"The Financial Crisis, Capital Flows, and Global Liquidity" Keynote Speech by Naoyuki Shinohara, Deputy Managing Director, International Monetary Fund, Bank of Korea International Conference 2013, Seoul, Korea, June 3, 2013
IMF News, June 3, 2013
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- Published: June 3, 2013
Introduction
- Topic: Global Liquidity in a Global Framework, with focus on capital flows, exchange rates, and unconventional monetary policy as tools to ward off global tail risks.
- Aim: Summarize IMF view of the global economy, identify major vulnerabilities and risks, and outline policy challenges.
Global Economic Prospects
- Recent context: Almost five years since the collapse of Lehman Brothers; global economy still feeling aftershocks.
- IMF forecasts cited:
- World growth expected to reach "3.3 percent in 2013".
- World growth improving to "4 percent in 2014".
- Short-term developments and downside risks:
- Q1 2013 data suggest softer real activity; Europe shrank more than expected.
- China reported sluggish activity in the first quarter.
- Investment in India, Russia, and South Africa continues to be sluggish.
- Divergence across countries:
- Emerging and developing economies generally doing better.
- Countries on the mend: U.S., Sweden, Switzerland.
- Countries still with significant work: Euro Area, Japan.
Emerging Markets
- Role: Led the world’s recovery over the past half decade.
- Regional growth projections:
- Developing Asia projected to grow at "7.1 percent" this year.
- Sub-Saharan Africa projected to grow at "5.6 percent" this year.
- Concerns: Emerging markets worry about adverse side-effects of unconventional monetary policy in advanced economies—effects on exchange rates, capital flows, asset prices, and rapid credit growth.
Countries on the mend (focused on the U.S.)
- U.S. growth projections:
- Modest recovery envisaged to about "2 percent in 2013".
- Growth to about "3 percent in 2014" as private demand firms up.
- Fiscal context:
- Recovery expected despite strong fiscal consolidation equivalent to about "1.8 percent of GDP".
- Policy note: U.S. should avoid another deep and sudden fiscal adjustment; a medium-term adjustment plan can provide room for recovery of private demand.
Countries still lagging (Euro Area and Japan)
- Euro Area:
- IMF forecast of a mild contraction of "one-quarter of a percent" this year.
- Germany’s growth likely to be "0.6 percent" this year.
- France’s growth expected to be slightly negative.
- Spain and Italy expected to experience substantial contractions.
- Policy needs in Europe:
- Fix banking systems by prompting banks to repair balance sheets.
- Collective solutions: bank recapitalization through the European Stability Mechanism; a comprehensive banking union adding a single resolution authority to supervisory authority; a deposit insurance fund; greater fiscal integration.
- Japan:
- New three-pronged approach: higher inflation target and more aggressive quantitative easing, flexible fiscal policy, and structural reforms.
- Immediate actions: setting a "2 percent" inflation target; sizable quantitative easing; fiscal stimulus of about "1½ percent of GDP over two years".
- IMF growth forecasts for Japan: "1.6 percent" in 2013 and "1.4 percent" in 2014.
- Risk: Given Japan’s very high level of public debt, fiscal stimulus without a medium-term plan for fiscal consolidation could raise risk premia and long-term sustainability concerns.
Macroeconomic Policy Challenges
- Near-term risks rooted in Euro Area problems.
- Emerging market challenges largely driven by external forces:
- Weak demand from traditional markets.
- Managing pressures from exceptionally loose monetary policy in advanced economies.
- Preparing for normalization when the price of risk returns to more normal levels.
Role of unconventional monetary policy
- Contributions:
- Helped ease tail risks of market breakdown, restored investors’ appetite for risk, encouraged resumption of flows.
- Supported sizable output gains in advanced economies and some emerging markets (per IMF macroeconometric work).
- Risks and trade-offs:
- May have added to uncertainty and fueled volatility in capital flows.
- Associated in some episodes with appreciating emerging-market currencies, affecting competitiveness.
- For emerging-market countries already facing inflationary pressures, the impulse can represent a sizable policy challenge.
- In countries allowing appreciation, internal demand supported at the cost of exports.
- Policy instrument novelty: Effects not yet fully understood; need for alertness to warning signs.
Implications for Global Liquidity
- Definition and measurement:
- Lack of consensus on definition; common element centers on the “ease of financing” at a point in time.
- Determinants: macroenvironment, monetary policy stance, financial regulation, financial innovation, and risk appetite.
- Useful to examine both price-based measures (policy rates, secured/unsecured money markets, swap and bond markets) and quantity-based measures, especially in turmoil.
- Quantity-based classification and indicators:
- Asset-side measures: track cross-border and foreign currency credit (international claims).
- Funding-side measures: distinguish “core” liquidity (traditional deposit-based funding, approximating M2 or M3) and “non-core” liquidity (securitization and collateral-based funding; shadow banking).
- Financial stability signals:
- "Asset growth" (cross-border credit) and "noncore funding" are highly procyclical and valuable for surveillance.
- Rapid system-wide credit growth in excess of deposits—funded through noncore channels—associated with financial imbalances.
- Empirical observations:
- Rising global liquidity tends to boost emerging-market asset prices (ongoing IMF research).
- Cross-country impact of changes to noncore liquidity is somewhat larger than for core liquidity.
- Largest and most procyclical component historically: noncore (shadow banking).
- Crisis effects:
- Dramatic collapse in non-core liquidity during global financial crisis.
- Collapse of cross-border credit over 2008–2009; since 2010 international claims remained effectively stagnant.
- Noncore liquidity continues to shrink as a proportion of GDP; no sign of rebound yet.
- Role of unconventional policy on liquidity:
- Offset decline in non-core liquidity by boosting funding to traditional core banks, resulting in a relatively flat profile for total core and non-core liquidity.
- Targeted measures (e.g., liquidity to securities firms and money market funds, repo operations extended to commercial paper and asset-backed securities in the U.S., SMP asset purchases in Europe) helped alleviate systemic fears and eased contraction of shadow banking.
Conclusion (findings and policy recommendations)
- Findings:
- Unconventional monetary policy measures in advanced markets have supported growth and warded off global tail risks.
- These measures reduced long-term interest rates, spurred growth, avoided deflation, and restored financial market functioning.
- So far, quantity indicators show little evidence of a return of excess global liquidity.
- Policy challenges and recommendations:
- Emerging markets facing inflationary pressures must manage spillovers from capital inflows; higher asset prices may be unavoidable but monitoring volatility is crucial.
- Clear communication and forward guidance can help lower the volatility of capital flows and recipient-country asset prices.
- As emerging markets rebuild monetary and fiscal policy space, macroprudential and capital flow measures will play a complementary role where conventional monetary policy is insufficient for specific financial stability issues.
- Liquidity trends should be monitored carefully; further analysis of the link between unconventional monetary policy and global liquidity measures is needed.
- Vigilance required for the possibility that balance-sheet repair completion could lead to rapid resumption in worldwide lending and improvement in conditions for funding with noncore liabilities.
- Continued vigilance by central banks is necessary to manage potential surge in global liquidity that could complicate policymaking for countries above absorption capacity and challenge financial stability where capital inflows are large and volatile.
Keynote Speech by Naoyuki Shinohara, Deputy Managing Director, International Monetary Fund; Bank of Korea International Conference 2013, Seoul, Korea, June 3, 2013.