By Rafiq Raji, PhD
Emerging markets central bankers are in somewhat of a flux at this time. Orthodox monetary policy measures to moderate capital outflows from their economies as global fund managers increasingly find the risk-reward characteristics of advanced economies attractive, as central banks there give up unconventional measures, are proving insufficient. Measures that seem to be able to live up to the task are not rules-based; capital controls, for instance. Their discretionary nature is precisely why they have been discouraged by the mainstream Washington Consensus. But even that consensus may be about to change. In October, the International Monetary Fund appointed Gita Gopinath as chief economist; a signal it is open to new thinking. Why so? Ms. Gopinath is a maverick of sorts. Her views on exchange rates are somewhat unorthodox. A prolific researcher, she has produced numerous papers to make her point. It seems the establishment finally decided such “unorthodox” views are now needed at the high table. One could argue the IMF is simply riding the wave, though. To resist what an increasing number of central bankers are beginning to institutionalize would be to lose relevance. At the IMF meetings in Bali in October, central bankers from Thailand, Malaysia, Singapore and Indonesia were unabashedly in support of newer and creative monetary policy measures to complement the predominant conventional inflation-targeting framework endorsed by the IMF.
Capital flows management (CFM), which are simply fine words for capital controls (albeit it includes other measures), is especially controversial. Crude at its worst, being no more than blocking the outflow of funds from an economy mostly, it is a mechanical way to manage the disruptions from sudden outflows, as was the case during the so-called American Fed taper tantrum in 2013, and now as the same central bank is decidedly and rightly on an interest rate hiking path. Still, the costs of capital controls are not likely to change. Investors do not soon forget when their funds are blocked from exiting a jurisdiction at precisely the time they so desperately needed them to. In some cases, if not most, when the flows are later eased, investors take significant losses from a likely depreciated local currency. Curiously, the same investors do not mind taking the same country risk much later on, when yields are temptingly attractive enough to make it worth their while.
But why should flexible exchange rates not suffice to absorb the shocks of sudden capital outflows? The inflationary effects can sometimes be too much to bear by the local populace of most developing economies, whose purchases tend to be mostly imported goods, leading to unrest. And the resultant damage can be difficult to repair in time enough to avoid a bigger crisis; political instability, for instance. In other words, even as foreign investors may be well pleased about ease of flows and liberality of the exchange rate, when the country becomes unstable because of too high prices from first and second round effects of exchange rate depreciation, they are not likely to want to invest anyway. Consequently, what would be apt would be for central bankers to strike a balance. Put another way, as Bank of Indonesia governor Perry Warjiyo put it on a panel (“Is there a new orthodoxy for monetary policy?”) at the IMF meetings in mid-October, a central bank should intervene in times of shock, not to target a certain level of exchange rate, but “to smooth out the adjustment process.” Similar to managing the capital flow cycle with CFM measures, macroprudential policy tools – which though take myriad forms but are simply measures aimed at maintaining financial stability – are proving to be quite effective in managing distruptions to the lending cycle as well. There has to be a new consensus. Inflation-targeting, while still relevant but increasingly less so (as the current dominant 2 percent target proves too low to avoid the zero lower bound of real interest rates), must be complemented by capital flows management and macroprudential measures as needed; and indeed any other future creative solutions aimed at financial stability. Together, they should become the new orthodoxy.
Also published in my BusinessDay Nigeria newspaper column (Tuesdays). See link viz. https://www.businessdayonline.com/columnist/rafiq-raji/article/unorthodox-economics-gets-nod/