Managing External Volatility: Policy Frameworks in Non-Reserve Issuing Economies

IMF Working Papers, December 18, 2020

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Canonical URL: Managing External Volatility: Policy Frameworks in Non-Reserve Issuing Economies

Authors: Hélène Poirson, Nathan Porter, Ghada Fayad, Itai Agur, Ran Bi, Jiaqian Chen, Johannes Eugster, Stefan Laseen, Jeta Menkulasi, Kenji Moriyama, Celine Rochon, Katsiaryna Svirydzenka, Camilo E Tovar Mora, Zhongxia Zhang, Aleksandra Zdzienicka
Published: December 18, 2020
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9781513564562.001

Study focus: vulnerability of non-reserve-issuing economies (NREs) to external shocks and policy frameworks when monetary policy independence is constrained.
Core conclusion: managing external shocks with multiple instruments can both lessen the policy response required from any one policy tool to financial and external shocks and increase the effectiveness of policies in stabilizing macro-financial conditions.
Caveat: effectiveness does not always imply appropriateness; appropriateness requires evaluation of potential trade-offs and unintended consequences.
Subject areas: Central bank policy rate, Exchange rate arrangements, Exchange rate flexibility, Exchange rates, Financial services, Foreign exchange, Inflation, Prices.

NREs have been highly sensitive to episodes of external pressures since the global financial crisis.
Use of multiple policy instruments:
- Can reduce the magnitude of response required from a single policy tool.
- Can increase effectiveness in stabilizing macro-financial conditions in some circumstances.
Effectiveness vs. appropriateness:
- Effectiveness in stabilization is distinct from appropriateness.
- Appropriateness depends on evaluating trade-offs and unintended consequences.

When monetary policy independence is constrained, consider deploying a mix of instruments beyond the central bank policy rate.
Assess trade-offs and unintended consequences before adopting multi-instrument strategies, since increased effectiveness may not equate to suitability for a given economy.
Areas implicated for policy design and coordination include:
- capital flow management measures
- foreign exchange intervention
- macroprudential policy
- monetary policy reaction and transmission