Central banks' panel suggests safeguards for inflation, geopolitical churns

New Delhi: A high level central banks' panel has suggested that the key financial institutions need to rebalance their policy mix, rebuild policy buffers and develop safe macro-financial stability frameworks (MFSFs) for the future.

The Asian Consultative Council of the Bank For International Settlements in its report titled ‘Inflation, external financial conditions and macro-financial stability frameworks in Asia-Pacific’, has suggested these measures.

"Going forward, once inflation moves closer to central bank targets and global financial conditions stabilise, these are three dimensions that central banks may wish to take into account while plotting the way forward," it said.

The first measure, the council has suggested is to rebalance the policy mix.

"Ideally, policymakers may prefer to shift to a mix that is more comparable to the one in place before the pandemic: monetary policy focusing on macroeconomic stability, macroprudential measures defending against the unwinding of financial imbalances and a mix of tools to ensure external stability.

However, the rebalancing process faces challenges that stem from high debt levels (in most regional economies), weak real estate markets (in some regional economies) and the risk of new shocks.

In this regard, one of the strategies authorities in several economies have been following is to adjust some of the measures used from being broad-based to being more targeted, the report suggested.

That said, some members noted that a pandemic-induced shift in some of the relevant “state variables”, especially debt levels, can make the transition to a “pre-pandemic” policy mix (i.e. one that is more suited for when inflation becomes low and stable and global financial conditions loosen) slow or uncertain,” it said further.

"Vulnerabilities also mean that the transition will have to be gradual and smooth in order to avoid any.

In principle, the need for multiple tools for each objective can arise either because a large shock dislodges the objective to a major extent, or because multiple or different types of shocks perturb the same objective in numerous ways. While it is difficult to pin down the exact rationale for each objective in every economy, in general, a combination of both the rationales is likely to have applied in 2022.

Moreover, the experience gained by policymakers in terms of executing multiple policies in a synchronised manner during 2020 and 2021 (as necessitated by the pandemic) is also likely to have facilitated the greater use of supplementary tools during the stress period," the report said.

Also, the transition will need to be mindful of developments elsewhere (for example the global policy cycle) as well as renewed risks (for example any intensification of the war in Ukraine or deglobalisation), it underlined.

Another dimension of the way forward is the need to rebuild policy buffers, the panel advocated.

Several central banks noted that the existence of buffers enabled them to launch an effective policy response in 2022.

"Rebuilding buffers if necessary, and ensuring that they remain sufficient, is the key to maintaining policy space in the future. Rebuilding macroprudential buffers may be especially important in economies where household debt is at high levels. Similarly, restoring FX reserves is likely to be most relevant in jurisdictions that used interventions materially when their currencies were depreciating in 2022," it said.

Lastly, the panel advocated the significance of lessons learnt while operating macro-financial stability frameworks (MFSFs) during the recent volatile period to further develop MFSFs for the future.

Members noted several common lessons but also underscored that, since economy-specific characteristics vary, not every lesson will apply in every jurisdiction.

First, new (or previously scarcely used) tools may become a more regular part of the toolbox in some economies because of a net positive experience regarding their use.

For example, intervention in domestic government and/or corporate bond markets, or even announcement of such programmes, was perceived to have beneficial effects on market functioning in some jurisdictions.

Second, while members mentioned already practicing some degree of flexible integration in the use of policy tools before the pandemic, they acknowledged that their experience in 2022 – when numerous shocks of relatively large magnitudes perturbed multiple objectives – offers additional lessons on how tools interact.

These lessons can help policymakers further optimise their joint use.

Third, members noted lessons in terms of the trade-offs associated with the pre-emptive versus reactive use of tools. For instance, while the Reserve Bank of New Zealand’s monetary policy tightening had been ahead of many peers, it noted that high inflation outcomes point to having waited too long to see conclusive data.

Fourth, members noted that the nature, intensity and transmission of shocks to the domestic economy matter for the optimal policy response. In particular, New Zealand stressed that it is more effective to address root causes of instabilities, where feasible.

Some central banks noted that monitoring, surveillance, and/or stress-tests are key in this regard.

Fifth, a preference for price-based instead of quantity-based policies and operational readiness were also noted as aspects of an effective policy framework.

Sixth, members noted that the efficacy of MFSFs depends in part on the ecosystem in which they operate, which may be beyond their control. This underscores the important roles of domestic structural reforms and other non-central bank policies in influencing the ecosystem and thus the efficacy of MFSFs.

Overall, many members’ responses reflected the view that the effectiveness of MFSFs hinges on taking account of the following key aspects of the policy actions: trade-offs (for example between stabilising inflation and output or between growth and external balance as well as those arising from leakages or unintended consequences), interactions or complementarities (for example one tool could help mitigate the spillovers from another), constraints or limits (such as diminishing returns to the continued use of a tool), policy communication (for example especially when different policies appear to be out of sync), and coordination between authorities (for example between the central bank, any other financial authorities and the government).

The Asian Consultative Council (ACC) of the Bank for International Settlements (BIS) was established in March 2001 to facilitate communication between the BIS shareholding central banks in the Asia-Pacific region and the BIS' Board and Management on matters of interest to the Asia-Pacific central banking community.

As of September 2023, the ACC comprised the Governors of the central banks and monetary authorities of Australia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, Thailand and Vietnam.

At the request of the ACC Governors during their September 2022 meeting, the BIS Representative Office for Asia and the Pacific set up a Working Group on “Inflation, external financial conditions and macro-financial stability frameworks in Asia-Pacific”.

The group commenced in November 2022, with a mandate of examining ACC economies’ policy frameworks during the stressed period of 2022, particularly the joint use of monetary, macroprudential, exchange rate and capital flow management policies.

The Working Group comprised of officials from the central banks and monetary authorities of ACC economies.

This was the second ACC Working Group. The first one was established in June 2019 and published its report in November 2020.