A BROAD VIEW OF MACROECONOMIC STABILITY

1. A BROAD VIEW OF MACROECONOMIC STABILITY JOSÉ ANTONIO OCAMPOUNDER-SECRETARY-GENERALUNITED NATIONS

2. A BROAD VIEW OF MACROECONOMIC STABILITY • Not only inflation and fiscal balance, but also: • Economic activity and employment • External sector balance • Balance sheets of financial and non-financial agents • Counter-cyclical macroeconomic policies are key • So, need to go beyond “inflation targeting”: Output and real exchange targeting, additional instruments… • …and supportive international financial institutions

3. MACROECONOMIC (IN)STABILITY (1) • Markets are inherently unstable • This is partly a question of price and wage “rigidities”… • …but particularly of the functioning of financial markets (risk/information asymmetries generate inherently incomplete markets): • Alternation of high “risk appetite” and “flight to quality” • Rationing of credit, particularly during downturns • Contagion

4. MACROECONOMIC (IN)STABILITY (2) • For developing countries: strong cyclical swings and pro-cyclical macro policies • This reflects inherent asymmetries of the international system: • Different capacity to issue debts in domestic currencies • Degrees of financial market development • Size of markets • Features of financial cycles: • Variations in availability, price and maturities • Short-term but, particularly, medium-term fluctuations • Self-insurance is possible but costly

5. UNSTABLE ACCESS TOEXTERNAL FINANCING…

6. … AND VOLATILE SPREADS

7. MACRO POLICIES:THE EXCHANGE RATE REGIME (1) • With trade and capital account liberalization, loss of policy instruments to manage shocks. • Thus, greater reliance on exchange rate… • … but exchange rate fluctuations have a counter-cyclical trade but pro-cyclical wealth effects… • … and are subject to conflicting demands: • Demand for stability (price stability, stable trade incentives, avoiding pro-cyclical wealth effects) • Demand for flexibility (room of maneuver to manage shocks)

8. MACRO POLICIES:THE EXCHANGE RATE REGIME (2) • An adequate management of the exchange rate regime must recognize the multiple objectives of macroeconomic policy… • …which implies that some degree of exchange-rate targeting is essential… • …and is the normal policy option

9. THE TRADITIONAL VIEW:THE IMPOSSIBLE TRINITY

10. PROBLEMS WITH THE TRADITIONAL VIEW • “Credibility” of pegs (even hard pegs) vary and are pro-cyclical, thus making this instrument more procyclical in developing countries. • “Monetary autonomy” under flexible exchange rates is also limited: • Pro-cyclical wealth effects. • Supply effects of exchange rates on domestic prices • Endogeneity of capital flows. • So, the room for monetary autonomy may be greater under “intermediate regimes”, but: • Effective capital account regulations are key • Costs of counter-cyclical reserve management • Credibility issues

11. MACRO POLICIES:FISCAL POLICY (1) • Fiscal policy can always play a counter-cyclical role. • But markets push it in a different direction: • Taxes, financing and debt service are procyclical • Contingency financing is also procyclical. • And there are political-economy arguments that push in the same direction: • Compensating pro-cyclical booms of private spending is politically difficult • If there was austerity during the preceding crisis, it is also difficult to justify it during booms • Procyclical fiscal policy has adverse effects on the efficiency of public sector spending and on growth.

12. PROCYCLICAL POLICIES

13. Pro-cyclical macroeconomic policy in developing countries has been harmful for growth • Pro-cyclical fiscal policies negatively affect long term-growth • Unstable public spending have negatively affected investments in infrastructure and human development

14. MACRO POLICIES:FISCAL POLICY (2) • Policy options: • Define a structural stance of the public sector. • Actively use stabilization funds • Automatic stabilizers (spending or taxes) may be preferable to discrete decisions.

15. CAPITAL MANAGEMENT:CAPITAL ACCOUNT REGULATIONS (1) • Second best intervention: segment what is already segmented. • Traditional regulations: segment according to residents and non-residents, and existing economic links. • For countries already integrated in to world capital markets: • Temporary administrative controls (Malaysia, 1994 and 1998) • Price-based regulations (Unremunerated Reserve Requirements, URR).

16. CAPITAL MANAGEMENT:CAPITAL ACCOUNT REGULATIONS (2) • Lessons from experience: • Both controls on outflows and inflows can work, but quantitative restrictions may be easy to administer • Dynamic adjustment is necessary to close loopholes, and in any case regulations are “leaky” • Traditional controls work better if the objective is to reduce procyclical flows. • Quantitative controls have stronger effects… • … but price-based regulations are also effective • Capital account regulations are a complement, not a substitute of adequate macro policy

17. THE EFFECT OF CAPITAL-ACCOUNT REGULATIONS

18. CAPITAL MANAGEMENT:MACRO-PRUDENTIAL REGULATIONS • Risks that financial sector faces have a large macroeconomic component: • Financial markets are pro-cyclical • Traditional regulation have a pro-cyclical bias • Price-sensitive risk management is also pro-cyclical. • Essential tools: • Forward-looking provisioning (rather than capital) • Discretionary prudential provisioning, based on growth of credit (general, by sector, by agent) • Regulation of maturity and, particularly, currency mismatches. • Valuation of collaterals.

19. CAPITAL MANAGEMENT:PUBLIC SECTOR LIABILITY MANAGMENT • Maturity of domestic liabilities of the public sector matter. • Avoid dollar/euroization of domestic liabilities • Counter-cyclical swings between domestic and external financing.

20. INTERNATIONAL COOPERATION • The room of maneuver for counter-cyclical policies should be at the center • Surveillance to avoid building up unsustainable dynamics. • Smoothing financing at the source • IFIs as “market makers” for counter-cyclical instruments • Counter-cyclical financing.