A BROAD VIEW OF MACROECONOMIC STABILITY

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

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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

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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

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UNSTABLE ACCESS TOEXTERNAL FINANCING
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AND VOLATILE SPREADS
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MACRO POLICIESTHE 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)

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MACRO POLICIESTHE 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

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THE TRADITIONAL VIEWTHE IMPOSSIBLE TRINITY
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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

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MACRO POLICIESFISCAL 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.

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PROCYCLICAL POLICIES
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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

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MACRO POLICIESFISCAL 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.

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CAPITAL MANAGEMENTCAPITAL 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).

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CAPITAL MANAGEMENTCAPITAL 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

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THE EFFECT OF CAPITAL-ACCOUNT REGULATIONS
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CAPITAL MANAGEMENTMACRO-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.

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CAPITAL MANAGEMENTPUBLIC 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.

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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.