With interest rates at historically low levels, and some even in negative territory, and after deploying extraordinary credit-support programmes, central banks have set about managing the size and composition of their balance sheet as a monetary policy instrument, through the so-called quantitative easing programmes. Under QE, the Eurosystem purchases outright on the secondary market private and public debt instruments, the former encompassing covered bonds, securitisations and corporate debt, and the latter securities issued by governments, European agencies and, since December 2015, regional and local governments. Cumulative asset purchases over the period of almost two years in which the purchase programme has been in place now stand at around € trillion, with public debt securities accounting for over 80%. The extension of the asset purchase programme until the end of 2017, at least, will mean that the volume of assets acquired by the Eurosystem may exceed € trillion, tantamount to around 20% of euro area GDP. European structural and governance reforms Euro area governments have focused their reform efforts since 2010 on two fronts: i) European Union institutions and euro area governance arrangements; and ii) domestic structural reforms. In the area of governance, the reforms were initially geared to strengthening national budgetary policy surveillance mechanisms, extending the multilateral surveillance perimeter to macroeconomic imbalances and agreeing on the creation of the European Systemic Risk Board, the new European body entrusted with macroprudential supervision.

These capital flows—a significant portion of which are non-resident activities—are more sensitive to global financial conditions which have been dictated largely by monetary policy stance of AEs and global investors’ sentiment rather than textbook-determinants like macroeconomic conditions in EMs and interest rate differentials. Moreover, due to the large foreign-exchange activities by non-residents relative to the size of domestic foreign exchange markets and increases in derivatives and algorithmic foreign exchange trading activities, exchange rate could at times act as an amplifier as opposed to a stabilizer of shocks and capital flows, especially in EMs with strong external positions that are considered as safe haven like Thailand. While capital flows in and out of EMs might be small relative to global financial activities, they could have real and significant impacts on the EM economies through the exchange rate channel. Concerning volatile exchange rate movements that could undermine financial stability, capital flows could affect EMs’ monetary policy stance. For example, in the low-for-long interest rate environment, EMs may need to follow AEs in delaying or reversing normalization of monetary policy to avoid appreciation of their currencies. Because of spillovers, monetary policy of EMs could be distracted from their core domestic policy mandates. The delayed normalization in the low-for-long or negative-for-long interest rate environment further exacerbates financial stability risks. Debts—both household and corporate— are now reaching historic highs. Emerging nations, often with nonbank financial activities outside the regulatory perimeter, are more susceptible to risk buildups. Financial spillovers need to be addressed at multiple levels.