Integrated Policy Framework

IMF’s systematic analytical framework to help countries respond to fluctuations in international capital flows

Cross-border capital flows provide significant benefits but may also generate or amplify shocks. Small open economies can be particularly vulnerable to swings in international capital flows. How should they respond? The traditional answer has been to use flexible exchange rates as a shock absorber. But flexible exchange rates may not offer full insulation from external shocks, for example, when financial markets do not work perfectly.

As a result, policy makers often reach for a mix of tools including intervention in the currency market, and macroprudential and capital flow management measures. These policy responses vary substantially across countries and over time. A significant shortcoming of this eclectic approach is the lack of clear frameworks.

The IMF’s Integrated Policy Framework was developed to provide a systematic framework to select the appropriate policy mix to achieve macroeconomic and financial stability. Over the course of 2019 and 2020, IMF staff made a major push to develop conceptual and quantitative models taking greater account of financial market frictions and vulnerabilities to guide how these tools should be used in an integrated way, as explained in an IMF blog. The modeling effort was also being complemented by extensive empirical analysis and country case studies.

The policy paper that was published in October 2020 summarizes key analytical findings from staff’s work under the Integrated Policy Framework umbrella. A key finding was that the optimal policy combinations depend on the nature of shocks, country characteristics, and initial conditions. Generally, in countries with flexible exchange rates, deep markets, and continuous market access, full exchange rate adjustment to shocks remains appropriate. However, when a country has certain vulnerabilities, such as shallow markets, balance-sheet mismatches, or poorly anchored inflation expectations, while flexible exchange rates continue to provide significant benefits, other tools can play a useful role as well.