## Navigating Monetary Policy in the New Normal, Monetary Policy in a Changing Financial Landscape, Speech by Christine Lagarde at the ECB Forum on Central Banking

_IMF News, May 25, 2014_

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## Bibliographic details
- Published: May 25, 2014

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### Overview and context
- Speech delivered at the first ECB Forum on Central Banking; date: May 25, 2014.
- Core aim: assess how the remit, independence, and operating environment of monetary policy should evolve in a post-crisis “new normal.”
- Three main themes addressed:
  - (i) The evolving mandate of monetary policy;
  - (ii) Monetary policy independence, given a possibly wider mandate for central banks; and
  - (iii) The impact of growing financial interlinkages and challenges for monetary policy in emerging market and small open economies.

### Theme 1 — The evolving mandate of monetary policy
Findings and observations:
- Pre-crisis consensus: monetary policy focused on price stability (low and stable inflation) with “light touch” microprudential regulation expected to deliver financial stability.
- The 2008 global financial crisis demonstrated that financial crashes can be extremely costly and that price stability alone is not always sufficient for output stability.
- Financial stability is now widely seen as an essential policy objective, but whether it should be part of monetary policy’s mandate is contested.

Empirical examples and exact figures preserved:
- Korea reduced banks’ short term external debt by half—to 27 percent—between 2008 and 2013.
- Hong Kong recently saw property prices level off and loan-to-value ratios decline (qualitative observation retained).
- In some countries (Israel, Switzerland, Turkey), credit growth and house price inflation remained high despite macroprudential measures.

Key practical questions and challenges:
- Transmission uncertainty: e.g., how much does a 100 basis points increase in interest rates deliver in terms of financial stability?
- Measurement ambiguity: how to define and measure financial stability—credit growth, asset price growth, leverage?
- Trade-offs in operating framework: raising rates to address financial imbalances versus lowering rates to support growth and inflation (example: Sweden shows less tendency to lower rates despite very low inflation because of rising financial stability risks).

Policy implication:
- Primary objective should be to strengthen prudential frameworks (macro- and micro-prudential tools such as loan-to-value limits, countercyclical capital buffers) to avoid overburdening monetary policy.
- Where macroprudential measures fall short, monetary policy may need a larger role to maintain financial stability.

### Theme 2 — Monetary policy independence, given a wider mandate
Findings and reasoning:
- Central bank independence historically associated with better inflation performance; foundations are credibility and accountability built on three pillars:
  - Clear mandate;
  - Consistent performance;
  - Consensus on objective.
- A wider financial stability objective challenges these pillars because:
  - Objectives, targets, and instruments for financial stability are ill-defined.
  - Performance is hard to measure and often revealed only after crises.
  - Consensus may be fragile as some groups may lose from measures that enhance financial stability.

Institutional approaches and examples:
- Separate institutions for monetary and macroprudential policy (examples: Australia, Chile, Mexico) — use of committees for information sharing and coordination.
- Single-institution approach with safeguards (examples: ECB, Bank of England) — both monetary and macroprudential responsibilities with distinct governance structures to protect independence.

Policy implication:
- Institutional structures must protect the achievement of price stability while enabling macroprudential action; safeguards and clear governance are required if responsibilities are combined.

### Theme 3 — Monetary policy independence in emerging market and small open economies
Findings and empirical evidence:
- Growing financial interlinkages and volatile capital flows pose challenges to monetary independence.
- Examples of exchange rate and capital flow volatility:
  - Strong appreciation between January 2009 and May 2013: nearly 50 percent in New Zealand and Australia, and 30 percent in Chile.
  - Reversal between May and August 2013: currency depreciations of nearly 15 percent in Brazil, India and Uruguay.
  - Non-resident holdings of domestic currency government bonds in Uruguay surged from 2 percent to 45 percent of the outstanding stock in May 2013 (increase occurred in a little over a year).

Three-pronged policy response framework (not mutually exclusive):
- Resilience:
  - Enhance resilience to shocks via sound macroeconomic fundamentals and reinforced macroeconomic and financial frameworks.
  - Advanced economies can reduce volatility by communicating clearly about their monetary policy.
- Response:
  - Use the full policy toolkit: monetary policy, exchange rate policy, macroprudential policy, fiscal policy.
  - Consider targeted, temporary capital flow management measures and foreign exchange intervention where appropriate.
  - Empirical examples: Brazil, Uruguay and Indonesia used some form of capital controls; India and Peru intervened in foreign exchange markets.
- Cooperation:
  - International monetary policy cooperation can reduce the risk of tail events and large international feedback effects (examples: coordinated policy rate cuts during the crisis; Fed swap arrangements; G-20 agreement on expanding IMF resources).
  - As conditions normalize, the urgency and clarity of cooperative gains may diminish, but uncertainties argue for continued evaluation of cooperative policies’ effectiveness and spillovers.

Policy implication:
- National policies alone risk ad hoc intervention and exported financial instability; international cooperation and careful evaluation of spillovers and “spillbacks” are important to limit global welfare losses.

### Conclusion and next steps highlighted in the speech
- Several pre-crisis principles remain useful; others must be revisited in light of crisis lessons.
- The IMF commits to advancing analysis and debate on the contours of monetary policy in the post-crisis world, including through surveillance, cross-country analysis, and collaborative projects.
- Announcement: a new IMF lecture series on monetary policy in honor of Michel Camdessus; inaugural lecture by Janet Yellen on July 2 (as stated in the speech).

*Speech by Christine Lagarde at the ECB Forum on Central Banking, May 25, 2014.*

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## References

- [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)
- [Uruguay and the IMF](http://www.imf.org/external/country/URY/index.htm)
- [Australia and the IMF](http://www.imf.org/external/country/AUS/index.htm)
- [Chile and the IMF](http://www.imf.org/external/country/CHL/index.htm)
- [India and the IMF](http://www.imf.org/external/country/IND/index.htm)
- [Portugal and the IMF](http://www.imf.org/external/country/PRT/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [Christine Lagarde](https://www.imf.org/external/np/omd/bios/cl.htm)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp052514_