Asia School of Business, established in 2015 by Bank Negara Malaysia and MIT Sloan School of Management, is a leading school of management with a mission of developing transformative and principled leaders who will contribute to a better future and the advancement of the emerging world. ASB offers a Master of Central Banking program, a rigorous residential program offering a uniquely central banking-focused curriculum designed to equip central bankers for the challenges of the future.
Central banks face several challenges in emerging markets. The International Monetary Fund often visits member countries to consult with the financial authorities (mainly the finance ministries and central banks) on the country’s overall economic outlook and policy strategies they can follow in dealing with challenges. One of the main topics often dealt with during these exchanges includes the effects of volatile capital flows on a nation’s domestic economy.
Prior to 2012, the IMF stressed the importance of avoiding restrictions on capital flows and movement towards free international capital mobility without embargoes on the management of exchange rates. However, practically, many countries felt that sudden surges or reverses of capital inflows could be disrupted.
The best way to deal with them was using policy tools such as interventions in the foreign exchange market for better moderation of exchange rate consequences and the introduction of macroprudential policies that guarded against the buildup of financial risks.
However, such policies became taboo or a last recourse. Nonetheless, various nations are of the view that the foreign exchange rate should be reformed as part of an integrated policy framework, which can be used together with more conventional monetary and fiscal policies.
The Speakers
In a recent webinar, as part of its Conversations on Central Banking series featuring seasoned central bankers, Asia School of Business hosted two distinguished and highly experienced panelists who provided their perspectives on the question of how an integrated policy framework can benefit emerging economies:
Panelist—Jose de Gregorio, Former Governor of the Central Bank of Chile
Jose de Gregorio has served as the Governor of the Bank of Chile (2007-2011) as well as a Vice-Governor (2003-2007), and as a member of the Bank of Chile’s board (2001-2003). Currently, he is a professor and Dean at the School of Economics and Business at the University of Chile.
Panelist—Veerathai Santiprabhob, Former Governor, Bank of Thailand
Veerathai Santiprabhob began his career working at the International Monetary Fund and was responsible for advising central banks and governments of member countries. Thereafter, he served as the co-director of the Economic Policy Research Institute, Fiscal Policy Office, at the Ministry of Finance. He has contributed significantly towards challenges associated with financial institutions and economic stimulus measures.
The moderator of the webinar was Hans Genberg, Professor of Economics and Senior Director of Central Banking and Finance programs at Asia School of Business. Let’s take a look at the key takeaways from the hour-long discussion.
Relevance of an Integrated Policy Framework
The discussion began with former Governor Veerathai Santiprabhob highlighting his views on dealing with capital flows. Regarding emerging market economies and small open economies, he spoke about how the IMF, while sticking to their institutional views on different policy tools, continues to be open to discussions of an integrated policy framework, which is ultimately highly beneficial.
The relevance of an integrated policy framework has become even more relevant in a post-COVID-19 world: central banks of advanced nations are easing monetary policy restrictions even more now, as compared to the easement seen in the aftermath of the global financial crisis. This aggressive easement has led to an excess of global liquidity or a platform for investors to invest in emerging markets.
“The first challenge when we talk about an integrated policy framework that the IMF started, they look at four main policies—the monetary policies, macro prudential policies, foreign exchange intervention, and capital flow management measures. But as we know, fiscal policy is also very important. As we all know, in the current COVID environment, fiscal policy is the main policy tool in stimulating the economy.” — Veerathai Santiprabhob
In this context, he stated that the two biggest sources of volatility in capital flows are excess global liquidity and investor risk appetite. He believes that an integrated policy framework becomes more relevant for central banks of emerging market economies because their respective policy spaces and fiscal spaces have become very limited.
Therefore, the need of the hour is to think in terms of optimum policy tool combinations to achieve multiple objectives. Another aspect is dealing with the effect of capital flows on overall economic stability, as well as trade channels, which in turn puts pressure on the exchange rates.
Learning from Models, Data, and Judgement
Former Governor Jose de Gregorio also stated that the integrated policy framework of the IMF is a useful step forward, based on sound economic principles and that the challenge lies in bridging economic conclusions from models to real policy-making across diverse economic structures.
He used Chile’s example to discuss whether one should use capital controls, a topic that has been long politicized. In one case, there is a central bank board that can independently use macro-prudential regulations, financial regulations, and foreign exchange interventions from time to time.
On the other hand, capital controls in place today mimic the controls used since the 90s and are not necessarily relevant in today’s volatile ecosystem. While some may argue that central banks ought to continue to use capital controls as a toolkit of the IMF, it needs to be done in a way that suits each nation’s requirements.
Perspectives on Capital Controls
Conceptually, said Gregorio, if all capital inflows were taxed, that would be a capital control that could work. However, practically, there are many contracts as well as institutional and economic reasons which end up excluding foreign investment.
“…if capital is flowing into a country, it enters through a foreign entity or person, as they have less control, through portfolio investments, instead of bank debt.” — Jose de Gregorio
Therefore, the very effectiveness of capital controls is a big question, and it varies from one country’s economy to another.
Summing it up
The webinar witnessed lively participation in terms of the use of various policy instruments by central banks. It also focused on practical challenges to the integrated policy framework involving monetary policy for exchange market intervention, creating tensions about legitimacy, organization, governance, and coordination within an economy.
As part of this series, ASB was privileged to host an excellent lineup of experts, professionals, and practitioners who discussed and shared their views on various other sessions in this webinar series.
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