IMF / Tobias Adrian at IMF Policy Dialogue: New Policy Frameworks for a "Lower-for-Longer" World




24 Nov 2020


WASHINGTON DC, United States



IMF / Tobias Adrian at IMF Policy Dialogue: New Policy Frameworks for a "Lower-for-Longer" World

1. Medium shot, IMF logo on building
2. Long shot, Kristalina Georgieva, IMF Managing Director, speaking


3. SOUNDBITE (English) Tobias Adrian, Financial Counsellor and Director of the Monetary and Capital Markets Department, IMF

“I would like to build on the analysis by considering implications of more accommodative monetary policy for medium term financial stability risks. As you all know, the challenges associated with COVID-19 have called for exceptional policy responses. The combined scale of interventions was truly staggering. Unconventional monetary policy operations amounted to seven point five trillion dollars globally based on our estimates here at the IMF. In my view, the importance of central banks exercising their implicit put option cannot be overstated and has been a game changer in helping to stabilize financial markets. And given the severity of the COVID shocks substantial policy accommodation will be needed going forward for central banks to achieve their policy objectives. At the same time, and as we have emphasized in the October Global Financial Stability Report, these policies are effective because they encourage risk taking. As such, these central bank interventions may also increase medium term and long run macro financial vulnerabilities. The same consideration applies to changes in policy frameworks, given that they also aim to provide more stimulus in an environment of already very low interest rates.

I believe that existing policy models are ill suited to quantify and help manage the resulting macro financial risks. My recent MCM departmental paper puts forward a parsimonious framework which addresses this issue. It places financial stability considerations right back at the heart of monetary policy making. We call the model NKV because it is a new Keynesian model in flavor but also accounts for financial vulnerabilities. The NKV model has designed to account is designed to account for the interplay of financial conditions with real economic variables. In particular, the model captures a key intertemporal trade of documented empirically, including in my 2018 paper with Grinberg, Liang and Malik. That paper use data for both advanced and emerging market economies to show that looser financial conditions have favorable effects on output growth in the near term, boosting output growth significantly and reducing downside risks. However, looser financial conditions also increase risks that output growth will be weak a couple of years down the road. Hence, there's a tradeoff. The chart that you can see here uses the NKV model to analyze lower for longer time policies in which the central bank credibly commits to providing monetary stimulus for extended periods of time that range between one and three years and may be interpreted as forward guidance about the policy rate path.

The panels help to make two points. First, they confirm that lower for longer policies are effective at providing short term stimulus as seen by the response of output and inflation in the upper panels. Arguably, this is one of the reasons why central bank interventions play such a large role in mitigating the adverse impact of the pandemic. Second, as seen in the lower right panel, these policies can have a marked impact on the evolution of financial conditions. While accommodative policy loosens financial conditions in the near term, these policies can be associated with a significant tightening of financial conditions in the medium term, with potentially adverse implications for real activity. This highlights the intertemporal tradeoff that policymakers are faced with when easing monetary policy. It's highlighted by the fund in an important 2015 board paper, Macro-prudential policies can, at least in theory, help mitigate financial stability risks.

Our NKV based model results confirm these observations as seen in the slide. The introduction of Macro-prudential policies can moderate swings in financial conditions, mitigating unintended side effects of lower for longer time policies. But there are many important differences between theory and practice on account of those differences. Macro-prudential policies are not a universal panacea, and there are many cracks that have difficulties getting into by prudential policies. For example, risks related to nonbank financial intermediaries are an important example. Macro-prudential policies may be difficult to deploy due to political considerations or even if deployed may be less effective in the short run due to sizable lags in transmission.

I believe that most existing monetary policy models fail to account for this key intertemporal trade off that I've highlighted in which a contemporaneous boost of activity eventually increases macro financial vulnerabilities and if one considers monetary stimulus as a free lunch, then we know that there may be a tendency to overindulge with potentially dire medium term and long run consequences. Macro financial risks can, and in my view should be the core of monetary in the core of monetary policy making. My framework helps to quantify the intertemporal tradeoffs that monetary policy makers face, as well as how Macro-prudential policy may influence these tradeoffs. Arguably, underlying endogenous risk considerations are even more relevant in an open economy. This is because swings in global financial conditions can bring about sudden stops or capital flow reversals. As you know, efforts to quantify such tradeoffs and to analyze synergies associated with various policy mixes are at the heart of the IMF's push to develop an integrated policy framework, which was launched earlier this year by the managing director, Georgieva.

Going forward, I want to underscore that continued monetary accommodation seems crucial in supporting economic activity and helping central banks achieving their objectives. But central banks will also need to be vigilant to the risks that are attendant on highly accommodative monetary policies and should take account of these intertemporal tradeoffs as a key part of decision making.”


4. Medium shot, IMF logo on building
5. Long shot, IMF building exterior
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