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Following past lessons, the Global Financial Crisis (GFC) triggered further adaptations in emerging market economies‘ (EMEs’) policy framework to simultaneously achieve macroeconomic and financial stability. The pragmatic policy framework that served the EMEs well after the Asian financial crisis has evolved. But even an integrated inflation targeting framework, complemented with macroprudential policies (MaPs) and FX interventions to smooth excessive exchange rate movements, has appeared insufficient to insulate EMEs from the large financial spillovers due to UMP.
So what changed with the GFC? The revival of calls for international cooperation has re-emerged mostly with the observation that the post-GFC unconventional policies pursued by both advanced and emerging market economies produce significant spillovers and spillbacks despite floating exchange rate regimes, restrictions on capital movements and successful experience with inflation targeting monetary policy regimes.
The most noted cross-border externalities (spillovers and spillbacks) that were the subject of mutual complaints inside the G20 circle consisted of “currency wars”, or the old competitive depreciation beggar-thy-neighbour practice. That practice was, under current floating ER regimes, associated with central banks’ massive asset purchase programmes. A related complaint was that, by deviating excessively from rules-based policy (Taylor (2013)), specific major central banks created incentives for others to also deviate from such policies and thus influenced their yield curves and hence the price of domestic assets including their exchange rates. But a number of other externalities were identified and debated. These included, but were not limited to, the effect of interest rate differentials on local credit cycles, the lack of fiscal coordination in the implementation/design of stimulus that affects risk premia (eg especially in the euro zone), the importance of forward guidance on central bank policies that reverberated on asset prices during the taper tantrum episodes) etc. Under these special circumstances of UMP, EMEs began considering and increasingly using MaPs and CFMs as a useful support against destabilising excessive capital inflows, exchange rate appreciation and imported financial exuberance. But in addition to the potential welfare costs associated with CFMs, the non-coordinated, non-systematic usage of MaPs also began showing potential negative externalities. Left unchecked, the non-coordinated usage of MaPs could be seen as the start of a potential “regulatory war” between countries.
Authors concluded: „Therefore, it seems that we stand at an important juncture in the post-GFC era. There is a realistic assessment that concrete international monetary policy coordination – albeit desirable – is in practice far from becoming a reality. Yet, while monetary policy coordination is out of reach, we also know that globalised financing will continue to allow movements of capital flows to affect global and local asset prices including the exchange rate, in spite of (or even because of) policy interventions in both AEs and EMEs. We also know that both monetary and macroprudential policies affect financial stability. An extensive literature shows that there are strong policy spillovers between MP and MaP. In a nutshell, if we know MP and MaP need coordination inside a country, and if we also know that MaPs and MPs produce negative international externalities, then logically MaPs also need some form of international coordination.”
Furthermore MaP coordination could be confronted with fewer political-economy constraints than MP, in the light of the globalisation of finance. The current challenge is to try to avoid negative externalities resulting in “regulatory wars” by coordinating MaPs internationally. Not only could such an international coordination help EMEs to cope with large spillovers, but AEs could also benefit from reduced spillbacks from EMEs. This would constitute an undeniable win-win for the global economy.