latam 5 Currency
110 85
Index
115 80
Jul-14
Jan-15
Jun-14 Jun-14 Oct-14 Oct-14
Sep-14 Dec-14 Dec-14 Feb-15
Aug-14 Aug-14 Nov-14
Mar-15 Mar-15
Source: Goldman Sachs Analysis replicated with Bloomberg data.
Note: Latam 5 FX Index is computed using an equally weighted average of the returns in the Mexican Peso,
the Brazilian Real, the Chilean Peso, the Colombian Peso and the Peruvian Sol.
Figure 12
Latam Currency Depreciation Amid Flatter Commodity Prices in 2015
Index 31-Dec-2014 = 100
170 125
160 120
Latam 5 Currency Index
150 115
140 110
130 105
S&P Goldman Sachs
120 100
Commodity Index
110 95
100 90
90 85
80 80
14 14 14 14 14 14 14 15 15 15 15
Jul
Jan
Jun Oct
Sep Dec Feb Apr
Aug Nov
Mar
Source: Goldman Sachs Analysis replicated with Bloomberg data.
Note: Latam 5 FX Index is computed using an equally weighted average of the returns in the Mexican Peso,
the Brazilian Real, the Chilean Peso, the Colombian Peso and the Peruvian Sol.
From the above, I hope that I have made the case that the initiation of the unwinding of the
UMP in the United States, certainly without being the sole contributor, has induced a
noticeable increase in volatility in financial markets, in particular in EMEs. In a way this could
be surprising, since the fact that the Fed is in a position to contemplate the full normalization
of its monetary policy stance signals that the economic recovery has almost been
consolidated in the context of price stability. This constitutes really good news for the United
States, EMEs and the world as a whole. But my fear is that during this transition period the
overextension of "financial risk-taking" is overwhelming the usual market responses. Let me
illustrate this with a simple example. In the pre-crisis period, good figures in the US nonfarm
payroll data generated an appreciation in EMEs currencies, given that a strong US economy
meant a positive impulse for their exports. In the post-crisis period, and more markedly in
recent times, a positive surprise in US payroll data generates depreciations of EMEs
currencies, given that such surprises makes market participants anticipate an earlier lift-off in
the US police reference rate (Figure 13)!
Figure 13
Percentage Change in the Foreign Exchange Rates per unit of Difference Between the
Expected Nonfarm Payrolls Data and the Observed
Percentage
South Africa*
Hungary
Mexico*
Peru
Peru*
Poland
Chile
Mexico**
Colombia*
South Africa
Brazil
Colombia**
Hungary
Chile***
Thailand
Turkey*
Poland
Brazil**
Turkey
008% 006% 004% 002% 000% 002% 004%
.002% .000% .002% .004% .006% .008% .010%
Note:*** p<0.05, ** p<0.15, *p<0.3. The percentage was calculated using a regression where the dependent
variable is the percentage change on the exchange rate for each developing country currency and the
independent variable is the difference between the expected Nonfarm Payrolls data and the observed.
In light of the complex external environment described above, central banks in EMEs are
currently facing significant challenges with respect to the conduction of monetary policy. On
the one hand, regarding domestic conditions, economic activity has lost momentum and
growth prospects have been revised downward. Furthermore, low energy prices have put
also downward pressure on inflation. On the other hand, with respect to external factors, the
imminent normalization of monetary conditions in the US have already triggered periods of
financial turbulence and, accordingly, EMEs have experienced exchange rate depreciations,
resulting oftentimes in higher inflation expectations.
In this scenario, central banks in EMEs have to weigh both internal and external
determinants of inflation, since they can point towards opposite policy actions. Thus, the
assessment of the appropriate monetary policy stance has become a more difficult task.
In order to determine to what extent central banks in small and open economies react to
changes in the monetary policy stance in the US, I estimated two specifications for the Taylor
Rule for a number of economies. The first one corresponds to a traditional (or conventional)
Taylor Rule where central banks take into account the output and the inflation gaps when
setting the policy rate. Then, I augment the Taylor Rule with the US policy rate and also with
the so-called shadow policy rate from 2008 onwards. The shadow rate accounts for the
effects of QE once the policy rate reached the zero lower bound, and is taken from the work
of Wu and Xia (2014). In sum, the shadow rate is an indicator of the degree of monetary
policy easing.
The estimations show that in most cases, including Mexico, monetary conditions in the US
have a statistically significant effect on EMEs policy rates (see Appendix).
That is, in response to a more accommodative monetary policy stance in the US, central
banks in EMEs have reduced their policy rate. This means that the inflation and output gaps
do not capture all the impact of external events on the domestic economy and, accordingly,
central banks react to the US monetary conditions (Figure 14 for the case of México). As Rey
(2013) has suggested, the U.S. monetary policy is a key determinant of the so-called global
financial cycle. In turn, monetary authorities in EMEs care about the impact of such cycle on
their domestic economies and, accordingly, take into account the evolution of monetary
conditions in the US when assessing their appropriate monetary policy stance. This situation
seems to have intensified after the GFC.
Figure 14
Taylor Rule for Mexico (augmented)1/:
6.0
5.5
No Fed
5.0
4.5
Observed MQE: 1.38
Fed
4.0
3.5
3.0
MQE: 0.13
2.5
2.0
Jun-10 Jun-11 Jun-12 Jun-13 Jun-14
Oct-10 Oct-11 Oct-12 Oct-13 Oct-14
Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Feb-15
Looking ahead, given the imminent normalization of monetary conditions in the US, it could
be expected that central banks in EMEs will increase their policy rates as the Federal
Reserve adjust upwards the federal funds rate. This might happen even if the domestic
economic conditions do not justify a policy rate increase. Although the baseline scenario is
one of a gradual and orderly normalization of US monetary conditions, episodes of financial
turbulence cannot be discarded. Under these circumstances, authorities might not only need
to increase their policy rate, but also might be forced to intervene in key financial markets,
namely the forex and money markets, in the later case to facilitate the adjustment of duration
in portfolios of domestic sovereign securities. These unorthodox market intervention by
central banks would be pertinent if, as it is likely, market liquidity dries up during stress
episodes. Precisely for this reason, I have mentioned the need for EMEs to have additional
backstops, for example the IMF ́s Flexible Credit Line (FCL).
The fact that EMEs would have to adjust their monetary policy rate due to external conditions
(i.e. Federal Reserve policy adjustments), overwhelming domestic ones (inflation and growth
gaps), makes it obvious that they cannot depend solely on monetary policy to achieve the
ultimate policy goal, which is to reach faster and sustainable growth and simultaneously
consolidate financial stability. In this sense macro-relevant structural reforms, together with
strong fundamentals, becomes of the essence. This is the path that Mexico has followed.
* * *
Let me conclude with a brief commentary on the International Monetary System (IMS). It is
fair to say that the IMS is in transition and much remains to be done to make it more stable
and adapt it to the challenges of the twenty-first century.
The global economy is becoming more multi-polar and interconnected, underpinned by rapid
structural growth in large EMEs. Dynamic EMEs generally exhibit lower levels of financial
development and global integration than their more advanced peers, suggesting scope for
catch-up. This transition raises challenges and provides opportunities, and how it will take
place has important implications for financial stability and growth, and for the architecture of
the IMS and its efficacy.
Despite some reforms after the GFC, question marks remain about the resilience of the IMS.
Incremental steps have been taken to strengthen policy collaboration, monitor and manage
capital flows, and broaden the financial safety net. However, more fundamental IMS reforms
to address sources of instability, have remained on a backburner. A key concern, developed
in my presentation, has been that monetary policy decisions by AEs can create large
spillovers, especially for EMEs, so some form of coordination is urgently needed.
The international community has an opportunity to facilitate and shape a virtuous further
integration of major EMEs into the global economy, while in the process addressing some
long-standing weaknesses of the IMS. These can be achieved by:
- First: Providing incentives and support for EMEs to join existing governance
structures, including by adapting those structures to their needs and ensuring fair
representation, which would help prevent fragmentation and duplication, and
promote deeper, more substantive global policy dialogue.
- Second: Orderly, well-sequenced financial deepening and opening in key EMEs
could deliver substantial welfare gains for these countries, along with positive global
spillovers and stability gains for the IMS, as deeper domestic financial markets
would promote domestic demand, facilitate greater reliance on exchange rates to
achieve external adjustment and thereby help reduce global imbalances, and
improve the ability to cope with capital flow volatility. Increased opportunities for
asset diversification, both domestically and at the global level, would provide
additional welfare gains.
- Third: Finally, further broad efforts are needed to strengthen and close gaps in the
global financial safety net, and avoid the need for costly and distortionary reserves
accumulation. Certainly, this implies reaching the point of full implementation of the
2010 Governance Reforms at the IMF, which would increase its lending capacity
based on quotas, and enhance the voice and representation of EMEs. This would
enrich the IMF ́s credibility, efficiency and legitimacy, placing the institution in a
stronger position to improve the functioning of the IMS.
Thank you very much.
References
1) Bergsten, Fred. (2013). "Currency Wars, the Economy of the United States and
Reforms of the International Monetary System". 12th Stavros Niarchos Foundation
Lecture. Peterson Institute for International Economics.
2) Carstens, Agustin. (2014). "Monetary Policy and Balance Sheet Adjustment". In
Monetary Policy in a Changing Financial Landscape. 2014 ECB Forum on Central
Banking Proceedings.
3) Carstens, Agustin. (2013). "Monetary Policy Options and Tools". In Global
Dimensions of Unconventional Monetary Policy. 2013 Jackson Hole Symposium
Proceedings. Federal Reserve Bank of Kansas City.
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