The global crisis changed the face of monetary policy. This column, written by the IMF’s chief economist, reviews the main changes. It draws on contributions to a recent IMF conference on the topic.
The views and theories on the impossible trinity are conflicting. This column discusses some of the theories and their potential drawbacks. It points out that the impossible trinity has policy relevance for advances economies because their currencies are often close substitutes, and exchange rates follow expectations. For emerging economies, however, the policies implied by the impossible trinity could not be sustained due to the instability of their financial markets.
Higher asset prices increase the value of firms’ collateral, strengthen banks’ balance sheets, and increase households’ wealth. These considerations perhaps motivated the Federal Reserve’s intervention to support the housing market. However, higher housing prices may also lead banks to reallocate their portfolios from commercial and industrial loans to real-estate loans. This column presents the first evidence on this crowding-out effect. When housing prices increase, banks on average reduce commercial lending and increase interest rates, leading related firms to cut back on investment.
Having promised to do ‘whatever it takes’ to ensure the survival of the euro, the ECB now faces the problem of record high unemployment combined with a strong currency. There is accumulating evidence that the ECB is more willing to fight currency appreciation than the Bundesbank would have been. Capital inflows have been a key source of recent upward pressure on the euro. Should this continue, the ECB may need to intervene more aggressively in order to promote economic recovery in the Eurozone.
This column argues that asset purchases and forward guidance by central banks can be effective in reducing financial market participants’ tail-risk perceptions. US data suggest that, since their inception in 2008, the unconventional policies adopted by the Federal Reserve have significantly compressed perceptions of tail risk. Despite increases in risk premia during the recent ‘tapering’ episode, estimates of tail-risk perceptions still remain significantly below the levels observed when the measures were introduced. Still, the effects of exit on tail-risk perceptions remain uncertain, and will require careful monitoring.
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