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The Multilateral Aspects of Policies Affecting Capital Flows Karl Habermeier, Assistant Director Mark Stone, Deputy Division Chief Monetary and Capital.

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Presentation on theme: "The Multilateral Aspects of Policies Affecting Capital Flows Karl Habermeier, Assistant Director Mark Stone, Deputy Division Chief Monetary and Capital."— Presentation transcript:

1 The Multilateral Aspects of Policies Affecting Capital Flows Karl Habermeier, Assistant Director Mark Stone, Deputy Division Chief Monetary and Capital Markets Department December 20, 2011 December 20, 2011

2 Context Fund is undertaking considerable work on policies affecting capital flows Fund is undertaking considerable work on policies affecting capital flows Motivated by: Motivated by: Greater cross-border interconnectedness Greater cross-border interconnectedness Experience of the crisis Experience of the crisis G-20 and IMFC have called for a “comprehensive, balanced and flexible approach for managing capital flows” G-20 and IMFC have called for a “comprehensive, balanced and flexible approach for managing capital flows” The current work-stream follows on the view developed at the Fund 10 years ago The current work-stream follows on the view developed at the Fund 10 years ago

3 Fund capital flow work-stream The Fund’s role regarding flows (December 2010) The Fund’s role regarding flows (December 2010) Experiences in managing capital inflows (March 2011)— framework for capital flow management measures (CFMs) Experiences in managing capital inflows (March 2011)— framework for capital flow management measures (CFMs) Multilateral aspects (today) Multilateral aspects (today) Focus on source countries Focus on source countries Focus on broad array of policies Focus on broad array of policies Capital outflows and capital acc. liberalization—March 2012 Capital outflows and capital acc. liberalization—March 2012 Chapeau paper—mid-2012 Chapeau paper—mid-2012

4 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

5 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

6 Stylized fact 1: intra-AE gross flows embed potential systemic risks Previous focus on net flows to EMEs, and on the composition of flows Previous focus on net flows to EMEs, and on the composition of flows The recent crisis showed that gross flows between AEs can be destabilizing The recent crisis showed that gross flows between AEs can be destabilizing Flows to EMEs originate from the same small group of AEs that dominate inter-AE flows Flows to EMEs originate from the same small group of AEs that dominate inter-AE flows Implication: strong transmission of AE policies Implication: strong transmission of AE policies

7 Figure 1. Global Capital Flows

8 Stylized fact 2: Global SIFIs bear directly on the riskiness of capital flows Volatile bank flows suggests banks did not internalize the associated risks Volatile bank flows suggests banks did not internalize the associated risks Expansion in portfolio flows means a larger share of capital flows outside of regulation Expansion in portfolio flows means a larger share of capital flows outside of regulation Business model of many G-SIFIs model helped drive an increase in shadow banking and global liquidity Business model of many G-SIFIs model helped drive an increase in shadow banking and global liquidity Implication: G-SIFI regulation is important Implication: G-SIFI regulation is important

9 Stylized fact 3: The volume and volatility of EME capital flows are on upward trends Gross EME inflows more volatile Gross EME inflows more volatile Net EME capital flows remain large Net EME capital flows remain large Capital inflows have been trending upwards in EMEs Capital inflows have been trending upwards in EMEs Declines in home bias in AEs Declines in home bias in AEs Widening growth differentials Widening growth differentials Financial market development Financial market development Implication: transmission of AE policies may get stronger Implication: transmission of AE policies may get stronger

10 Figure 2. Volatility in Capital Flows (Coefficient of variation in percent) Figure 3. Trends in Gross and Net Flows (Hodrick-Prescott filtered series, billions of U.S. dollars) Sources: World Economic Outlook and staff calculations.

11 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

12 AE regulation and supervision: motivation Traditional focus: national microprudential Traditional focus: national microprudential Limited attention paid to cross-border issues Limited attention paid to cross-border issues Crisis showed shortcomings in R&S that transmitted across borders Crisis showed shortcomings in R&S that transmitted across borders Paper looks at the recent past, present and future of AE regulation and supervision Paper looks at the recent past, present and future of AE regulation and supervision

13 AE regulation and supervision: the recent past Five specific cross-border risks not adequately appreciated by supervisors 1.Foreign exchange liquidity risk—e.g. large European banks, AE banks in Europe EMEs, AIG 2.Counterparty risk—exposure to AIGFP, US MMMFs

14 AE regulation and supervision: the recent past 3.Indirect exchange rate risk—Fund in FX and lend in FX to borrowers who earn in LC 4.Mortgage market risk—National mortgage market risks transmitted globally 5. Credit concentration risk—Foreign affiliates concentrated in regions

15 AE regulation and supervision: summary of the recent past These risks contributed to cross-country stress and undermined confidence in the global system These risks contributed to cross-country stress and undermined confidence in the global system Regulatory perimeter is key policy implication Regulatory perimeter is key policy implication Macroprudential perspective needed Macroprudential perspective needed Problem of lack of feedback to large countries undermining their incentives Problem of lack of feedback to large countries undermining their incentives Box 2 has specific policy recommendations Box 2 has specific policy recommendations

16 AE regulation and supervision: the present Discussion in the paper already a little dated! Discussion in the paper already a little dated! Systemic financial stress is on the rise Systemic financial stress is on the rise Low interest rates having subtle effect Low interest rates having subtle effect Flows are already becoming more unstable Flows are already becoming more unstable R&S reform urgently needed to mitigate these risks R&S reform urgently needed to mitigate these risks

17 AE regulation and supervision: the future Enormous agenda now underway Enormous agenda now underway But progress has been mixed But progress has been mixed This means regulatory arbitrage opportunities This means regulatory arbitrage opportunities Capital and liquidity requirements Capital and liquidity requirements Carving out of risky activities Carving out of risky activities Financial markets Financial markets Supervisory perimeter Supervisory perimeter Downside reform dynamic must be avoided Downside reform dynamic must be avoided

18 AE regulation and supervision: policy messages Crisis taught us that national R&S has important multilateral effects Crisis taught us that national R&S has important multilateral effects Completing national R&S reform is win-win Completing national R&S reform is win-win Complete and implement national macroprudential frameworks Complete and implement national macroprudential frameworks Complete and implement international architecture reforms Complete and implement international architecture reforms Cross-border coordination Cross-border coordination

19 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

20 AE monetary policy: overview Big issue is whether expansionary US MP increased flows to EMEs after crisis Big issue is whether expansionary US MP increased flows to EMEs after crisis Channels Channels Interest rate differentials Interest rate differentials Growth differentials Growth differentials Literature review: powerful effect Literature review: powerful effect Based on pre-crisis Based on pre-crisis Overall effect Overall effect Differences across investors and types of flows Differences across investors and types of flows

21 AE monetary policy: QE impact on long-term interest rates ZLB prompted Fed and BoE shift to QE to lower long-term yields ZLB prompted Fed and BoE shift to QE to lower long-term yields QE—Bond purchases for macro purposes QE—Bond purchases for macro purposes Most empirical analysis based on event studies— QE1 reduced yields by 50 basis points, QE2 smaller Most empirical analysis based on event studies— QE1 reduced yields by 50 basis points, QE2 smaller The interest rate effect likely increased capital flows to EMEs The interest rate effect likely increased capital flows to EMEs

22 AE monetary policy: other QE channels QE can narrow growth differentials and thus reduce flows to EMEs QE can narrow growth differentials and thus reduce flows to EMEs Some model-based evidence of domestic growth effect Some model-based evidence of domestic growth effect Counterfactual of no QE could have led to much sharper world recession Counterfactual of no QE could have led to much sharper world recession

23 AE monetary policy: conclusion Weak case for active consideration by central banks of multilateral effects Weak case for active consideration by central banks of multilateral effects Clear-cut case when domestic and multilateral objectives coincide Clear-cut case when domestic and multilateral objectives coincide But usually very difficult to assess But usually very difficult to assess Issue of mandate of large AE central banks Issue of mandate of large AE central banks Fully effective R&S of AEs would help Fully effective R&S of AEs would help

24 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

25 Capital flow management measures: background CFMs are administrative, tax, and prudential measures designed to influence capital flows CFMs are administrative, tax, and prudential measures designed to influence capital flows Two flavors: Two flavors: “Capital controls”—discriminate on the basis of residency “Capital controls”—discriminate on the basis of residency “Other measures”—do not discriminate on the basis of residency e.g. some macroprudential measures “Other measures”—do not discriminate on the basis of residency e.g. some macroprudential measures Renewed popularity has led to new cycle of work Renewed popularity has led to new cycle of work CFMs can effectively manage inflows in a policy package CFMs can effectively manage inflows in a policy package Can have adverse effects domestically Can have adverse effects domestically Unilateral impact seems to be limited Unilateral impact seems to be limited

26 Figure 4. Capital Flows Management Measures and Related Measures Source: IMF Country Desks

27 Capital flow management measures: multilateral aspects Focus here on CFMs aimed to address inflows Focus here on CFMs aimed to address inflows CFM can be expected to reduce asset prices and inflows in the home country CFM can be expected to reduce asset prices and inflows in the home country CFMs could transmit multilaterally via capital flows to likewise countries with similar characteristics: CFMs could transmit multilaterally via capital flows to likewise countries with similar characteristics: Divert flows and increase asset prices and inflows in likewise Divert flows and increase asset prices and inflows in likewise Reduce flows and decrease asset prices and inflows in likewise Reduce flows and decrease asset prices and inflows in likewise Event studies suggested CFMs can increase or decrease flows to likewise countries Event studies suggested CFMs can increase or decrease flows to likewise countries

28 Capital flow management measures: implications As of today, CFMs seem to have limited implications for the riskiness of flows As of today, CFMs seem to have limited implications for the riskiness of flows Modest unilateral effectiveness Modest unilateral effectiveness Inconclusive multilateral transmission Inconclusive multilateral transmission Market participants view them as ineffective Market participants view them as ineffective Downside risk of CFM proliferation Downside risk of CFM proliferation Adverse dynamic (trade wars) Adverse dynamic (trade wars) Closure of capital accounts limits benefits of capital flows Closure of capital accounts limits benefits of capital flows

29 Organization of presentation Reconsidering the stylized facts of capital flows Reconsidering the stylized facts of capital flows Advanced economy regulation and supervision and global reforms Advanced economy regulation and supervision and global reforms The impact of advanced economy monetary policy on capital flows The impact of advanced economy monetary policy on capital flows Capital flow management measures Capital flow management measures Conclusions and extension of the proposed framework Conclusions and extension of the proposed framework

30 Extension of policy framework Bottom line: national authorities should pay more attention to policy transmission, especially prudential Bottom line: national authorities should pay more attention to policy transmission, especially prudential Fund previously proposed framework to address domestic aspects of CFMs for recipient countries Fund previously proposed framework to address domestic aspects of CFMs for recipient countries This paper proposed extending framework to help: This paper proposed extending framework to help: policymakers understand how risks transmit across borders policymakers understand how risks transmit across borders promote policy coordination promote policy coordination

31 Extension of policy framework National supervisors should understand risk cross-border transmission and be prepared to take countervailing measures National supervisors should understand risk cross-border transmission and be prepared to take countervailing measures National supervisors should have the appropriate capacity and perimeter National supervisors should have the appropriate capacity and perimeter Macroprudential policy should account for capital flows, and coordinate across countries Macroprudential policy should account for capital flows, and coordinate across countries Complete and fully implement the ongoing international architecture reforms Complete and fully implement the ongoing international architecture reforms

32 Reaction to paper Broad agreement by Directors on the conclusions of the paper Broad agreement by Directors on the conclusions of the paper Discussion of AE monetary policy Discussion of AE monetary policy Discussion of applicability of extension of the framework Discussion of applicability of extension of the framework Extensive press coverage Extensive press coverage Next steps Next steps Paper on capital account liberalization Paper on capital account liberalization Chapeau paper Chapeau paper

33 Questions


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