## fd0323-monetary-policy ## Source details **Canonical URL:** [fd0323-monetary-policy](https://www.imf.org/-/media/files/publications/fandd/article/2023/march/fd0323-monetary-policy.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fandd/article/2023/march/fd0323-monetary-policy.pdf.md) - [Structured JSON version](/-/media/files/publications/fandd/article/2023/march/fd0323-monetary-policy.pdf.json) --- ### New directions for monetary policy — Giancarlo Corsetti - Post-1980s convergence: advanced-economy policy converged on low inflation targeting to stabilize activity and let fiscal authorities focus on public goods and redistribution; automatic stabilizers (for example, unemployment insurance) should handle anti-cyclical stabilization. - Institutional design principles: - Independent institutions with clear mandates best implement monetary and fiscal policies. - Explicit coordination across fiscal and monetary authorities risks confounding responsibilities and misdirecting instruments (for example, monetary financing of deficits). - Key vulnerabilities ("cracks in the vase"): - Effective lower bound: low nominal interest rates limit scope for expansionary cuts. - High government debt can pressure monetary and regulatory authorities to favor budget sustainability by keeping rates too low. - High private leverage combined with high public debt increases systemic vulnerability to liquidity and solvency crises. - Post-crisis institutional shifts: - Supervisory, regulatory, and resolution powers often returned to central banks. - Central banks expanded unconventional policies and large balance-sheet asset purchases. - Macroprudential policy rose in importance; central banks set up extensive currency swap lines. - Monetary–fiscal interaction in exceptional circumstances: - At the effective lower bound, coordinated temporary fiscal deficits plus a temporary central bank commitment to guarantee the nominal face value of government liabilities can raise the price level, reduce the real value of public debt, and avoid deflationary spirals—conditional on unpredictability and sufficiently long nominal debt maturities. - Success requires temporary suspension of normal rules, strict constitutional rules, and strong and independent institutions. - Monetary backstop: - Central bank backstops (explicit or implicit) can prevent increases in borrowing costs (example referenced: ECB’s Outright Monetary Transactions program in 2012). - Credibility depends on fiscal cooperation because central bank bond purchases risk balance-sheet losses that could force monetary financing unless the Treasury provides contingent fiscal guarantees. - Policy prescriptions: - Central banks must pursue price stability in the medium and long term. - Fiscal authorities must guarantee debt sustainability and credibly raise structural primary surpluses with sufficient intensity in response to rises in the stock of debt. - Fiscal consolidation eases monetary policy by reducing required monetary contraction. - Recognize the possibility of secular stagnation where r < g, which may contain debt dynamics but accompany low productivity growth and political pressure for large deficits. ### Shaping expectations — Michael Weber - Household expectations: inflation expectations are less anchored and more heterogeneous than often assumed. - Empirical findings and statistics: - Survey of 25,000 Americans (2018): fewer than 20 percent answered “about 2 percent” when asked what they thought the average inflation rate in the US was; almost 40 percent reported a number higher than 10 percent. - New York Fed survey data (2011–2018): men on average expected inflation to rise to about 4 percent over 12 months; women expected a rate of 6 percent; realized inflation averaged below 2 percent. - NielsenIQ Homescan panel of 50,000 households: families hit hardest by inflation expected an inflation rate 0.7 percentage point higher than other households, on average. - Sources and formation: - Households rank grocery shopping as the most relevant source of information for inflation. - Households pay more attention to price increases than to price decreases; price changes in frequently used categories produce immediate increases in overall inflation expectations. - Communication findings: - More complex policies are harder to explain and less effective at shaping expectations. - Simpler, concrete communications (for example, consumption tax announcements) can move household expectations and spending; some forward guidance announcements had no measurable impact on household expectations. - Sender identity matters: messages from diverse senders can change response rates across demographic groups. - Practical recommendations: - Use simple messaging, appropriate mediums, and attention to messenger identity to reach ordinary families that do not follow official releases. ### Revolutions in monetary policy — Lars E.O. Svensson - Advocacy and policy design: - Promoted inflation targeting and transparency; recommended publishing interest rate paths and forward guidance to achieve inflation targets and full employment. - Emphasized choosing a policy path that aligns forecasted inflation and employment with targets to avoid leaving the economy "200 miles off course." - Tools and experiments: - Argued for negative interest rates (levying fees on deposits) when conventional rates hit zero; noted Danish central bank adoption in 2012 followed by the ECB and others. - Institutional tensions: - Separation of monetary policy and financial stability: monetary policy should focus on inflation and output goals; financial stability should be managed by macroprudential policy. - Ongoing research: work on housing price overvaluation indicators and the relationship between household mortgage debt and spending in crises. ### Central bank accountability and crisis response — Karnit Flug - Accountability and transparency: - Emphasizes control of the narrative, professional analysis, and active participation in public debate grounded in high-quality research. - Historical example (Israel): - Peak inflation in 1984: prices had increased by 445 percent; public deficit about 15 percent of GDP; debt was 280 percent of GDP. - Legal reform (“no printing clause”) prevented the central bank from financing government deficits. - Crisis assessment: - Monetary policy responses to the global financial crisis were broadly correct to avert deeper recession. - Macroprudential measures accompanied accommodation in some jurisdictions to limit risk build-up. - Post-COVID withdrawal of extreme fiscal and monetary support was sometimes too late, contributing to rapid inflation that required faster withdrawal of stimulus. ### Emerging market perspectives — Lesetja Kganyago - Emerging market specificities: - Supply shocks, greater indexation of prices and wages, and lower tolerance for real income losses make timely policy responses more necessary. - Inflation-targeting frameworks have helped shape expectations and provide policy flexibility. - Fiscal sustainability: - Monetary policy can be distorted by fiscal dominance; concerns rise as central banks hold larger stocks of government debt. - Recommends simple and direct central bank mandates and a broader macroeconomic strategy delivering fiscal sustainability. - South Africa case: - 1990s reforms (floating exchange rate, inflation targeting, fiscal restraint) underpinned the longest period of unbroken growth in South Africa’s history and helped manage crises. ### Balance between conviction and debate; policy interactions (emerging markets) - Central banks should: - Reiterate strategic goals clearly, patiently, and backed by good evidence. - Nurture consensus where possible without mistaking it for groupthink. - Remain open to changing tactical decisions as new information arrives. - Global policy spillovers: - Post-2008 low rates and recent rapid tightening drive capital flows affecting emerging market exchange rates, inflation, and interest rate decisions. - Free-floating currencies are generally preferred; large external shocks can cause misalignment with fundamentals. - Coordination benefits: - Better coordination between sustainable fiscal policy and monetary policy can reduce supply-shock impacts, keep government financing costs low, and reduce inflation concerns. ### Foreign exchange intervention and reserve strategies - Factors for successful intervention: - Level of foreign exchange reserves and reserve adequacy, especially for linked exchange rate regimes. - Strength of domestic economy and financial system. - A defensible intended exchange rate reflecting fundamentals. - Management of liquidity consequences: intervention reduces local currency supply and raises local interest rates; re-injecting liquidity can undermine support. - Openness of the capital account: highly open accounts can generate overwhelming one-way swings. - Private sector foreign currency exposure and hedging: central banks must track and possibly regulate exposures. - Reserve building and emergency liquidity: - Reserves built from current account surpluses and foreign direct investment are more reliable than short-term portfolio flows. - Developing local foreign currency markets and hedging instruments reduces demand on central bank reserves. - Emergency sources: IMF funding as last resort; bilateral swaps; Chiang Mai Initiative Multilateralisation Agreement provides a $240 billion resource-pooling arrangement for liquidity support among ASEAN+3 economies. - When reserves are low: temporary capital controls can act as "circuit breakers" to buy time for reforms; timing of removal requires caution. ### Inflation targeting in emerging markets — Colombia case study and post–COVID challenges - Historical performance: - Inflation targeting introduced in Colombia in 1999 after decades of high inflation and indexation; allowed exchange rate flexibility as first line of defense. - In 2014–16 shocks: annual nominal depreciation reached 68 percent in 2015; inflation moved from about 3 percent in mid-2014 to 9 percent in July 2016 and later returned to the 3 percent target. - Post–COVID developments and exact figures: - Inflation rose from less than 2 percent in 2020 to 13.1 percent in 2022. - Food prices rose at a yearly rate of nearly 28 percent in 2022. - GDP growth: more than 10 percent in 2021 and 8 percent in 2022. - Core inflation rose from 2.5 percent in 2021 to 9.5 percent in 2022. - Currency depreciation: Colombian peso had depreciated 38 percent by end-2022 compared with early 2021. - Minimum wage indexation: minimum wage raised by 10 percent in 2022 and 16 percent in 2023. - Monetary tightening: Banco de la República raised the policy interest rate from 1.75 percent in September 2021 to 12.75 percent in January this year. - Communication and outlook: - Central bank committed to bringing inflation down to its 3 percent target over a two-year period with an acceptable deviation of 1 percentage point. - Inflation expected to decrease fast by historical standards but likely to remain above target for an unusually long period; monetary policy challenges especially difficult during 2023 and 2024. - Growth projection: - Growth projected at 0.2 percent in 2023 as a result of tighter global financial conditions, slower growth in trading partners, and a contractionary domestic monetary policy to guarantee inflation convergence. ### Euro area: returning inflation to target — Philip R. Lane (ECB) - Policy actions and objectives: - ECB raised interest rates to 15-year highs to bring euro area inflation, which peaked at more than 10 percent in October, back to the 2 percent target. - Essential to set policy clearly so inflation returns in a timely manner to 2 percent and longer-term expectations remain anchored. - Risks and guidance: - Prolonged high inflation risks loss of public confidence and self-sustaining inflation via price and wage setting. - Shrinking central bank balance sheets (quantitative tightening) is being implemented while monitoring effects on markets and government financing. - Fiscal policy should focus on productivity and gradual debt reduction; temporary, targeted fiscal support for the vulnerable should be rolled back promptly as energy crisis eases. ### Structural forces shaping monetary policy - Remote work: - Remote work increased by 44 percent over the past 5 years; effects on labor supply and productivity can either dampen or raise inflationary pressure depending on net productivity change. - The green transition: - Annual clean energy investment will need to reach $4 trillion by 2030 to get to net zero emissions by 2050; increased investment demand will tend to raise the natural level of interest rates. - Central bank digital currency (CBDC): - More than 100 countries are currently exploring CBDC; CBDC could allow central banks to set interest paid to households directly and change transmission mechanics, but raise questions about permanent balance sheet expansion and independence. - Demographics: - The number of people in the world over 60 years old will double by 2050; aging affects saving, potential output, and long-run real interest rates ambiguously. - De-globalization: - Trade openness peaked at about 60 percent in 2008 and has fallen since then; de-globalization can be inflationary and fiscally challenging. ### Historical perspective: gold, silver, and monetary stability - 1873 transition to gold: silver depreciated by some 20 percent relative to gold between 1873 and the end of the decade. - Early gold standard years saw severe deflation and recessions in several countries; later gold discoveries reversed deflation and fed liquidity into the system. - Lesson: monetary stability is a global public good requiring international cooperation; regime transitions without cooperation produce large economic costs. ### Digital public infrastructure and data empowerment (India’s DEPA example) - Digital rails and implementation: - Digital public infrastructure built as rails; India Stack is publicly designed and controlled but privately implemented across 29 states and 22 languages. - Verifiable identity and financial inclusion: - In 2008, only 1 in 8 Indians had a verifiable identity. - After Aadhaar rollout (2009), the share of adults with a bank account rose from 25 percent to more than 80 percent in less than 10 years. - Fast payment system (UPI): - At the end of 2022, UPI was processing nearly 8 billion transactions a month, about 70 percent more than the previous year. - DEPA mechanics and costs: - DEPA provides a consent-based data-sharing system with transaction costs at about $0.07 a data pull. - Since going live in India’s financial sector last year, some 1.1 billion individual accounts on the system can reap benefits from the value of their data. - Time-to-credit improvements: individual experiences reduced time to access credit from months to days. - Governance and challenges: - Absence of a national data protection law when DEPA was developed; the consent framework was developed under central bank supervision. - Recommendation: global conversation on open technology standards, regulatory coordination, and interoperable accreditation to govern cross-border data transactions. *Source: Finance & Development, March 2023.* ### References: ### fd0323-monetary-policy - References ### References cited - Archer, D., and A. Levin. 2019. “Robust Design Principles for Monetary Policy Committees.” In RBA Annual Conference Volume, edited by J. Simon, 233–51. Sydney, Australia: Reserve Bank of Australia. - Blanchflower, D. 2008. “Inflation, Expectations, and Monetary Policy.” Speech given at the Royal Society of Edinburgh, April 29, 2008. - Blanchflower, D. 2021. Not Working: Where Have All the Good Jobs Gone? Princeton, NJ: Princeton University Press. - Bordo, M., A. Levin, and M. Levy. 2020. “Incorporating Scenario Analysis into the Federal Reserve’s Policy Strategy and Communications.” NBER Working Paper 27369, National Bureau of Economic Research, Cambridge, MA. - Levin, A. 2014. “The Design and Communication of Systematic Monetary Policy Strategies.” Journal of Economic Dynamics and Control 49 (December): 52–69. - Bartsch, Elga, Agnès Bénassy-Quéré, Giancarlo Corsetti, and Xavier Debrun, eds. 2020. Geneva 23: It’s All in the Mix: How Monetary and Fiscal Policies Can Work or Fail Together. London: CEPR Press. - Corsetti, Giancarlo, and Luca Dedola. 2016. “The Mystery of the Printing Press: Monetary Policy and Self-Fulfilling Debt Crises.” Journal of the European Economic Association 14 (6): 1329–371. - Corsetti, Giancarlo, Luca Dedola, Marek Jarociński, Bartosz Maćkowiak, and Sebastian Schmidt. 2019. “Macroeconomic Stabilization, Monetary-Fiscal Interactions, and Europe’s Monetary Union.” European Journal of Political Economy 57 (March): 22–33. - Zhang, Tongli. 2021. “Monetary Backstop and Sovereign Default on Domestic Debt.’’ Johns Hopkins University Department of Economics, Baltimore, MD. - Coibion, O., Y. Gorodnichenko, and M. Weber (multiple working papers and articles cited within the text). - D’Acunto, F., S. Malmendier, and M. Weber (multiple studies cited within the text). - Additional references and “see also” citations are present within the source text. ### Major themes and substantive findings — Giancarlo Corsetti (New directions for monetary policy) - Post-1980s convergence: Advanced-economy policy converged on low inflation targeting to stabilize economic activity and let fiscal authorities focus on public goods and redistribution; automatic stabilizers (for example, unemployment insurance) should handle anti-cyclical stabilization. - Institutional design principle: - Independent institutions with clear mandates best implement monetary and fiscal policies. - Explicit coordination across fiscal and monetary authorities risks confounding responsibilities and misdirecting instruments (for example, monetary financing of deficits). - Identified "cracks in the vase": - Effective lower bound: low nominal interest rates limit scope for expansionary cuts. - High government debt can pressure monetary and regulatory authorities to favor budget sustainability by keeping rates too low. - High private leverage intertwined with high public debt increases systemic vulnerability to liquidity and solvency crises. - Post-global financial crisis institutional shifts: - Supervisory, regulatory, and resolution powers often returned to central banks. - Central banks expanded unconventional policies and large balance-sheet asset purchases. - Macroprudential policy rose in importance; central banks set up extensive currency swap lines. - Monetary-fiscal interaction in exceptional circumstances: - Theory: At the effective lower bound, coordinated temporary fiscal deficits plus a temporary central bank commitment to guarantee the nominal face value of government liabilities can raise the price level, reduce the real value of public debt, and avoid deflationary spirals—conditional on unpredictability and sufficiently long nominal debt maturities. - Constraints: Success requires temporary suspension of normal rules, strict constitutional rules, and strong and independent institutions. - Reverse mechanism: Running budget surpluses that increase the real value of debt can help reduce inflation. - Restoring moderation and policy prescriptions: - Central banks must pursue price stability in the medium and long term. - Fiscal authorities must guarantee debt sustainability and credibly raise structural primary surpluses with sufficient intensity in response to rises in the stock of debt. - Risks of tolerating high and variable inflation: markets charge an inflation premium, raising borrowing costs and worsening the fiscal outlook. - Fiscal consolidation eases monetary policy by reducing required monetary contraction. - Secular stagnation possibility: a scenario with real interest rates (r) below growth rate (g) could help contain debt dynamics but may accompany low productivity growth and political pressure for large deficits. - Monetary backstop as a policy tool: - Central bank backstops (explicit or implicit) can prevent increases in borrowing costs; example referenced: European Central Bank’s Outright Monetary Transactions program in 2012. - Credibility of a backstop depends on fiscal cooperation because central bank bond purchases risk balance-sheet losses that could force monetary financing unless the Treasury provides contingent fiscal guarantees. - A monetary backstop can rule out self-fulfilling sovereign risk crises, but ultimate stability depends on fiscal policy and sustainable debt paths. ### Major themes and substantive findings — Michael Weber (Shaping expectations) - Household inflation expectations are less anchored and more heterogeneous than commonly assumed. - Survey evidence and measured statistics: - Survey of 25,000 Americans in 2018: fewer than 20 percent answered “about 2 percent” when asked what they thought the average inflation rate in the US was; almost 40 percent reported a number higher than 10 percent. - Using New York Fed survey data, between 2011 and 2018 men on average expected inflation to rise to about 4 percent over 12 months, while women expected a rate of 6 percent; actual inflation averaged below 2 percent. - NielsenIQ Homescan panel of 50,000 households: families hit hardest by inflation expected an inflation rate 0.7 percentage point higher than other households, on average. - Sources and formation of household expectations: - Households rank grocery shopping as the most relevant source of information for inflation (chart-based finding). - Households pay more attention to price increases than to price decreases. - Price changes in frequently used categories (for example, milk and eggs) produce immediate increases in overall inflation expectations. - Communication and complexity: - More complex policies are harder to explain and less effective at shaping expectations. - Empirical comparison: preannounced consumption tax increases versus forward guidance — consumption tax announcement (simpler) had observable effects on German household expectations and spending (example: November 2005 announcement of a 3 percentage point consumption tax increase effective January 2007), whereas the ECB’s 2013 forward guidance announcement had no impact on household inflation expectations or spending patterns in Germany. - Experimental evidence from Finland: target communications (specifying the aim) improved individuals’ income expectations; instrument communications did not have the same effect. - Language and medium matter: simple terms like “current inflation,” the “inflation target,” or “inflation forecast” are most effective. Official FOMC statements have more impact than newspaper coverage despite newspapers being simpler to read; households rate credibility of news sources differently. - Sender identity matters: messages from diverse senders can change response rates. In one study, women and Black respondents were substantially more likely to revise expectations when messages came from either Mary Daly or Raphael Bostic rather than from Thomas Barkin. - Practical implications: - Central banks can influence household inflation expectations through simple messaging, appropriate choice of medium, and attention to messenger identity. - Reaching ordinary families who do not follow official releases is a central challenge; creative and clear communications are recommended. ### Key statistics and exact numeric findings (preserved) - Survey size: 25,000 Americans (2018). - Response shares: fewer than 20 percent answered “about 2 percent”; almost 40 percent reported a number higher than 10 percent. - Expectations (2011–2018): men expected about 4 percent over 12 months; women expected 6 percent; realized inflation averaged below 2 percent. - NielsenIQ Homescan panel: 50,000 households used for household-specific price index analysis. - Expectation differential: families hit hardest by inflation expected 0.7 percentage point higher inflation, on average. - Policy communication example: announcement of consumption tax increase of 3 percentage points (November 2005 announcement; effective January 2007). - NBER Working Paper number cited: 27369. - Journal volume and pages cited: Journal of Economic Dynamics and Control 49 (December): 52–69; Journal of the European Economic Association 14 (6): 1329–371; European Journal of Political Economy 57 (March): 22–33. *Content synthesized from the supplied Finance & Development March 2023 material.* ### References: ### fd0323-monetary-policy - References ### Key references - Coibion, Olivier; Yuriy Gorodnichenko; Michael Weber. 2022. “Monetary Policy Communications and Their Effects on Household Inflation Expectations.” Journal of Political Economy 130 (6): 1537–584. - D’Acunto, Francesco; Daniel Hoang; Maritta Paloviita; Michael Weber. 2020. “Effective Policy Communication: Targets versus Instruments.” BFI Working Paper, Becker Friedman Institute for Economics, University of Chicago. - D’Acunto, Francesco; Ulrike Malmendier; Michael Weber. 2021. “Gender Roles Produce Divergent Economic Expectations.” Proceedings of the National Academy of Sciences 118 (21): 1–10. - D’Acunto, Francesco; Ulrike Malmendier; Juan Ospina; Michael Weber. 2021. “Exposure to Grocery Prices and Inflation Expectations.” Journal of Political Economy 129 (5): 1615–639. - D’Acunto, Francesco; Andreas Fuster; Michael Weber. 2021. “Diverse Policy Committees Can Reach Underrepresented Groups.” BFI Working Paper, Becker Friedman Institute for Economics, University of Chicago. ### Revolutions in monetary policy — Lars E.O. Svensson (profile and analysis) - Background and influence - Svensson’s advocacy for inflation targeting and transparency is credited with helping central banks manage the 2007 financial crisis and the Great Recession. - He promoted making public the path of future policy to achieve inflation targets, influencing central banks such as the Norges Bank, the Riksbank, and the Czech National Bank to publish interest rate paths. - Inflation targeting and flexible approach - Advocated that central banks target a long-term inflation goal while remaining flexible to keep the economy close to full employment. - Noted shift away from “inflation nutters” toward dual focus on inflation and employment. - Inflation forecast targeting (policy design) - Recommended selecting a path for current and future rates so central bank forecasts for inflation and employment support reaching the inflation target and full employment. - Emphasized forward guidance: publish and explain planned policy paths because monetary policy works with long lags. - Analogy used: avoid setting policy that leaves the economy “200 miles off course” when reaching the target horizon. - Negative interest rates and tool-kit expansion - Argued for negative interest rates (levying fees on deposits) when conventional policy rates hit zero to encourage lending and spending. - Noted policy adoption timeline: Danish central bank in 2012, followed by the European Central Bank and several others. - Cited view (Ken Rogoff) that “if done correctly ... negative rates would operate similarly to normal monetary policy, boosting aggregate demand and raising employment.” - Riksbank episode and policy disagreement - Riksbank adopted inflation targeting with a 2 percent long-term goal to be achieved by 1995. - During the krona crisis (1992) the central bank raised rates to 500 percent to defend the peg. - By July 2009 the Riksbank had cut rates to 0.25 percent. - Svensson opposed 2010–2011 rate hikes on grounds that inflation forecasts remained far below target and unemployment was high; he opposed “leaning against the wind.” - He left the Riksbank in mid-2013 after failing to secure support for his preferred policy. By 2014 the rate hikes had contributed to deflationary pressures and weakening, prompting cuts to zero and entry into negative rates in 2015. - Separation of monetary policy and financial stability - Argued monetary policy should focus on inflation and output goals; financial stability should be managed by macroprudential policy. - IMF staff paper (2015) on “Monetary Policy and Financial Stability” concluded that in most cases the costs of using monetary policy for financial stability exceed the benefits. - Ongoing research and critiques - At 75, Svensson continues research on housing price overvaluation indicators and the relationship between household mortgage debt and spending in crises. ### Central bank accountability, communication, and crisis response — Karnit Flug (interview highlights) - Accountability and transparency - Emphasizes being “in control of the narrative” and the importance of transparency and professionalism in analysis. - Recommends active participation in public debate based on high-quality research. - Historical context and policy lessons - Israel’s peak inflation in 1984: prices had increased by 445 percent; public deficit about 15 percent of GDP; debt was 280 percent of GDP. - Legal reform (“no printing clause”) prevented the central bank from financing government deficits. - Assessment of crisis-era policies - Views monetary policy response to the global financial crisis as broadly correct and necessary to avert deeper recession. - Notes that in some jurisdictions macroprudential measures accompanied monetary accommodation to limit risk build-up (Israel introduced mortgage market restrictions). - After COVID-19, argues the withdrawal of extreme fiscal and monetary support came too late in some places; strong demand met with supply constraints contributed to rapid inflation, necessitating faster withdrawal of stimulus. ### Emerging market perspectives — Lesetja Kganyago (lessons and policy recommendations) - Distinct challenges and experience of emerging markets - Emerging markets often confront supply shocks, greater indexation of prices and wages, and lower tolerance for real income losses, making timely policy responses more necessary. - Inflation-targeting frameworks in emerging markets have helped shape expectations and provide policy flexibility. - Fiscal sustainability and mandates - Monetary policy effectiveness can be distorted by fiscal policy; concerns about fiscal dominance are rising as central banks hold larger stocks of government debt. - Recommends simple and direct central bank mandates and a broader macroeconomic strategy that delivers fiscal sustainability. - South Africa case study (policy package and outcomes) - Key reforms in the 1990s: a floating exchange rate, inflation targeting, and fiscal restraint. - These reforms underpinned the longest period of unbroken growth in South Africa’s history and helped manage emerging market crises in 1998 and thereafter. *Italic: Content extracted from fd0323-monetary-policy - References (PDF chapter/section).* ### 2001. But because they involved discipline and ### Monetary policy ### Balance between conviction and debate - Emerging market policymakers need divergent tactical views but consensus on grand strategy. - South Africa central bank mandate (constitution): protect the value of the currency in the interest of balanced and sustainable growth. - Central banks should: - Reiterate strategic goals clearly, patiently, and backed by good evidence. - Nurture consensus where possible without mistaking it for groupthink. - Remain open to changing tactical decisions as new information arrives. - 2023 could see reversal of 2022 inflation trends in some advanced economies, potentially easing pressure on emerging markets; this outcome is uncertain. ### Interaction of fiscal policy, external conditions, and monetary autonomy - Global policy moves (post-2008 low rates, recent rapid tightening) drive capital flows that affect emerging market exchange rates, inflation, and interest rate decisions. - Free-floating currencies are generally preferred, but large external shocks can misalign exchange rates with fundamentals. - Policy autonomy requires economies strong enough to withstand volatile exchange rates and misalignment. - Better coordination between sustainable fiscal policy and monetary policy would: - Create synergies to reduce supply-shock impacts. - Keep government financing costs low. - Help remove inflation as a major concern for households and firms. ### Foreign exchange intervention: factors for success (when defending a depreciating currency) - Level of foreign exchange reserves: - Reserves are invaluable during unwarranted depreciation pressure. - Reserve adequacy matters especially for linked exchange rate regimes and exchange-rate-based monetary frameworks. - Strength of domestic economy and financial system: - Strong fundamentals allow more effective and flexible intervention. - Intended exchange rate that is “defensible” (reflects economic fundamentals): - Intervention cannot substitute for addressing weak fundamentals (large fiscal deficit, excessive monetary growth, high inflation). - Actions to manage liquidity consequences of intervention: - Intervention reduces local currency supply and raises local interest rates, supporting the exchange rate. - Reinjecting liquidity to protect domestic economy can undermine exchange-rate support and domestic price stability. - Openness of the capital account: - Highly open capital accounts can bring two-way flows normally but one-way swings can overwhelm stabilization efforts. - Private sector foreign currency exposure and hedging: - Central banks must track and possibly regulate private foreign currency exposure to avoid panic-induced pressures that negate intervention. ### Reserve adequacy and emergency liquidity arrangements - Building reserves: - Reserves built from current account surpluses and foreign direct investment are generally more reliable than those from short-term portfolio flows. - Reserves should be accumulated in good times; political pressure to divert reserves undermines intervention capacity. - Developing local foreign currency markets and hedging instruments reduces demand on central bank reserves. - Emergency sources: - IMF funding is an option of last resort for many countries. - Bilateral swap arrangements provide emergency liquidity. - Among the ASEAN+3 economies, the Chiang Mai Initiative Multilateralisation Agreement provides a $240 billion resource-pooling arrangement for liquidity support. - When reserves are low or capital flows overwhelm intervention: - More direct measures, including restrictions on financial flows (capital controls), can be considered as temporary “circuit breakers.” - Timing of removal of capital controls requires caution; premature removal can be as risky as prolonged use. - Controls should be used to buy time for reforms that restore confidence; once credibility is restored, controls can be relaxed and removed. ### Inflation targeting in emerging markets: experience and challenges - Since 1990, inflation targeting has generally reduced inflation and inflation volatility and allowed procyclical monetary policies to become countercyclical. - Colombia example: - Inflation targeting introduced in 1999 after decades of stubbornly high inflation and indexation mechanisms. - Allowing the exchange rate to fluctuate enabled the exchange rate to act as first line of defense against external shocks. - During the global financial crisis (2007–09) and COVID-19 (2020), Colombia allowed depreciation while relying on the inflation target as the nominal anchor. - In 2014–16 shocks (oil price collapse, drought, supply shocks): - Annual nominal depreciation reached 68 percent in 2015. - Inflation went from about 3 percent in mid-2014 to 9 percent in July 2016, and later returned to the 3 percent target without major output sacrifice. - Credibility of monetary policy and stability of long-term inflation expectations were instrumental. ### Post–COVID challenges to inflation targeting (Colombia case) - Inflation rose from less than 2 percent in 2020 to 13.1 percent in 2022. - Food prices rose at a yearly rate of nearly 28 percent in 2022. - Aggregate demand recovery contributed: GDP grew by more than 10 percent in 2021 and 8 percent in 2022. - Widening current account deficit close to a historical record despite beneficial terms of trade in 2022. - Core inflation (excluding food and government-regulated prices) rose from 2.5 percent in 2021 to 9.5 percent in 2022. - Currency depreciation: Colombian peso had depreciated 38 percent by end-2022 compared with early 2021. - Minimum wage indexation effects: - Minimum wage raised by 10 percent in 2022 and 16 percent in 2023—both above headline inflation—contributing to higher production costs and a wage-price spiral. - Monetary tightening: - Banco de la República raised the policy interest rate from 1.75 percent in September 2021 to 12.75 percent in January this year. - Communication challenge: - Large, protracted inflationary shocks require explaining a long convergence period back to the target. - Too fast a convergence risks output and employment costs; too slow risks de-anchoring expectations. - The central bank has stated the tightening process is not over and is committed to bringing inflation down to its 3 percent target over a two-year period with an acceptable deviation of 1 percentage point. - Inflation expectations are broadly consistent with the desired convergence path. - Outlook: - Inflation is expected to decrease fast by historical standards but will probably be above its target rate for the longest period since inflation targeting was introduced. - Monetary policy challenges will be particularly difficult during 2023 and 2024, with an expected sharp deceleration of economic activity that would shrink GDP growth (projection details truncated in source). *Source: Finance & Development, March 2023.* ### 0.2 percent in 2023 as a result of tighter global ### Monetary Policy ### Colombia: inflation targeting and current stance - Growth projected at 0.2 percent in 2023 as a result of tighter global financial conditions, slower growth in our trading partners, and a much-needed contractionary domestic monetary policy that guarantees inflation convergence toward the central bank’s goal. - Challenges described do not argue against the inflation-targeting strategy; instead they reinforce: - the importance of strengthening the anchoring role of inflation targeting, and - the need to pursue a contractionary monetary policy at the current juncture that demonstrates the central bank’s commitment to an explicit and credible inflation target. - Assessment of past performance: - Inflation targeting, coupled with a floating exchange rate, has served Colombia’s economy well and has helped the country confront economic shocks in ways that were not possible before. - Attribution: LEONARDO VILLAR, governor of Banco de la República, Colombia’s central bank. ### Euro area: returning inflation to target (ECB, Philip R. Lane) - Context and objectives: - The ECB raised interest rates to 15-year highs to bring euro area inflation, which peaked at more than 10 percent in October, back to the 2 percent target. - It is essential that monetary policy is clearly set to make sure that inflation returns in a timely manner to our 2 percent target to keep longer-term inflation expectations anchored. - Key risks and policy rationale: - A prolonged phase of high inflation risks public loss of confidence that price stability (in practice, a 2 percent inflation target) will be maintained, which could make inflation self-sustaining through price and wage setting. - Over the last year, central banks reversed out of quantitative easing programs and cumulatively raised interest rates quite a bit over a relatively short period. - Lessons and forward-looking considerations: - The pandemic and the war-related surge in energy prices constituted extraordinarily large and asymmetrical shocks that were bound to generate an initial phase of high inflation. - Ongoing examination is warranted to assess whether central banks could have better assessed the size and duration of the inflation shock. - Shrinking the central bank’s balance sheet (quantitative tightening) is being implemented while monitoring effects on markets and government financing. - Fiscal-monetary interaction and policy guidance: - Long-end yield management programs were aimed at contributing to monetary easing, not to directly finance governments. - Normalization of interest rates has increased demand from institutional investors for euro area government bonds. - Fiscal policy should be oriented toward making the economy more productive and gradually bringing down high public debt, consistent with the EU’s economic governance framework. - Fiscal support measures to shield the most vulnerable from the energy price shock should be temporary, targeted, and tailored to preserving incentives to consume less energy; as the energy crisis becomes less acute, it is important to start rolling these measures back promptly in line with the fall in energy prices and in a concerted manner. - Distributional considerations: - The poor are hardest hit by persistent inflation; medium-term price stability benefits all households. - Monetary policy should deliver the inflation target while minimizing costs in terms of output and employment. - Governments should protect the most vulnerable, but fiscal measures that directly offset interest rate movements can be problematic for the efficiency of monetary policy and may be less effective than other income policies. ### Structural forces shaping monetary policy (Picture This) - Remote work: - Remote work shapes inflationary conditions through the supply of labor and its productivity. - Remote work tends to increase the amount of working hours households can supply; workers are willing to take a pay cut when allowed to work a given job remotely. - Some jobs cannot be performed as efficiently remotely, reducing productivity per worker-hour; if productivity losses outweigh increased labor supply, firms’ marginal costs rise and generate inflationary pressure. - Remote work has increased by 44 percent over the past 5 years. - The green transition: - Requires substantial reallocation of resources away from fossil fuels toward renewable sources of energy—mainly wind and solar—and likely a large increase in investment. - Increased investment demand will tend to increase the natural level of interest rates, so the green transition will probably require central banks to support a higher policy rate. - Annual clean energy investment will need to reach $4 trillion by 2030 to get to net zero emissions by 2050. - Central bank digital currency (CBDC): - CBDC would allow central banks to directly set the rate of interest paid by CBDC, permitting them to transmit monetary policy directly to households rather than indirectly through banks. - Banks do not fully transmit rate increases to households; CBDC could change transmission mechanics. - If central banks issue digital currency directly to households, they may have to expand their balance sheets permanently and could invest enlarged portfolios in government bonds or lend to the private sector, raising questions about central bank independence. - More than 100 countries are currently exploring CBDC. - Demographics: - An aging population will lower demand as individuals save for retirement, temporarily reducing the natural level of interest rates. - Declining labor force participation reduces potential output and results in slower income growth that incentivizes saving; after transition, retired populations consume from savings at a high rate and labor participation stabilizes, so long-run effects on real interest rates are ambiguous. - The number of people in the world over 60 years old will double by 2050. - De-globalization: - Tends to impoverish countries by creating trade barriers and reallocating resources toward less-efficient industries; drops in output can reduce government revenues and cause fiscally driven inflation if governments do not adjust spending or taxes. - Importing countries may see inflationary pressure from reduced access to foreign goods; exporters may experience lower future income and falling household demand. - Trade openness peaked at about 60 percent in 2008 and has fallen since then. ### Historical perspective: gold, silver, and monetary stability (Johannes Wiegand) - 1873 transition: - The year 1873 marked a turning point: many leading industrial nations shifted to gold currencies, ending global bimetallism. - Between 1873 and the end of the decade, silver depreciated by some 20 percent relative to gold after trading at stable exchange values for 70 years. - Gold countries experienced severe deflation that lasted until the early 1890s; industrial production indicators point to a severe and long recession in several countries. - Mechanics of bimetallism and Gresham’s law: - Money tied to precious metals; France’s Napoleonic law set fixed mint prices that established global bimetallism and quasi-fixed exchange rates between gold and silver currencies. - Gresham’s law: in fixed exchange rate systems, “bad money drives out good.” Changes in bullion supply affected the composition of specie in circulation when mint price guarantees were effective. - Breakdown and geopolitical factors: - Large gold discoveries in California and Australia around 1850 increased gold production by a factor of 5, shifting France’s specie composition toward gold and straining bimetallism. - The Franco-Prussian War and the French indemnity payment in silver constrained France’s ability to abandon bimetallism, enabling Germany to adopt gold in the early 1870s and formalize the gold standard in July 1873. - France limited silver coinage on September 6, 1873, breaking the bimetallic bond; by early 1875 and 1876 France suspended silver coinage entirely, and the classic gold standard emerged. - Aftermath and lessons: - Early gold standard years were rough: persistent deflation raised real interest rates, weighed on profits and investment, and provoked distributional conflicts. - A later gold boom (Witwatersrand discovery in 1886) fed liquidity into the system, ending deflation and ushering in the belle époque. - Central lesson: monetary stability is a global public good that requires international cooperation; when cooperation failed in the 19th century, transitions to different monetary regimes produced large economic costs. *Finance & Development — March 2023* ### References: ### Data by People, for People ### Digital public infrastructure overview - Innovations in India’s digital public infrastructure ecosystem have enhanced basic societal functions and provided a pathway to democratize data and return to the people control over their own data. - Digital infrastructure replaces people-and-paper processes with code, operating around the clock at low cost and scalable to reach large populations. - India's approach to data governance "neither favors excessive state intervention nor is it exclusively laissez-faire" and combines private and public features to encourage better regulation and innovation. ### Key components and implementation model - Strategic design: digital public infrastructure built as rails, each addressing a specific need. - Integrated stack: technological innovation across several rails created the India Stack, scalable to over a billion people across 29 states and 22 languages. - Implementation model: publicly designed and controlled but privately implemented; public sector focuses on regulatory framework, private sector handles consumer interface and service delivery. - Major rails highlighted: - Verifiable identity (Aadhaar) - Fast payment system (Unified Payments Interface, UPI) - Data empowerment and data sharing protocols for finance, health, commerce, education, and skills ### Verifiable identity and financial inclusion - In 2008, only 1 in 8 Indians had a verifiable identity. - In 2009, India rolled out Aadhaar; it eventually reached over a billion people, including those who could not read or write. - Financial inclusion impact: - Share of adults with a bank account rose from 25 percent to more than 80 percent in less than 10 years. - One rough estimate suggests that relying solely on traditional growth processes would have taken nearly 50 years to achieve the same rise in inclusion. ### Fast payment system (UPI) outcomes - UPI is run by the nonprofit National Payments Corporation of India and is interoperable with services such as PhonePe, Paytm, and Google Pay. - Cost model: the cost of running the payments rail is borne by participating commercial banks. - Network effects delivered without monopolistic disadvantages: instant transfers and near-zero charges. - Usage statistic: At the end of 2022, UPI was processing nearly 8 billion transactions a month, about 70 percent more than the previous year. - Role during shocks: digital commerce rails augmented by digital payment systems blunted the worst ravages of the country’s COVID-19 lockdowns. ### Broad applicability across sectors - Pandemic examples: vaccine development and distribution, e-commerce rails protecting jobs and livelihoods, delivery of education digitally minimizing schooling loss. - Health sector: digital rails enable data sharing across hospitals, diagnostic laboratories, and research institutions—with patients’ consent—to support comprehensive patient records for more accurate diagnosis and treatment. - Skills sector: digital rails allow exchange and certification of skill credentials, enabling mobility and empowerment. - Education sector: digital rails complement existing practices to deliver personalized learning outcomes at national scale. ### Data Empowerment and Protection Architecture (DEPA) - DEPA provides a techno-legal, consent-based data-sharing system combining digital public infrastructure and private-market-led innovation. - Security and transaction costs: - High level of security and low transaction costs (at about $0.07 a data pull), borne by consumers seeking the service. - Consent mechanics: - Data sharing occurs only with detailed consent specifying which data are requested, retention period, and processors. - Protocols allow revocation of consent, auditing of data-sharing transactions, and imposition of data security requirements. - Consent manager functionality: - Consent manager knows identities of data users and providers but is blind to data content. - Data users/providers know content but are blind to the identity of the counterparty. - Separation of consent flows from data flows supports efficient transfers while respecting privacy. ### Measurable impacts and user outcomes - System reach: Since going live in India’s financial sector last year, some 1.1 billion individual accounts on the system can reap benefits from the value of their data. - Time-to-credit improvements: Individual experiences show the system has significantly reduced the time it takes to access credit—from months to days. - Case example: A small business able to raise financing and avoid bankruptcy because of readily shareable financial data during COVID-19 liquidity difficulties. ### Challenges and governance considerations - Absence of a national data protection law: India’s data consent framework was developed under the regulatory supervision of the central bank rather than a dedicated data protection regulator. - Ongoing development: India’s new draft law (referenced) is part of the evolving regulatory context for DEPA and related frameworks. *Source: Finance & Development, March 2023.* ### references the technical and regulatory mandate ### fd0323-monetary-policy - references the technical and regulatory mandate ### Consent manager and DEPA mandate - The consent manager is central to the DEPA framework and, when enacted, will play a critical role in shaping DEPA’s regulatory and supervisory foundations. - The text references a “technical and regulatory mandate of the consent manager” as foundational to DEPA. ### Data governance: lessons from India and other jurisdictions - Key lessons from India, and from jurisdictions including Australia, Singapore, the United Kingdom, and the European Union: - Citizens should have the right to access and use their data, wherever it resides, for their own benefit. - The rules for access and the use of data should be practical and clear and allow users to access and share their data with consent, at reasonable cost, and in a manner that respects their privacy and security. - The system must be digital and the data protection principles integrated into the technology, given the large quantity of data involved and the need to keep it safe with low transaction costs. - Senior policymakers from Australia, France, India, Japan, Rwanda, the Bank for International Settlements, and the European Commission have deliberated data empowerment approaches and affirmed the importance of reinforcing the twin policy goals of privacy and data-driven innovation through open, interoperable technical protocols. ### Regional and international policy linkages - Data governance has become an essential element of some new regional trade initiatives in the Asia and Pacific region. - Examples cited in the source: - The Digital Economy Partnership Agreement between Chile, New Zealand, and Singapore. - The Indo-Pacific Economic Framework for Prosperity. - Digital public infrastructure and data empowerment were identified as central themes of India’s G20 presidency in 2023. - The source argues that to make progress worldwide, a global governance mechanism is needed to: - Support open technology standards. - Enable regulatory coordination across multiple stakeholders. - Facilitate interoperable accreditation. - Provide satisfactory governance of cross-border transactions. - The source states: “It is too early to talk about common standards for data governance, but conversations in informal settings and at international institutions about the broad parameters for such standards have already begun.” - The continued lack of institutions to represent global interests in the digital arena is identified as a major gap in the current international architecture. - Recommendation: Promote global conversation, encourage like-minded countries to share experiences, and expand the frontier of best practices in data governance. ### Empowering data sharing (India’s digital public ecosystem) - India’s digital public ecosystem enables the provision of financial services through the seamless exchange of data with consent, ensuring compliance with data privacy principles. - Roles and flows depicted (conceptual steps from the source): - DATA SUBJECTS: Consumers | SMEs - 1: Enroll with consent manager; Seek service - 2: Consent for sharing data - 3: Data access transfer request - 4: DATA USERS: Flow-based credit lender; Health services; Personal finance management - 5: Data provision transfer request - 6: Encrypted data for data users - 7: DATA PROVIDERS: Financial information; Health information; TAX/GST platform; Insurance providers - Note in source: “The chart depicts the data-sharing system applied by India’s Data Empowerment and Protection Architecture. GST = goods and services tax; SME = subject matter expert.” ### Attribution and authorship - Named contributors in the source: - SIDDHARTH TIWARI (a fellow at Chatham House, London; former head of the Bank for International Settlements’ Office for Asia and the Pacific; former director of the IMF’s Strategy, Policy, and Review Department) - FRANK PACKER (regional advisor at the Bank for International Settlements’ Office for Asia and the Pacific) - RAHUL MATTHAN (partner at Trilegal) - Source cited in the text: Tiwari, S., S. Sharma, S. Shetty, and F. Packer. 2022. "The Design of a Data Governance System." BIS Paper 124, Bank for International Settlements, Basel. *Source: fd0323-monetary-policy - references the technical and regulatory mandate (PDF).* --- _Source: https://www.imf.org/-/media/files/publications/fandd/article/2023/march/fd0323-monetary-policy.pdf_