WASHINGTON, USA – The International Monetary Fund’s (IMF) executive board met on September 28, 2020, to discuss findings of staff’s analytical work on an Integrated Policy Framework (IPF) aimed at helping formulate appropriate responses to fluctuations in international capital flows and other shocks.
A staff paper summarizes the key analytical findings, which will serve as an input into a forthcoming review of the IMF’s Institutional View on the Liberalization and Management of Capital Flows. It does not propose changes to the IMF’s operational framework at the present juncture.
While generally beneficial, cross-border capital flows can generate or amplify shocks. To manage these flows and achieve domestic and external stabilization objectives, in practice policymakers resort to different strategies and instruments and provide various rationales for their choices.
The IPF aims to provide a systematic analytical approach to selecting an appropriate policy mix for managing large and volatile capital flows and more generally preserving macroeconomic and financial stability in the face of domestic and external shocks.
It jointly considers the role of monetary, exchange rate, macroprudential and capital flow management policies and their interactions with each other and other policies, accounting for country circumstances. The analysis suggests that the appropriate policy mix depends on the nature of shocks, country characteristics, and initial conditions. This finding, however, does not rationalize indiscriminate use of multiple tools or support their deployment in all circumstances. Reliance on such tools is also not a substitute for warranted economic adjustment, deep markets, healthy balance sheets, and strong institutions.
The framework draws on modeling for small, open economies, empirical analysis, and a review of country experiences; and has been developed by IMF staff from various departments.
Executive board assessment
Executive Directors welcomed the opportunity to discuss the takeaways from the Integrated Policy Framework (IPF) analytical workstream. They noted that policymakers often face difficult tradeoffs in pursuing domestic and external stabilization objectives in the presence of volatile capital flows. In this context, they recognized the importance of jointly considering, under certain circumstances, the role of monetary, exchange rate (including foreign exchange intervention), macroprudential and capital flow management policies, and their interactions with each other and other policies. They noted that having a systematic framework can also help central banks employing multiple tools communicate policy decisions and enhance credibility.
Directors agreed that the IPF offers valuable analytical insights into how country characteristics, initial conditions, and the nature of shocks affect whether the use of multiple policy tools is warranted. They appreciated the breadth and depth of the analysis, including advances in modeling, extensive empirical work, and informative case studies. Directors agreed that the paper highlights the main tradeoffs in the use of multiple tools, although many directors also stressed the importance of other considerations, including integrating fiscal policy more fully into the analysis, exploring more deeply multilateral implications or spillovers of IPF policies, extending the analysis of intertemporal tradeoffs, and deriving lessons from the COVID-19 crisis. Some directors also suggested other potential extensions of the framework.
Directors agreed that optimal policy combinations depend on the nature of shocks, country characteristics, and initial conditions. They noted the IPF finding that in countries with flexible exchange rates, deep foreign exchange markets, and continuous market access, allowing full exchange rate adjustment to economic and financial shocks is typically optimal. A few directors emphasized that in such cases, the findings indicate no rationale for capital flow management measures. On the other hand, directors noted that in the presence of frictions and vulnerabilities common in emerging market and developing economies, while flexible exchange rates continue to provide significant benefits, other tools can play a useful role for certain shocks.
In particular, directors took note of the analytical finding that macroprudential measures, foreign exchange intervention, and capital flow management measures can, under certain circumstances, help enhance monetary autonomy, improve financial and price stability, and reduce output volatility in countries with financial frictions and/or balance sheet vulnerabilities. A number of directors highlighted the finding that the use of precautionary capital flow management measures can lower risks to financial stability under certain conditions, although a few directors pointed out that such measures tend to become “sticky” and that policymakers’ ability to adjust them over the financial cycle needs to be taken into account.
Directors agreed that the deployment of policy tools should be guided by a clear framework and an assessment of costs and benefits. The macroeconomic and financial stabilization benefits of IPF policies need to be balanced against potential costs in terms of market development and other possible unintended consequences. The persistent use of IPF tools may perpetuate the very vulnerabilities that rationalize their deployment. Directors noted that the use of IPF tools is not a substitute for deep markets, healthy balance sheets, and strong institutions. The tools should not be used to support misaligned exchange rates or substitute for warranted macroeconomic adjustment. In this context, directors highlighted the Fund’s role in assisting members in fostering deeper markets, strengthening institutions, and addressing underlying vulnerabilities.
Directors also underscored that while models provide a useful guide, the complexity of real life situations and tradeoffs (particularly intertemporal ones), as well as other practical challenges (such as endogeneity of policy and country conditions and determining the nature and source of shocks) suggest a need for caution and judgment in the application of IPF tools and the importance of communicating clearly the actions and objectives. Similarly, country experiences should be assessed in detail and carefully integrated in the framework.
Directors emphasized that the analysis does not support indiscriminate use of IPF tools and that the operationalization of the findings should include safeguards to minimize the risk of inappropriate use of IPF policies. Directors noted that ensuring robustness and developing metrics to assess country characteristics will be essential for translating the framework’s findings into implementable policy advice. Directors cautioned against the mechanical application of safeguards and emphasized the need for judgment when the framework is operationalized.
Directors affirmed that Fund policy advice remains guided by the Institutional View on the Liberalization and Management of Capital Flows and other existing Fund policies. In this context, they emphasized the importance of careful communication of the IPF’s analytical findings, acknowledging its assumptions, limitations, and qualifications. Directors welcomed the intention to use the IPF’s analytical findings as an input for the upcoming review of the institutional view, along with the report by the independent evaluation office on IMF advice on capital flows.