The Multilateral Aspects of Policies Affecting Capital Flows

1. The Multilateral Aspects of Policies Affecting Capital Flows Karl Habermeier, Assistant Director Mark Stone, Deputy Division Chief Monetary and Capital Markets Department December 20, 2011

2. Context • Fund is undertaking considerable work on policies affecting capital flows • Motivated by: • Greater cross-border interconnectedness • Experience of the crisis • G-20 and IMFC have called for a “comprehensive, balanced and flexible approach for managing capital flows” • The current work-stream follows on the view developed at the Fund 10 years ago

3. Fund capital flow work-stream • The Fund’s role regarding flows (December 2010) • Experiences in managing capital inflows (March 2011)—framework for capital flow management measures (CFMs) • Multilateral aspects (today) • Focus on source countries • Focus on broad array of policies • Capital outflows and capital acc. liberalization—March 2012 • Chapeau paper—mid-2012

4. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

5. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

6. Stylized fact 1: intra-AE gross flows embed potential systemic risks • Previous focus on net flows to EMEs, and on the composition of flows • The recent crisis showed that gross flows between AEs can be destabilizing • Flows to EMEs originate from the same small group of AEs that dominate inter-AE flows • Implication: strong transmission of AE policies

7. 20 10 20 10 Advanced economies Emerging markets In percent of global GDP In percent of global GDP 15 15 Inflows Net (right) 10 5 10 5 (liabilities, left ) 5 5 0 0 0 0 - 5 - 5 - 10 - 5 - 10 - 5 Outflows (assets, left) - 15 - 15 - 20 - 10 - 20 - 10 1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008 10 Advanced economies Emerging markets 20 20 10 In percent of own GDP In percent of own GDP 15 15 5 10 10 5 5 5 0 0 0 0 - 5 - 5 - 5 - 10 - 10 - 5 - 15 - 15 - 20 - 10 - 20 - 10 1980 1984 1988 1992 1996 2000 2004 2008 1980 1984 1988 1992 1996 2000 2004 2008 Source: World Economic Outlook Figure 1. Global Capital Flows1980-2010

8. Stylized fact 2: Global SIFIs bear directly on the riskiness of capital flows • Volatile bank flows suggests banks did not internalize the associated risks • Expansion in portfolio flows means a larger share of capital flows outside of regulation • Business model of many G-SIFIs model helped drive an increase in shadow banking and global liquidity • Implication: G-SIFI regulation is important

9. Stylized fact 3: The volume and volatility of EME capital flows are on upward trends • Gross EME inflows more volatile • Net EME capital flows remain large • Capital inflows have been trending upwards in EMEs • Declines in home bias in AEs • Widening growth differentials • Financial market development • Implication: transmission of AE policies may get stronger

11. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

12. AE regulation and supervision: motivation • Traditional focus: national microprudential • Limited attention paid to cross-border issues • Crisis showed shortcomings in R&S that transmitted across borders • Paper looks at the recent past, present and future of AE regulation and supervision

13. AE regulation and supervision: the recent past Five specific cross-border risks not adequately appreciated by supervisors 1. Foreign exchange liquidity risk—e.g. large European banks, AE banks in Europe EMEs, AIG 2. Counterparty risk—exposure to AIGFP, US MMMFs

14. AE regulation and supervision: the recent past 3. Indirect exchange rate risk—Fund in FX and lend in FX to borrowers who earn in LC 4. Mortgage market risk—National mortgage market risks transmitted globally 5. Credit concentration risk—Foreign affiliates concentrated in regions

15. AE regulation and supervision: summary of the recent past • These risks contributed to cross-country stress and undermined confidence in the global system • Regulatory perimeter is key policy implication • Macroprudential perspective needed • Problem of lack of feedback to large countries undermining their incentives • Box 2 has specific policy recommendations

16. AE regulation and supervision: the present • Discussion in the paper already a little dated! • Systemic financial stress is on the rise • Low interest rates having subtle effect • Flows are already becoming more unstable • R&S reform urgently needed to mitigate these risks

17. AE regulation and supervision: the future • Enormous agenda now underway • But progress has been mixed • This means regulatory arbitrage opportunities • Capital and liquidity requirements • Carving out of risky activities • Financial markets • Supervisory perimeter • Downside reform dynamic must be avoided

18. AE regulation and supervision:policy messages • Crisis taught us that national R&S has important multilateral effects • Completing national R&S reform is win-win • Complete and implement national macroprudential frameworks • Complete and implement international architecture reforms • Cross-border coordination

19. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

20. AE monetary policy: overview • Big issue is whether expansionary US MP increased flows to EMEs after crisis • Channels • Interest rate differentials • Growth differentials • Literature review: powerful effect • Based on pre-crisis • Overall effect • Differences across investors and types of flows

21. AE monetary policy: QE impact on long-term interest rates • ZLB prompted Fed and BoE shift to QE to lower long-term yields • QE—Bond purchases for macro purposes • Most empirical analysis based on event studies—QE1 reduced yields by 50 basis points, QE2 smaller • The interest rate effect likely increased capital flows to EMEs

22. AE monetary policy: other QE channels • QE can narrow growth differentials and thus reduce flows to EMEs • Some model-based evidence of domestic growth effect • Counterfactual of no QE could have led to much sharper world recession

23. AE monetary policy: conclusion • Weak case for active consideration by central banks of multilateral effects • Clear-cut case when domestic and multilateral objectives coincide • But usually very difficult to assess • Issue of mandate of large AE central banks • Fully effective R&S of AEs would help

24. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

25. Capital flow management measures: background • CFMs are administrative, tax, and prudential measures designed to influence capital flows • Two flavors: • “Capital controls”—discriminate on the basis of residency • “Other measures”—do not discriminate on the basis of residency e.g. some macroprudential measures • Renewed popularity has led to new cycle of work • CFMs can effectively manage inflows in a policy package • Can have adverse effects domestically • Unilateral impact seems to be limited

26. Figure 4. Capital Flows Management Measures and Related Measures Source: IMF Country Desks

27. Capital flow management measures: multilateral aspects • Focus here on CFMs aimed to address inflows • CFM can be expected to reduce asset prices and inflows in the homecountry • CFMs could transmit multilaterally via capital flows to likewise countries with similar characteristics: • Divert flows and increase asset prices and inflows in likewise • Reduce flows and decrease asset prices and inflows in likewise • Event studies suggested CFMs can increase or decrease flows to likewise countries

28. Capital flow management measures: implications • As of today, CFMs seem to have limited implications for the riskiness of flows • Modest unilateral effectiveness • Inconclusive multilateral transmission • Market participants view them as ineffective • Downside risk of CFM proliferation • Adverse dynamic (trade wars) • Closure of capital accounts limits benefits of capital flows

29. Organization of presentation • Reconsidering the stylized facts of capital flows • Advanced economy regulation and supervision and global reforms • The impact of advanced economy monetary policy on capital flows • Capital flow management measures • Conclusions and extension of the proposed framework

30. Extension of policy framework • Bottom line: national authorities should pay more attention to policy transmission, especially prudential • Fund previously proposed framework to address domestic aspects of CFMs for recipient countries • This paper proposed extending framework to help: • policymakers understand how risks transmit across borders • promote policy coordination

31. Extension of policy framework • National supervisors should understand risk cross-border transmission and be prepared to take countervailing measures • National supervisors should have the appropriate capacity and perimeter • Macroprudential policy should account for capital flows, and coordinate across countries • Complete and fully implement the ongoing international architecture reforms

32. Reaction to paper • Broad agreement by Directors on the conclusions of the paper • Discussion of AE monetary policy • Discussion of applicability of extension of the framework • Extensive press coverage • Next steps • Paper on capital account liberalization • Chapeau paper

33. Questions