Second, according to the IMF Articles, countries are free to choose their capital account and exchange rate regimes with the proviso that they do not engage in currency manipulation. This is a basic pillar of our current system. The proviso has proved very difficult to define, let alone to implement. The IMF has met with some difficulties in trying to set up an efficient a symmetric process of multilateral surveillance. And, third, we live in a world of greater interdependence and complexity. International capital flows have made countries truly interconnected. The monetary and financial system has become “multipolar”. An increasing number of countries, both developed and emerging, have become active participants in the global capital market. Spillovers between national monetary and economic policies have multiplied. And no country can truly be indifferent to actions taken by others. In current circumstances, those three basic realities have become much harder to reconcile. Divergences in monetary policies are unavoidable given the uneven paths of recovery across the world. And, for each country, this may be a time where price and financial stability objectives may not coincide. In advanced economies, monetary easing, together with inhibitions on credit growth, creates a potential for further financial imbalances. In many emerging countries, inflationary pressures would warrant monetary tightening but there is a clear risk this would trigger destabilizing capital inflows. In those circumstances, there is a major role to play for macro prudential policies. For advanced economies, they should aim at spurring credit growth, while increasing the resilience of the financial sector.

First, conducting monetary policy based on the view that potential is permanently lower – without clear evidence that this is the case – could prove self-fulfilling and costly. The evidence increasingly shows that destroying demand also affects supply. Research on recessions over the last fifty years has found that deep contractions – including those driven by monetary policy – lead to long-lasting effects on real GDP compared to the pre-contraction trend. [20] This suggests that current macroeconomic policies should be designed to avoid unnecessarily heightening the risk that the increasingly likely contraction in coming months becomes a severe and protracted one, which would scar the economy. This requires that energy and fiscal policies remain targeted and contribute to dampen inflationary pressures, helping to keep inflation expectations anchored while preserving productive capacity. But it also requires that monetary policy does not ignore the risks of overtightening. [21] If we were to compress demand in an excessive and persistent manner, we would face the risk of also pushing output permanently below trend, irrespective of whether the initial shocks were temporary or not (that is, even if a harsh policy reaction was unnecessary). And that could not be easily reversed by subsequent policy easing, not least because expansions do not rebuild supply nearly as much as contractions destroy it. [22] Second, even if we were to conclude that supply shocks will lower potential durably, we would still need to examine their effects on demand before deciding our policy stance.