Multi-Track Monetary Policies in Advanced Economies: What This Means for Asia

James Daniel, Rachel van Elkan

April 27, 2015

Since mid-2014, diversity and divergence—applying to countries’ economic situations, policies and performance—have dominated global economic discussions. Differing economic performance in major advanced countries has led to divergent monetary policies.

Both the Bank of Japan and the European Central Bank have started significant expansions of their balance sheets, while the U.S. Federal Reserve has ended its bond-buying program and is expected to start raising rates. This has had many effects, in particular, contributing to a sharp depreciation of the Yen and the Euro against the U.S. dollar (see chart 1).


Asia Central Banking-Multi Track Central Banking_1
The policy actions by the major advanced economies, among other factors, have also had diverse effects within Asia (excluding Japan).

In this chart-based blog, we consider three key issues: the impact on the region of monetary policy divergence among major advanced economies, potential tensions this may pose, and possible policy responses.

Impact on the region

Recent actions by the Bank of Japan and European Central Bank would tend to create capital inflows into Asia (excluding Japan) and appreciation pressure, but prospective action by the Fed would tend to create the opposite.

Asia Central Banking-Multi Track Central Banking_2

Chart 2 shows three groups:

Countries with external positions stronger than implied by fundamentals have, as one would expect, tended to see their REERs appreciate (e.g., China), and vice versa (e.g., Australia). However, Group 2 countries (Korea, Singapore) and Malaysia have seen little or no REER appreciation despite strong external positions and some Group 1 countries (Indonesia, India, Hong Kong SAR, Thailand) have seen significant REER appreciation despite having balanced, or indeed, weaker, external positions.

Asia Central Banking-Multi Track Central Banking_3

However, these REER movements should be seen in the context of other global developments since June (see charts 3 and 4). In particular, as a result of the sharp fall in the price of oil and most other commodities, many countries’ trade balances have risen. But others, especially Malaysia and Indonesia, but also Australia and New Zealand, have lost significant export revenue from lower commodity prices (helping explain why, for example, Malaysia’s currency has depreciated).

Asia Central Banking-Multi Track Central Banking_4

The fall in commodity prices together with REER appreciations across most economies, is also pushing down inflation (see chart 5). In many countries, inflation is now at very low levels (China, Korea, New Zealand), or even negative (Thailand, Singapore). Core inflation has tended to move less, but generally in the same direction.

Asia Central Banking-Multi Track Central Banking_5

The potential tensions

The main tensions that may emerge from policy actions by advanced economies, especially in some of the largest economies, relate to weakening exports and financial instability.

Asia Central Banking-Multi Track Central Banking_6

Need for flexible monetary policy response

Many countries have responded to these developments above by cutting interest rates (see chart 7). Several countries have also taken other measures, for example, India accumulated international reserves to strengthen buffers ahead of potential increased global financial volatility.

Asia Central Banking-Multi Track Central Banking_7

Going forward, especially if exchange rate and capital flow pressures continue, monetary policy should generally continue to respond flexibly, with macro-prudential policy the first line of defense for addressing financial stability concerns. The specific response should of course depend on individual country circumstances.

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