G20 High-Level Seminar on Macroeconomic Policy Mix

(MENAFN-Caribbean News Global)

By Janet L. Yellen

Just as the post-COVID-19 recovery was taking hold, Russia’s unwarranted war on Ukraine sent shockwaves through the global economy. Indeed, the fallout from this shock wave is at the center of our discussions in Bali. Russia’s war has propagated a commodity price shock as food, fertilizer and energy prices remain high, causing more people to go hungry.

This shock compelled us to take action to help alleviate food insecurity, including through our call to action for international financial institutions to redouble their efforts, and through our leadership role in the Global Program for Agriculture and Food Security – to which the United States is donating an additional $155 million.

The economic impact of war is further exacerbating inflation, hurting government fiscal positions and exacerbating capital flow volatility as many countries are still recovering from COVID-19. As a result, we all need to review our approach to macroeconomic policy. Like many of you here today, I am no stranger to macroeconomic policy-making, having spent three decades in various policy roles. During this period, the global economy has faced many challenges, including balance of payments crises, debt crises, financial crises and a global pandemic.

In my remarks today, I will share thoughts and three lessons learned from my experience. I will also reflect on the challenges that policy makers, particularly those in emerging and developing countries, face in the face of external shocks. And I will share my view that, going forward, the IMF’s Integrated Policy Framework – or CIP – is a step forward in our understanding and consideration of a broader range of macroeconomic policy tools.

What lessons have we learned?

First, it is essential to establish, maintain and update a manual of policy responses aimed at minimizing the duration and severity of recessions and mitigating the negative economic consequences on businesses and individuals. During the global financial crisis and the COVID-19 pandemic, many countries implemented significant fiscal responses, serving both the “macro” objective of reducing the severity of shocks across the world. economy, as well as the “micro” objective of supporting the individuals, families and businesses most affected by these crises.

During the global financial crisis, many advanced economies pushed monetary policy into new territory, adopting negative policy rates and implementing quantitative easing. Targeted liquidity support was provided to some asset markets which started to seize up. A similar monetary response has occurred around the world during the pandemic, with more emerging market economies cutting rates aggressively than was the case after previous global shocks.

These macroeconomic policies served as “first responders” to the economic fallout from the pandemic, and lessons learned from past shocks enabled us to respond quickly and aggressively. The impact on the global economy has been severe, but less severe than it otherwise would have been. In June 2020, the IMF predicted a 5% contraction in global economic activity for that year, but the actual decline was just over 3%. I am convinced that the global macroeconomic response played a role in reducing the magnitude of the contraction.

A second lesson is that strong fundamentals, strong institutions and political credibility underpinned by clear communication remain important foundations of any policy mix. Fiscal responses are effective only to the extent that they are implemented. The public sector must be able to effectively raise funds and distribute them to the targeted beneficiaries. Institutional transparency is also important to reduce corruption on both the revenue and expenditure sides of fiscal policy.

The effectiveness of monetary policy depends on the credibility of the central bank. As the United States learned in the 1980s, if inflation expectations become unanchored, lowering inflation is much more difficult and costly for the economy. Liquidity support is also more effective when markets are sufficiently developed to respond to it. For some US liquidity facilities, the announcement effect was enough to calm the markets and restore their functioning.

Third, even with sound fundamentals and strong institutions, financial flows can be volatile. The flow of capital benefits both source and recipient economies through a more efficient global allocation of resources and by allowing countries to smooth consumption. Foreign capital can increase productivity and wages, transfer know-how, increase GDP growth and increase the supply of credit. Yet countries with large surges in capital flows or large fluctuations may experience greater macroeconomic volatility and are vulnerable to crises.

Strong national policy frameworks can help attract flows that are less volatile or less sensitive to external shocks, such as local currency debt flows and direct investment. Macroprudential measures can help stabilize cross-border lending and dampen financial cycles that undermine overall financial stability. But while sound macroeconomic and financial policies can help manage these risks, they cannot eliminate them.

This is particularly relevant for emerging markets in the context of the current global economic environment. Financial conditions have tightened due to growing and widespread inflationary pressures, geopolitical uncertainty caused by Russia’s war against Ukraine and slowing global growth. Today, portfolio investments are starting to move out of emerging markets. Maintaining or strengthening policy frameworks and institutional credibility remains an essential safety net to manage the risks of volatile capital flows.

Countries react to these developments from different starting positions. This highlights the obvious need for policy makers to understand what course of action is most effective and what is appropriate, taking into account these three lessons learned. In addition, factors such as external borrowing constraints, rigid export prices, shallow markets, and other economic characteristics affect policy effectiveness, especially in the short term.

The field of economics has made great strides in understanding open economies, global capital flows, and the role of politics. From Mundell-Fleming to work under the IMF’s new Integrated Policy Framework, we have broadened our understanding of the complexities of the international financial system. These advances help refine our understanding of how policies interact and can jointly respond to pandemics, financial crises, and other local and global shocks.

The IPF recognizes that country-specific characteristics can lead to externalities in economic decisions and that adding a broader set of policy tools to the playbook can be beneficial to optimally achieve national goals. Emerging markets and low-income countries can, in certain circumstances, benefit from capital flow management and foreign exchange interventions alongside monetary, fiscal and macroprudential policies.

However, a key remaining challenge is to identify in real time when these circumstances arise or when, instead, more structural policies should be prioritized. We now have a better understanding of the arguments for using exchange rate policies and capital flow management. But that doesn’t mean we’ve forgotten the charges against them. For example, it remains important that foreign exchange intervention is not used to create an unfair competitive advantage or delay necessary balance of payments adjustments.

With its primary mandate of maintaining the stability of the international monetary system and monitoring exchange rate policies, the IMF has a clear role to play in ensuring that these countries responsibly apply complementary policy tools. Country-specific circumstances help shed light on appropriate underlying macroeconomic policies and appropriate complementary policy tools. But clear guidance on when these policies are not appropriate remains equally important. As is the case with all the tools we use as decision-makers, these new frameworks should provide a solid foundation for consistent face-to-face guidance.


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About Stephen Arrington

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