The IMF is reviewing its approach to unorthodox central bank tools such as currency intervention and capital-flow management as it looks to create a modern policy framework that better reflects the needs of developing economies in a more integrated global market system.
The move marks a departure from its traditional role as an advocate of conventional monetary policy.
The Fund is in talks with a number of countries, finance ministers and central banks to devise a new integrated policy framework, David Lipton, first deputy managing director of the IMF, tells Euromoney.
“Our aim is that over time we will be able to have a more complete playbook to help [central banks],” he says.
“Our advice will be to countries that are free sailing in choppy waters, which is different to a programme or a crisis. A lot of the work we are doing is focused on macro prudential tools and capital-flow measures to modulate the breadth of the likely outcomes and avoid extreme booms and busts.”
These markets are so big that even a sizeable intervention won’t make a huge difference- David Lipton, IMF
Free markets, a liberalized exchange rate and an open economy have been central tenets of the IMF’s advice on monetary policy since the Fund was formed in 1945, but greater dollarization and integration of financial markets has meant that smaller economies are now more exposed than ever to global market forces, prompting a re-think on its advice.
The framework proposes greater integration between fiscal and monetary policy measures, moving the dial further in the direction of manual management and giving central banks more authority to intervene where necessary.
“Since 2000, countries have gravitated to inflation targeting with flexible exchange rates and open capital markets, but now in a world which has seen more volatile capital flows, and where capital flows and risk-on risk-off sentiment are more important, we are starting to see countries experiment with alternative approaches to these instruments,” says Lipton.
Economists are welcoming the re-think, nothing that the Fund not only operates in a very different market environment from 10 years ago, but that its most influential members – such as China – are pursuing and operating disparate policy paths.
“Small open economies and emerging-market central banks are like little boats when the big tankers go by, they are integrated into the global economy,” says Elina Ribakova, deputy chief economist at the Institute of International Finance.
“If you think about how the IMF developed, it was for trade shock,” she says. “The idea was that if you let capital flow freely, there would be no problems. But now they are acknowledging the degree of integration in financial cycles is unprecedented, and local central banks don’t have as much autonomy as they would like to.”
But in the context of global trade wars and rising protectionism, a direct endorsement of capital controls from the IMF could be a dangerous tool. As such, the IMF is being extremely careful about how it goes about its work and analysis, and how it frames the results, Lipton says.
The IMF’s new framework will initially feed into its ongoing surveillance advice, rather than link to any emergency lending programmes such as the Extended Fund Facility or Standby Credit Agreements.
It also does not represent a change in the IMF’s attitude towards currency pegs.
“We don’t tell a country that it should have a peg or a floating exchange rate; it is their choice,” says Lipton, explaining that the IMF would focus its advice on the consequences of the choice the country has already made.
Charles Enoch, a former IMF staffer now at St Anthony’s College, Oxford, explains that programme reviews are informed by the findings of the IMF’s surveillance work, and those findings will likely feed into the structure of any new programmes.
“They will look at Argentina [and consider] was the advice in line, what was missed and was total liberalization appropriate,” he says.
We see strong value in allowing the currency to float and running a non-interventionist policy to build that buffer- Christopher Loewald, South African Reserve Bank
Through case studies, theoretical analysis and empirical modelling, the IMF is analysing and mapping the effectiveness of more heterodox approaches to monetary policy, says Lipton.
Some of the preliminary insights are obvious. In large countries with deep capital markets and large foreign exchange reserves, such as the US or Japan, traditional monetary policy tools and flexible exchange rates make sense, Lipton says.
“These markets are so big that even a sizeable intervention won’t make a huge difference.”
But in emerging markets, with shallower capital markets, less FX liquidity and where capital flows are large compared to the size and depth of the financial sector, “we see when we model it that there are some cases where FX intervention can be effective in stabilizing the economy,” Lipton says.
Pressure on central banks
The review comes at a time when central banks worldwide are coming under pressure to take on untraditional roles such as delivering economic growth.
Bank of England Governor Mark Carney recently called on central banks to play a greater role in addressing climate change, saying that the issue had become a financial stability risk.
But for some central bankers, any encroachment on traditional monetary policy is seen as tantamount to political pressure.
“There is a group that is following very orthodox policies, and they are worried we may say that anything goes, and they fear they might be subject to criticism at home from people who have doubted their policies,” says Lipton.
South Africa and Russia in particular have been vocal about not wanting to move away from the one objective, one policy tool, says the IIF’s Ribakova.
“We see strong value in allowing the currency to float and running a non-interventionist policy to build that buffer,” Christopher Loewald, head of economic research at South African Reserve Bank, told audience members at the IIF’s Annual Meeting in Washington DC in October.
Mauro Alessandro, head of economic research at the Central Bank of Argentina, said that there is already too much pressure on central banks to offset the impact of external market factors.
“I feel pressure on central banks,” he said. “There is an integrated framework, but the common denominator is that [monetary policy] instruments have a temporary effect. All a central bank can do is buy time, but the real factor needs a real solution.”
Others, such as Turkey, are welcoming the changes. Ankara has used several unorthodox measures – currency forwards, swaps, and providing access to reserve requirements – to help its corporates manage their heavy reliance on foreign exchange
“It has become increasingly difficult for emerging-market central banks to follow monetary policy independent from the global cycle,” said Ugur Kucuk, deputy governor of the central bank of the Republic of Turkey, at the IIF gathering.
“We need more studies from the IMF and BIS. We need more evidence to support [our] policies better and to share with our investors.”
The framework, which has not yet been finalised, will mark a departure from the IMF’s original mandate and central tenet of inflation targeting for central banks, but is part of the gradual evolution of the fund, says JC Sambor, deputy head of emerging markets fixed income at BNP Paribas Asset Management.
“What you have seen is much more of an inclusive mandate from the IMF,” he says. “I was getting some information on the website recently and I was surprised to see all the information on inclusive growth and working papers on green financing. That would never have happened 10 years ago. Then, it was all balance of payments and fiscal.”
[Olivier Blanchard] said capital controls could be a very good thing. It was like leaving a bomb- JC Sambor, BNP Paribas Asset Management
In addition, Sambor says the stewardship of the IMF’s new president Kristalina Georgieva, the increasing influence of the Fund’s emerging-market members, as well as China’s weight in policy discussions, may accelerate the changes.
“When you have more people from China at the IMF, it is possible to re-think the framework,” he says. “You can’t be so naïve on the distinction between fiscal and monetary policy when you have senior people coming from China where they don’t make such a clear cut distinction.”
For Sambor, the changes are long overdue. Challenges to the IMF’s framework were publicly mounted by Olivier Blanchard, the IMF’s chief economist from 2008 to 2015, who was frequently quoted on the benefits of selective and timely capital controls and a more inclusive approach to fiscal policy.
At one of his last public appearances as chief economist, Blanchard again called on the IMF to reconsider its approach to capital controls. The speech surprised some market participants.
“I was attending the speech, and he said capital controls could be a very good thing," says Sambor. "It was like leaving a bomb. It was a very good thing to say, that you need to rethink the overall framework."
Integrating the IMF’s approach to fiscal and monetary policy more closely could address one of the failings of the Fund, according to Enoch, the former IMF staff member.
“Integrating the financial side into IMF surveillance is where the Fund has historically struggled,” he says. “Simple monetary policy was not enough; you needed to consider the instruments available as a holistic way to analyse economies.
“Why didn’t the Fund warn about the financial crisis in 2008? That is because there were some guys writing the financial stuff, and others about the macro stuff, but it did not blend.”He says the new thinking marks the Fund’s development from firefighting crisis management in the first part of the decade to longer-term thinking as countries such as Greece emerge from the crisis.