## Monetary Policy Will Never Be the Same _IMF Blog, November 19, 2013_ ## Source details **Canonical URL:** [Monetary Policy Will Never Be the Same](https://www.imf.org/en/blogs/articles/2013/11/19/monetary-policy-will-never-be-the-same) ## Other formats - [Markdown version](/en/blogs/articles/2013/11/19/monetary-policy-will-never-be-the-same/index.md) - [Structured JSON version](/en/blogs/articles/2013/11/19/monetary-policy-will-never-be-the-same/index.json) - [Bundle manifest](/en/blogs/articles/2013/11/19/monetary-policy-will-never-be-the-same/bundle-manifest.json) ## Bibliographic details - Authors: Olivier Blanchard - Published: November 19, 2013 --- ### Overview and context - Author: Olivier Blanchard - Date: November 19, 2013 - Context: Reflections following an IMF research conference in honor of Stanley Fischer on lessons from the crisis. - Two preliminary non-monetary policy conclusions highlighted: - Having your macro house in order pays off in an external crisis; prudent pre-crisis fiscal policy gave emerging market countries room to pursue countercyclical fiscal policies during the crisis. - Rapid cleanup and recapitalization of banks after a financial crisis is essential; the US recapitalization helped recovery, whereas Japan’s failure to do so in the 1990s was costly. ### Liquidity trap: evidence and implications - Key observations: - The zero lower bound can be binding and persist for a long period — "five years at this point." - Unconventional monetary policy can systematically affect term premia and bend the yield curve through portfolio effects. - Compared to conventional policy, the effects of unconventional monetary policy are "very limited and uncertain." - Counterfactual / quantitative illustration: - If inflation had been "2 percentage points higher" before the crisis: - The best guess is inflation would be "2 percentage points higher today." - The real rate would be "2 percentage points lower." - The United States would "probably be close ... to an exit from zero nominal rates today." - Risks and scenarios: - Possibility (as raised by Larry Summers) that economies may need "negative real rates for a long time." - Negative real rates can be achieved through "low nominal rates and moderate inflation." - Current danger: an adverse feedback loop where depressed demand → lower inflation → higher real rates → even more depressed demand. ### Liquidity provision: lender of last resort and sovereign risks - Lessons: - Runs are relevant not only for banks but also for other financial institutions and for governments. - In an environment of high public debt, rollover risks cannot be excluded. - Policy implication: - Essential to have a lender of last resort ready to lend not only to financial institutions but also to governments (theme emphasized by Paul Krugman). - Supporting evidence: - The behavior of periphery sovereign bonds in the Euro area, before and after the European Central Bank’s announcement of outright monetary transactions, supports the importance of a lender of last resort. ### Capital flows and exchange rate policy in emerging markets - Preferred broad approach: - Let the exchange rate absorb most—but not necessarily all—of the adjustment to volatile capital flows. - Standard argument (stated by Paul Krugman): if investors withdraw funds, allow them to exit; depreciation will likely increase exports and output. - Traditional counterarguments against relying on exchange rate adjustment: 1. Depreciation can harm domestic balance sheets where borrowers have foreign-currency debt, reducing domestic demand possibly offsetting export gains. 2. Nominal depreciation may translate into higher inflation. 3. Large exchange rate movements may disrupt the real economy and financial markets. - Empirical reassessment based on recent crisis experience: - The first two concerns are "much less relevant than they were in previous crises" because of: - Macroprudential measures. - Development of local currency bond markets. - Exchange rate flexibility improving borrowers' perception of exchange rate risk, reducing foreign exchange exposure. - Increased credibility of monetary policy and inflation targets, better anchoring inflation expectations and limiting pass-through of exchange rate movements to inflation. - The third concern (disruptions from large exchange rate movements) remains relevant. - Policy practice and tools: - Many emerging market central banks use a "managed float" rather than full float: - Joint use of the policy rate, foreign exchange intervention, macroprudential measures, and capital controls. - Rationale: - Avoids the dilemma where the policy rate is the sole instrument: raising the policy rate to counter capital inflows can itself attract more foreign investment. - Foreign exchange intervention, capital controls, and macroprudential tools can, in principle, limit exchange rate movements and financial disruptions without relying solely on the policy rate. - Experience during the crisis: - Countries employed combinations of these tools; some relied more on capital controls, others more on foreign exchange intervention. - Evidence from the conference and IMF work suggests these tools have "worked, if not perfectly." - Research and policy challenge: - The "clear (and quite formidable) challenge" is to understand how best to combine these tools going forward. ### Conclusions and research agenda - Core conclusion: "Monetary policy will never be the same after the crisis." - The conference clarified how monetary policy has changed and identified focal points for future research and policy: - Preventing and mitigating liquidity traps, including rethinking inflation targets and the role of negative real rates. - Strengthening frameworks for liquidity provision, including lender-of-last-resort capacity for sovereigns. - Refining the use and combination of policy rate, foreign exchange intervention, macroprudential measures, and capital controls to manage volatile capital flows while limiting disruptions. *Olivier Blanchard — "Monetary Policy Will Never Be the Same," November 19, 2013.* --- ## Content in this bundle - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/english.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/english.pdf){rel="external" type="application/pdf"} - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/farhi.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/farhi.pdf){rel="external" type="application/pdf"} - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/forbes.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/forbes.pdf){rel="external" type="application/pdf"} - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/hoshi.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/hoshi.pdf){rel="external" type="application/pdf"} - **Currency Regimes, Capital Flows, and Crises** - [Currency Regimes, Capital Flows, and Crises (Markdown version)](/external/np/res/seminars/2013/arc/pdf/krugman1.pdf.md){rel="alternate" type="text/markdown"} - [Currency Regimes, Capital Flows, and Crises (PDF)](/external/np/res/seminars/2013/arc/pdf/krugman1.pdf){rel="external" type="application/pdf"} - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/Ostry.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/Ostry.pdf){rel="external" type="application/pdf"} - **14th Jacques Polak Annual Research Conference; November 7–8, 2013** - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (Markdown version)](/external/np/res/seminars/2013/arc/pdf/vegh.pdf.md){rel="alternate" type="text/markdown"} - [14th Jacques Polak Annual Research Conference; November 7–8, 2013 (PDF)](/external/np/res/seminars/2013/arc/pdf/vegh.pdf){rel="external" type="application/pdf"} --- ## References - [research conference](http://www.imf.org/external/pubs/ft/survey/so/2013/RES112113A.htm) - [emerging market countries](http://www.imf.org/external/mmedia/view.aspx?vid=2820844470001) _Source: https://www.imf.org/en/blogs/articles/2013/11/19/monetary-policy-will-never-be-the-same_