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Financial Sector Policies

Virtual: Selected Central Banking Issues in Fixed Exchange Rate Arrangements Without Capital Controls

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Session No.: CE 21.36V

Location: Kuwait City, Kuwait

Date: July 7-8, 2021

Primary Language: English

Interpretation Language: Arabic

    Target Audience

    Mid-level to senior officials working on monetary operations and financial stability in central banks or other monetary authorities.

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    Participants are expected to have experience with monetary operations and financial markets.

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    Course Description

    This course, presented by the Central Bank Operations Division of the Monetary and Capital Markets Department (MCMCO), is dedicated to the central banking challenges in fixed exchange rate arrangements without capital controls. The course covers three topics: (i) managing systemic liquidity; (ii) setting up collateral frameworks as well as emergency liquidity assistance (ELA), and (iii) stress testing the central bank balance sheet. While, in theory, capital flows alone could manage domestic liquidity and stabilize short-term rates at the right level, short-term rate volatility could arise in the absence of central bank intervention in the domestic market due to friction cost between the local and international money market, counterparty risk perception in the domestic market, and prudential liquidity regulations. Moreover, Central banks operating under a fixed exchange rate arrangement are exposed to exchange rate risk and negative carry trade on their assets that could be acute if domestic interest rate spread needs to widen to defend the exchange rate parity. The technical aspects of the course will focus on (i) the optimal operational set up to reduce domestic interest rate volatility, and to address bank liquidity risks effectively while protecting the central bank's balance sheet, and (ii) the stress-testing of the central bank balance sheet items under adverse scenarios to pro-actively monitor and manage risks, and articulate monetary policy with financial stability.  

    The course gives participants the opportunity to learn and apply new tools used or created by MCM for the purposes of calibrating open market operations and managing systemic liquidity risk, and stress testing central bank balance sheets, also incorporating the impact of the COVID-19 crisis. Moreover, the course allows participants to share their experiences on market operations, stress testing methodologies, and risk mitigation policies. Much of the course consists of lectures and of hands-on modules that expose participants to concrete experiences, including inputting data, designing scenarios, stress-testing the central bank balance sheets at different horizons and interpreting the results. MCM experts will then discuss how to articulate the outcome of the risk analysis with policy decision making. The concrete policy outcome could be to fine-tune the calibration open market operations and improve the structural liquidity management tools, as well as differentiating the usage of monetary policy instruments and ELA depending on the stress scenarios.

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    Course Objectives

    Upon completion of the course, participants should be able to:

    • Manage liquidity in a way that is supportive of the exchange rate and monetary arrangements as well as market development;
    • Develop collateral and emergency liquidity assistance frameworks that are robust to the constraints related to the monetary policy regime; and
    • Design different stress scenarios and estimate the central bank balance sheet at risk at different horizons.
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