Macro-financial stability frameworks: experience and challenges

Summary

Focus 

The 2007–09 Great Financial Crisis underscored the rationale for macro-financial stability frameworks, in both advanced economies (AEs) and emerging market economies (EMEs). Domestically, both AE and EME central banks have increasingly adopted macroprudential tools as a complement to monetary policy to better reconcile price and financial stability over longer horizons. Externally, EME central banks have resorted to FX intervention and, occasionally, to capital flow management measures (CFMs) to address capital flow and exchange rate volatility.

Contribution 

We review the use of monetary, macroprudential and exchange rate policies, sometimes alongside CFMs, in both AEs and EMEs. We pay particular attention to policies that seek to moderate the impact of external financial conditions on domestic financial conditions and the real economy, and review the effectiveness of macroprudential tools. We also assess how far the deployment of these policy tools can be regarded as a holistic macro-financial stability framework (MFSF) as opposed to being ad hoc measures.

Findings 

First, combining the various policies has succeeded in improving the terms of policy trade-offs, notably by mitigating the risks to domestic stability in the face of external shocks. Second, a holistic MFSF is still a work in progress. For example, the different frequencies of business, domestic and global financial cycles limit the realistic degree of integration of the policies, while analytical tools have some way to catch up with practice. Moreover, fiscal policy remains largely outside the framework. Finally, more needs to be done to better understand the channels of international spillovers and spillbacks and to incorporate them into the framework.

Abstract

Since the 2008–9 Great Financial Crisis, major advanced economies (AEs) have used monetary and macroprudential policies to achieve macroeconomic and financial stability. Emerging market economies (EMEs) have, in addition, combined interest rate tools with FX intervention, macroprudential policy and, sometimes, capital flow management measures (CFMs) to address the challenges from capital flow and exchange rate volatility. This paper provides an overview of the use of monetary, macroprudential and exchange rate policies, sometimes alongside CFMs, both in AEs and EMEs. It also assesses the extent to which the use of these policies constitutes a holistic macro-financial stability framework (MFSF). We reach three conclusions. First, combining tools has succeeded in improving policy trade-offs, notably by mitigating the risks to domestic stability arising from external influences. Second, a holistic MFSF is still a work in progress. Finally, more efforts need to be made to better understand the channels of international spillovers and spillbacks.

JEL classification: E44, E52, F38, G28

Keywords: capital flow, exchange rate policy, macro-financial stability framework, macroprudential measure, monetary policy