L-1MacroeconomicStability,MacroeconomicPolicies,andMacro-PrudentialPoliciesPresenterClintonShiellsJointChina-IMFTrainingProgramCourseonMacroeconomicManagementandFinancialSectorIssuesCT14.05L-1MacroeconomicStability,MOutlineWhatismacroeconomicstabilityandwhydowecare?PoliciesformacroeconomicstabilityFiscalpolicyMonetarypolicyExchangeratepolicyThefinancialsectorandmacroeconomicstabilityMacro-prudentialpolicies2ThistrainingmaterialisthepropertyoftheInternationalMonetaryFund(IMF)andisintendedforuseinIMFInstitutecourses.AnyreuserequiresthepermissionoftheIMFInstitute.”O(jiān)utlineWhatismacroeconomicsWhatisMacroeconomicStabilityandWhyDoWeCare?3MMFWhatisMacroeconomicStabilitWhatdowemeanby“macroeconomicstability”?Macroeconomicstabilityexistswhenkeyeconomicrelationshipsareinbalance:Internalbalanceoccurswhenrealoutputisatorclosetoitscapacitylevelandtheinflationrateislowandnon-acceleratingExternalbalanceoccurswhenthecurrentaccountpositioncanbesustainedbycapitalflowsontermscompatiblewiththegrowthprospectsoftheeconomywithoutresorttorestrictionsontradeandpayments4MMFWhatdowemeanby“macroeconoWhydowecareaboutmacrostability?“Inpractice,theconceptofastablemacroeconomicframeworkisusedtomeanamacroeconomicpolicyenvironmentthatisconducivetogrowth.”Fischer(1993)“Conceptually,macroeconomicinstabilityreferstophenomenathatdecreasethepredictabilityofthedomesticmacroeconomicenvironment,anditisofconcernbecauseunpredictabilityhampersresource-allocationdecisions,investmentandgrowth.”MontielandServén(2005)5MMFWhydowecareaboutmacrostaVolatilityandgrowthSource:Ramey&Ramey(AER,1995)92countries,1962-85Growth=0.030–0.154Vol(-2.3)R2=0.057ThereappearstobeanegativerelationshipbetweentheaverageandthestandarddeviationofpercapitaGDPgrowth,bothcalculatedoverlongperiods.6MMFVolatilityandgrowthSource:VolatilityandgrowthSource:HnatkovskaandLoayza(2005)79countries,1960-2000“Normal”volatilityvs.“crisis”volatility?7MMFVolatilityandgrowthSource:CrisisvolatilitySource:WEO(Ch.IV,Oct.2009)8MMF(Logscale)CrisisvolatilitySource:WEO(OutputcostsofcrisesLevelofoutputLevelofoutputSource:CerraandSaxena(2008)9MMFOutputcostsofcrisesLevelofOutputcostsofcrisesSource:WEO(Ch.IV,Oct.2009)Onaverage,outputfallssteadilybelowitspre-crisistrenduntilthethirdyearafterthecrisisanddoesnotreboundthereafter.Firstyearofcrisisatt=0Meandifferencefromyeart=-11Theinterquartilerangeindicatesthemiddle50%ofallcrises88bankingcrisesfromearly1970sto2002222currencycrisesfromearly1970sto2002Outputevolutionafterbankingcrises(Percentofpre-crisistrend)Outputevolutionaftercurrencycrises(Percentofpre-crisistrend)YearYear10MMFOutputcostsofcrisesSource:GDPgrowthSource:WEO(October2013)11MMFGDPgrowthSource:WEO(OctobeOutputgrowthvolatilitySource:WEO(Ch.V,Oct.2007)Beforetheglobalfinancialcrisis,outputgrowthvolatilityhadbeensteadilydecliningfromitspeakduringthe1970s.12MMFOutputgrowthvolatilitySourceOutputgrowthvolatilitySource:WEO(Ch.V,Oct.2007)(Rolling10-yearstandarddeviationsofdetrendedgrowth)13MMFOutputgrowthvolatilitySourceVolatilitypatternsSource:WEO(Ch.V,Oct.2007)Growthtakeoffbeginsintimet=0onthex-axis.(1950forBrazil,Japan,Mexico,W.Germany;1963forKorea;1979forChina;1984forIndia)14MMFVolatilitypatternsSource:WEPoliciesfor

MacroeconomicStability15MMFPoliciesfor

MacroeconomicStWhatcausesmacroeconomicinstability?ExogenousshocksE.g.,termsoftradeshocks,naturaldisasters,financialcontagion,etc.InappropriatepoliciesE.g.,excessivelyloosefiscalpolicy16MMFWhatcausesmacroeconomicinstWhatshouldpolicymakersdo?RemovedestabilizingpoliciesthatarethemselvessourcesofshocksE.g.,tightenexcessivelyloosefiscalpolicyDependsontheinstitutionalsettingUsepoliciesasstabilizinginstrumentsinresponsetoexogenousshocksE.g.,countercyclicalfiscalpolicyDependsonhowvulnerabletheeconomyistoshocks17MMFWhatshouldpolicymakersdo?RePoliciesformacroeconomicstabilityFiscalpolicyMonetarypolicyExchangeratepolicyFinancialsectorpolicies18MMFPoliciesformacroeconomicstaFiscalpolicyIffiscalpolicyisthecauseofmacroeconomicinstability,strengtheningthefiscalbalancewillpromoteinternalbalanceandexternalbalanceCAB=SI=(SgIg)+(SpIp)Keymeasures:Expenditurerestraint,expenditurereallocationRevenue-raisinginitiatives(taxandnon-tax)Fiscalreformmustbepermanentinordertobecredible19MMFFiscalpolicyIffiscalpolicyPublicsectorsolvencyconditionThepresentvalue(PV)ofprimarysurpluses(T-G)andseignioragerevenue(dM)shouldbeatleastaslargeasthegovernment’soutstandingstockofnetdebt(B):PV{T-G+dM}=BStabilityrequiresthattheauthoritieschooseamonetaryandfiscalpolicystancethatisconsistentwithmaintainingpublicsectorsolvencyatlowlevelsofinflation,whileleavingsomescopeformitigatingtheimpactofrealandfinancialshocksonmacroeconomicperformance20MMFPublicsectorsolvencyconditiFiscalpolicyoverthecycleOldview:LimitedroleforfiscalpolicyrelativetomonetarypolicyFocusondebtsustainabilityandfiscalrulestoachievethisNewview:CountercyclicalfiscalpolicyisanimportanttoolCreatemorefiscalspaceingoodtimes:lowertargetdebtlevelsDesignbetterautomaticfiscalstabilizers:rulesthatallowsometransfersortaxestovarybasedonpre-specifiedtriggerstiedtothestateoftheeconomiccycle21MMFFiscalpolicyoverthecycleOlFiscalbalancesSource:WEO(Ch.I,Oct.2009)Generalgovernmentfiscalbalances(PercentofGDP)22MMFFiscalbalancesSource:WEO(CFiscalvolatility(Unweightedaverages)4Definedastherolling10-yearstandarddeviationofcyclicallyadjustedgovernmentconsumptionasapercentofGDPSource:WEO(Ch.V,Oct.2007)23MMFFiscalvolatility(UnweightedaFiscalvolatility:EastAsiaSource:OlaberriaandRigolini(PRWP4989,2009)EastAsiadisplaysahighcorrelationbetweenthevolatilityoffiscalpolicyandoutputgrowthvolatility(0.89)Volatilityofgovernmentspendingismeasuredastheweightedaveragestandarddeviationofdetrendedgovernmentconsumptiongrowthusinga10-yearwindow.OutputvolatilityismeasuredasthestandarddeviationofpercapitaGDPgrowthusinga10-yearwindow.24MMFFiscalvolatility:EastAsiaSoProcyclicalfiscalpolicy:DevelopingcountriesSource:IlzatzkiandVegh(NBERWP14191,2008)A10%shocktoGDPleadstoanincreaseofaround3%ingovernmentconsumptionafter2quarters.27developingcountries,1960-2006ResponseofrealgovernmentconsumptiontoGDPshock25MMFProcyclicalfiscalpolicy:DevPublicdebtSource:WEO(October2013)26MMFPublicdebtSource:WEO(OctobMonetarypolicyFiscaldominance“Therootsofinflationareultimatelyfiscal.”StrengtheningcentralbankindependencemaybeimportantforcredibilityRulesversusdiscretionEffectivenessofmonetarypolicyformacroeconomicstabilizationdependsontheexchangerateregimeandthedegreeofinternationalfinancialintegration27MMFMonetarypolicyFiscaldominancInflationSource:WEO(October2013)28MMFInflationSource:WEO(OctoberTheGreatModerationSource:Bean(2009)29MMFTheGreatModerationSource:BMonetarypolicycredibilitySource:WEO(Ch.III,Apr.2006)Minimum=0;Maximum=130MMFMonetarypolicycredibilitySouCentralbankautonomySource:WEO(Ch.III,Oct.2008)Thisindexcapturestheabilityofacentralbanktopursueindependentmonetarypolicy31MMFCentralbankautonomySource:Monetarypolicyindex(Unweightedaverages)Source:WEO(Ch.V,Oct.2007)Thisindexmeasuresthesuccessofthemonetaryframeworkinmaintaininglowinflation3/Definedasexp[–0.005*(inflation–2%)2]32MMFMonetarypolicyindex(UnweightCreditexpansionFinancialliabilitiesofhouseholdandbusiness(PercentofGDP)Ifmonetarypolicywassoadvancedintheadvancedeconomies,whywasthereacreditboomintherun-uptothecrisis?Source:Bean(2009)33MMFCreditexpansionFinancialliabDeviationofpolicyratesfromTaylorruleSource:Bean(2009)Wasmonetarypolicytooexpansionary?34MMFDeviationofpolicyratesfromMonetarypolicyandhousingboomsSource:WEO(Ch.III,Oct.2009)Euroareaeconomiesaredesignatedbybluesquares.Otheradvancedeconomiesaredesignatedbyredsquares.Bluelinesarefittedtoasubsampleofeuroareaeconomies.Blacklinesarefittedtothewholesampleofadvancedeconomies.Didexpansionarymonetarypolicyleadtoassetpricebooms?35MMFMonetarypolicyandhousingboExchangeratepolicyGoalsofexchangeratepolicy:PromotecompetitivenessandasustainablecurrentaccountpositionServeasacrediblenominalanchor(inthecaseofapeg)Whatistheappropriateleveloftherealexchangerate?OnethatensuresasustainablecurrentaccountbalanceWhenisanexchangerateadjustmentneeded?Possiblesignals:NoticeableparallelmarketinforeignexchangeLargeandpersistentcurrentaccountdeficitsLargeandsustainedappreciationintherealeffectiveexchangerate36MMFExchangeratepolicyGoalsofeCurrencycrashesSource:ReinhartandRogoff(2009)Shareofcountrieswithannualdepreciationgreaterthan15%,1800-2006MedianAnnualDepreciation,Allcountries,5-yearmovingaverage,1800-200637MMFCurrencycrashesSource:ReinhLimitationsofmacroeconomicstabilizationMacroeconomicstabilizationcanachievelowinflationandexternalsustainability......Butstabilizationaloneisoftennotenoughtoachieverapidgrowthandhigherrealincomes.Structuralreformmustusuallyaccompanystabilizationtoachievehigherincomes.Structuralreformmayalsobeneededforthecredibilityofanadjustmentprogram.38MMFLimitationsofmacroeconomicsExamplesofstructuralreformsFinancialsectorpoliciesFinancialsectordevelopmentandregulationExternalsectorreformsTradeliberalization,capitalaccountliberalizationPriceadjustmentandliberalizationWagepolicy,administeredprices,etc.PoliciestopromotecompetitionTax,expenditure,andbudgetaryreformsStateenterprisereform,privatization,restructuring39MMFExamplesofstructuralreformsTheFinancialSectorandMacroeconomicStability40MMFTheFinancialSectorandMacroFinancialsectorpolicyAnefficientdomesticfinancialsystemisimportantforgrowthAsounddomesticfinancialsystemisimportantformacroeconomicstabilityAsounddomesticfinancialsystemrequiresregulationandoversightFinancialliberalizationshouldbeameanstoachievinganefficientfinancialsystem,notanendinitself41MMFFinancialsectorpolicyAneffiFinancialsystemAnefficientfinancialsystemallocatescapitaltothemostproductiveusesandcontinuallymonitorstheuseoffundsKeyservicesprovidedbythefinancialsystemLenders/SaversBorrowers/SpendersConveysinformationIncreasesliquidityReducesrisk42MMFFinancialsystemKeyservicespFinancialdevelopmentandgrowthFinancialdevelopmentHigherincomepercapitaHighernetworth

lowermonitoringcosts,thickersecuritiesmarketsMorepublicgoodsthatfacilitatefinancialintermediationHigherinvestmentHigherproductivityMoreincentivetosave43MMFFinancialdevelopmentandgrowFinancialdevelopmentandgrowthDependentvariableDEPTH(1960)R2RealpercapitaGDPgrowth,1960-892.8**(0.001)0.61Realpercapitacapitalgrowth,1960-891.9**(0.001)0.63Productivitygrowth,1960-892.2**(0.001)0.58Source:Levine(1997)44MMFFinancialdevelopmentandgrowFinancialsectorandmacroeconomicstabilityBankingcrisesandfinancialmarketcrisescandirectlycausemacroeconomicinstabilityFinancialmarketconditionscanamplifyrealshocksandthebusinesscycleFinancialacceleratorFinancialsectorweaknesscandecreasetheeffectivenessofmacropolicytoolsduringacrisisDisrupttransmissionlinksbetweenmonetarypolicyandoperatingtargetsWeakensupplyresponsetoexchangeratechanges45MMFFinancialsectorandmacroeconSystemicbankingcrisesandrecessionsSource:ReinhartandRogoff(2008)Spain,1977Japan,1992Norway,1987Philippines,1997Sweden,1991HongKong,1997Colombia,1998Korea,1997HistoricalAverageMalaysia,1997Finland,1991Thailand,1997Indonesia,1997Argentina,2001U.S.,19291.9years-9.3%Durationofdownturn(inyears)PercentdeclineinrealGDPPastRealPerCapitaGDPCyclesandBankingCrises:Peak-to-trough46MMFSystemicbankingcrisesandreCreditcrunches,assetpricebusts,andrecessionsRecessionsassociatedwithcreditcrunchesandassetpricebustsarelongerandareassociatedwithgreateroutputlossesthanrecessionswithoutsuchfinancialstresses.Source:Claessens,Kose,andTerrones(2008)47MMFCreditcrunches,assetpricebFinancialacceleratorTheeffectsofarealshockonfinancialconditionscanleadtopersistentfluctuationsintheeconomy.Externalfinance(raisingfundsfromlenders)ismoreexpensivethaninternalfinance(usinginternallygeneratedcashflows).Theexternalfinancepremiumthataborrowermustpaydependsinverselyonthestrengthoftheborrower'sfinancialposition(networth).Positiveshocksincreasenetworth,reducethecostofcredit,andinducemoreinvestmentandconsumption;negativeshocksreducenetworth,increasethecostofcredit,andinducelessinvestmentandconsumption.Henceshocksareamplifiedandbecomemorepersistent.48MMFFinancialacceleratorTheeffeBank-lendingchannelShocksaffectingthenetworthandliquidityofbanks,andthustheircreditworthiness,inturnaffecttheexternalfinancepremiumthatbanksfaceandwillbereflectedinthecostandavailabilityoffundstobank-dependentborrowers.49MMFBank-lendingchannelShocksaffFinancialregulationOldview:Financialregulationisoutsidethemacropolicyframework;itsobjectiveistokeepindividualinstitutionsandmarketsbehavingprudently.Micro-prudentialregulationNewview:Financialregulationisnotmacroeconomicallyneutral;itcanbeusedasacyclicalpolicytool.Macro-prudentialregulationNeedforapolicyapproachthatfallsbetweenmacroeconomicmanagementandtraditionalprudentialregulationoffinancialinstitutions50MMFFinancialregulationOldview:Macrostabilityandriskperceptions“Atendencyofpeopletounderestimatefuturerisksduringperiodsofgoodeconomicperformanceseemstobearecurringthemeinthehistoryoffinancialmarkets.“(Bean,2009)Impliedvolatilitiesfromoptions(standardizedtozeromeanandunitvariance)ChicagoBoardOptionsExchangeVolatilityIndex(VIX)measuresimpliedvolatilityofS&P500indexoptionsMerrillLynchOptionVolatilityEstimateIndex(MOVE)measuresimpliedvolatilityon1-monthTreasuryoptionsSource:Bean(2009)51MMFMacrostabilityandriskperceFeedbackonthewayupIntheup-phaseoftheeconomiccycle:Price-basedmeasuresofassetvaluesrise,price-basedmeasuresofriskfall,andcompetitiontogrowbankprofitsincreases.Marketdisciplineencouragesfinancialinstitutionstorespondbyincreasingleverage(usingshort-term“wholesale”funding).IncreasebalancesheetsizeStrongerbalancesheetsIncreaseleverageAssetpriceboom52MMFFeedbackonthewayupIntheuFeedbackonthewaydownInthedown-phaseoftheeconomiccycle:Probabilityofdefaultonassetsrisesbalancesheetsweaken.Bankssellassetstosatisfyliquidityrunsbyinvestorsortore-establishcapitalratios(“firesale”).Saleofassetsbyoneinstitutiondecreasesthevalueofallsimilarassetsheldbyotherinstitutions(mark-to-marketvaluation)downwardpricespiral.

ReducebalancesheetsizeWeakerbalancesheetsDecreaseleverageAssetpricebust53MMFFeedbackonthewaydownIntheCountercyclicalregulation?Overallgoal:Tomaintainastableprovisionoffinancialservicestothewidereconomy—paymentsservices,creditsupply,andinsuranceagainstriskSpecifically:Toreducethesize,frequency,anddamagecreatedbyassetpricebubbleslinkedtoexcessivecreditbooms

2approaches:Increasethefinancialsystem’sresilienceascyclicalrisksriseIdentifythoseinstitutionsandmarketsthatpresentsubstantialsystemicriskandincreasetheirresilienceacrosstheboard,notjustwhencyclicalrisksseemmostpressingMMF54Countercyclicalregulation?OveMacro-prudentialpolicytoolsOldLimitthetotalamountofcreditprovidedbybanksControltheamountofleveragethatcanbeemployedinassetpurchasesMarginrequirements,maximumloan-to-valueratioformortgagesLimittheinterestratethatbanksandotherdepositoryinstitutionscanpayontheirdepositsNewCounter-cyclicalbankcapitalrequirementsAdjustcapitalratiosuptoreducetheincentivestoprovidecreditduringboomsthatthreatentobecomebubblesDynamicprovisioningforloanlossreservesRequirebankstosetasidehigherlevelsofreservesforfutureloanlossesduringanupswingMMF55Macro-prudentialpolicytoolsOMacroPrudentialMacroeconomicPoliciesMicroprudentialPolicyPriceStabilityEconomicActivityIdiosyncraticRiskPoliciesandObjectivesHowweseetheworldnowMacroprudentialPolicyFinancialStabilitySystemicRiskCCMacroL-1MacroeconomicStability,MacroeconomicPolicies,andMacro-PrudentialPoliciesPresenterClintonShiellsJointChina-IMFTrainingProgramCourseonMacroeconomicManagementandFinancialSectorIssuesCT14.05L-1MacroeconomicStability,MOutlineWhatismacroeconomicstabilityandwhydowecare?PoliciesformacroeconomicstabilityFiscalpolicyMonetarypolicyExchangeratepolicyThefinancialsectorandmacroeconomicstabilityMacro-prudentialpolicies58ThistrainingmaterialisthepropertyoftheInternationalMonetaryFund(IMF)andisintendedforuseinIMFInstitutecourses.AnyreuserequiresthepermissionoftheIMFInstitute.”O(jiān)utlineWhatismacroeconomicsWhatisMacroeconomicStabilityandWhyDoWeCare?59MMFWhatisMacroeconomicStabilitWhatdowemeanby“macroeconomicstability”?Macroeconomicstabilityexistswhenkeyeconomicrelationshipsareinbalance:Internalbalanceoccurswhenrealoutputisatorclosetoitscapacitylevelandtheinflationrateislowandnon-acceleratingExternalbalanceoccurswhenthecurrentaccountpositioncanbesustainedbycapitalflowsontermscompatiblewiththegrowthprospectsoftheeconomywithoutresorttorestrictionsontradeandpayments60MMFWhatdowemeanby“macroeconoWhydowecareaboutmacrostability?“Inpractice,theconceptofastablemacroeconomicframeworkisusedtomeanamacroeconomicpolicyenvironmentthatisconducivetogrowth.”Fischer(1993)“Conceptually,macroeconomicinstabilityreferstophenomenathatdecreasethepredictabilityofthedomesticmacroeconomicenvironment,anditisofconcernbecauseunpredictabilityhampersresource-allocationdecisions,investmentandgrowth.”MontielandServén(2005)61MMFWhydowecareaboutmacrostaVolatilityandgrowthSource:Ramey&Ramey(AER,1995)92countries,1962-85Growth=0.030–0.154Vol(-2.3)R2=0.057ThereappearstobeanegativerelationshipbetweentheaverageandthestandarddeviationofpercapitaGDPgrowth,bothcalculatedoverlongperiods.62MMFVolatilityandgrowthSource:VolatilityandgrowthSource:HnatkovskaandLoayza(2005)79countries,1960-2000“Normal”volatilityvs.“crisis”volatility?63MMFVolatilityandgrowthSource:CrisisvolatilitySource:WEO(Ch.IV,Oct.2009)64MMF(Logscale)CrisisvolatilitySource:WEO(OutputcostsofcrisesLevelofoutputLevelofoutputSource:CerraandSaxena(2008)65MMFOutputcostsofcrisesLevelofOutputcostsofcrisesSource:WEO(Ch.IV,Oct.2009)Onaverage,outputfallssteadilybelowitspre-crisistrenduntilthethirdyearafterthecrisisanddoesnotreboundthereafter.Firstyearofcrisisatt=0Meandifferencefromyeart=-11Theinterquartilerangeindicatesthemiddle50%ofallcrises88bankingcrisesfromearly1970sto2002222currencycrisesfromearly1970sto2002Outputevolutionafterbankingcrises(Percentofpre-crisistrend)Outputevolutionaftercurrencycrises(Percentofpre-crisistrend)YearYear66MMFOutputcostsofcrisesSource:GDPgrowthSource:WEO(October2013)67MMFGDPgrowthSource:WEO(OctobeOutputgrowthvolatilitySource:WEO(Ch.V,Oct.2007)Beforetheglobalfinancialcrisis,outputgrowthvolatilityhadbeensteadilydecliningfromitspeakduringthe1970s.68MMFOutputgrowthvolatilitySourceOutputgrowthvolatilitySource:WEO(Ch.V,Oct.2007)(Rolling10-yearstandarddeviationsofdetrendedgrowth)69MMFOutputgrowthvolatilitySourceVolatilitypatternsSource:WEO(Ch.V,Oct.2007)Growthtakeoffbeginsintimet=0onthex-axis.(1950forBrazil,Japan,Mexico,W.Germany;1963forKorea;1979forChina;1984forIndia)70MMFVolatilitypatternsSource:WEPoliciesfor

MacroeconomicStability71MMFPoliciesfor

MacroeconomicStWhatcausesmacroeconomicinstability?ExogenousshocksE.g.,termsoftradeshocks,naturaldisasters,financialcontagion,etc.InappropriatepoliciesE.g.,excessivelyloosefiscalpolicy72MMFWhatcausesmacroeconomicinstWhatshouldpolicymakersdo?RemovedestabilizingpoliciesthatarethemselvessourcesofshocksE.g.,tightenexcessivelyloosefiscalpolicyDependsontheinstitutionalsettingUsepoliciesasstabilizinginstrumentsinresponsetoexogenousshocksE.g.,countercyclicalfiscalpolicyDependsonhowvulnerabletheeconomyistoshocks73MMFWhatshouldpolicymakersdo?RePoliciesformacroeconomicstabilityFiscalpolicyMonetarypolicyExchangeratepolicyFinancialsectorpolicies74MMFPoliciesformacroeconomicstaFiscalpolicyIffiscalpolicyisthecauseofmacroeconomicinstability,strengtheningthefiscalbalancewillpromoteinternalbalanceandexternalbalanceCAB=SI=(SgIg)+(SpIp)Keymeasures:Expenditurerestraint,expenditurereallocationRevenue-raisinginitiatives(taxandnon-tax)Fiscalreformmustbepermanentinordertobecredible75MMFFiscalpolicyIffiscalpolicyPublicsectorsolvencyconditionThepresentvalue(PV)ofprimarysurpluses(T-G)andseignioragerevenue(dM)shouldbeatleastaslargeasthegovernment’soutstandingstockofnetdebt(B):PV{T-G+dM}=BStabilityrequiresthattheauthoritieschooseamonetaryandfiscalpolicystancethatisconsistentwithmaintainingpublicsectorsolvencyatlowlevelsofinflation,whileleavingsomescopeformitigatingtheimpactofrealandfinancialshocksonmacroeconomicperformance76MMFPublicsectorsolvencyconditiFiscalpolicyoverthecycleOldview:LimitedroleforfiscalpolicyrelativetomonetarypolicyFocusondebtsustainabilityandfiscalrulestoachievethisNewview:CountercyclicalfiscalpolicyisanimportanttoolCreatemorefiscalspaceingoodtimes:lowertargetdebtlevelsDesignbetterautomaticfiscalstabilizers:rulesthatallowsometransfersortaxestovarybasedonpre-specifiedtriggerstiedtothestateoftheeconomiccycle77MMFFiscalpolicyoverthecycleOlFiscalbalancesSource:WEO(Ch.I,Oct.2009)Generalgovernmentfiscalbalances(PercentofGDP)78MMFFiscalbalancesSource:WEO(CFiscalvolatility(Unweightedaverages)4Definedastherolling10-yearstandarddeviationofcyclicallyadjustedgovernmentconsumptionasapercentofGDPSource:WEO(Ch.V,Oct.2007)79MMFFiscalvolatility(UnweightedaFiscalvolatility:EastAsiaSource:OlaberriaandRigolini(PRWP4989,2009)EastAsiadisplaysahighcorrelationbetweenthevolatilityoffiscalpolicyandoutputgrowthvolatility(0.89)Volatilityofgovernmentspendingismeasuredastheweightedaveragestandarddeviationofdetrendedgovernmentconsumptiongrowthusinga10-yearwindow.OutputvolatilityismeasuredasthestandarddeviationofpercapitaGDPgrowthusinga10-yearwindow.80MMFFiscalvolatility:EastAsiaSoProcyclicalfiscalpolicy:DevelopingcountriesSource:IlzatzkiandVegh(NBERWP14191,2008)A10%shocktoGDPleadstoanincreaseofaround3%ingovernmentconsumptionafter2quarters.27developingcountries,1960-2006ResponseofrealgovernmentconsumptiontoGDPshock81MMFProcyclicalfiscalpolicy:DevPublicdebtSource:WEO(October2013)82MMFPublicdebtSource:WEO(OctobMonetarypolicyFiscaldominance“Therootsofinflationareultimatelyfiscal.”StrengtheningcentralbankindependencemaybeimportantforcredibilityRulesversusdiscretionEffectivenessofmonetarypolicyformacroeconomicstabilizationdependsontheexchangerateregimeandthedegreeofinternationalfinancialintegration83MMFMonetarypolicyFiscaldominancInflationSource:WEO(October2013)84MMFInflationSource:WEO(OctoberTheGreatModerationSource:Bean(2009)85MMFTheGreatModerationSource:BMonetarypolicycredibilitySource:WEO(Ch.III,Apr.2006)Minimum=0;Maximum=186MMFMonetarypolicycredibilitySouCentralbankautonomySource:WEO(Ch.III,Oct.2008)Thisindexcapturestheabilityofacentralbanktopursueindependentmonetarypolicy87MMFCentralbankautonomySource:Monetarypolicyindex(Unweightedaverages)Source:WEO(Ch.V,Oct.2007)Thisindexmeasuresthesuccessofthemonetaryframeworkinmaintaininglowinflation3/Definedasexp[–0.005*(inflation–2%)2]88MMFMonetarypolicyindex(UnweightCreditexpansionFinancialliabilitiesofhouseholdandbusiness(PercentofGDP)Ifmonetarypolicywassoadvancedintheadvancedeconomies,whywasthereacreditboomintherun-uptothecrisis?Source:Bean(2009)89MMFCreditexpansionFinancialliabDeviationofpolicyratesfromTaylorruleSource:Bean(2009)Wasmonetarypolicytooexpansionary?90MMFDeviationofpolicyratesfromMonetarypolicyandhous