Policy responses to currency depreciation pressures should focus on the drivers of the exchange-rate moves and signs of market disruptions
The dollar is at its highest level since 2000, having appreciated 22 percent against the yen, 13 percent against the Euro and 6 percent against emerging market currencies since the start of this year. Such a sharp strengthening of the dollar in a matter of months has sizable macroeconomic implications for almost all countries, given the dominance of the dollar in international trade and finance.
While the US share in world merchandise exports has declined from 12 percent to 8 percent since 2000, the dollar’s share in world exports has held around 40 percent. For many countries fighting to bring down inflation, the weakening of their currencies relative to the dollar has made the fight harder. On average, the estimated pass-through of a 10 percent dollar appreciation into inflation is 1 percent. Such pressures are especially acute in emerging markets, reflecting their higher import dependency and greater share of dollar-invoiced imports compared with advanced economies.

The dollar’s appreciation also is reverberating through balance sheets around the world. Approximately half of all cross-border loans and international debt securities are denominated in US dollars. While emerging market governments have made progress in issuing debt in their own currency, their private corporate sectors have high levels of dollar-denominated debt. As world interest rates rise, financial conditions have tightened considerably for many countries. A stronger dollar only compounds these pressures, especially for some emerging market and many low-income countries that are already at a high risk of debt distress.
In these circumstances, should countries actively support their currencies? Several countries are resorting to foreign exchange interventions. Total foreign reserves held by emerging market and developing economies fell by more than 6 percent in the first seven months of this year.

The appropriate policy response to depreciation pressures requires a focus on the drivers of the exchange rate change and on signs of market disruptions. Specifically, foreign exchange intervention should not substitute for warranted adjustment to macroeconomic policies. There is a role for intervening on a temporary basis when currency movements substantially raise financial stability risks and/or significantly disrupt the central bank’s ability to maintain price stability.
As of now, economic fundamentals are a major factor in the appreciation of the dollar: rapidly rising US interest rates and a more favorable terms-of-trade—a measure of prices for a country’s exports relative to its imports—for the US caused by the energy crisis. Fighting a historic increase in inflation, the Federal Reserve has embarked on a rapid tightening path for policy interest rates. The European Central Bank, while also facing broad-based inflation, has signaled a shallower path for their policy rates, out of concern that the energy crisis will cause an economic downturn. Meanwhile, low inflation in Japan and China has allowed their central banks to buck the global tightening trend.

The massive terms-of-trade shock triggered by Russia’s invasion of Ukraine is the second major driver behind the dollar’s strength. The euro area is highly reliant on energy imports, in particular natural gas from Russia. The surge in gas prices has brought its terms of trade to the lowest level in the history of the shared currency.

As for emerging markets and developing economies beyond China, many were ahead in the global monetary tightening cycle—perhaps in part out of concern about their dollar exchange rate—while commodity exporting EMDEs experienced a positive terms-of-trade shock. Consequently, exchange-rate pressures for the average emerging market economy have been less severe than for advanced economies, and some, such as Brazil and Mexico, have even appreciated.
Given the significant role of fundamental drivers, the appropriate response is to allow the exchange rate to adjust, while using monetary policy to keep inflation close to its target. The higher price of imported goods will help bring about the necessary adjustment to the fundamental shocks as it reduces imports, which in turn helps with reducing the buildup of external debt. Fiscal policy should be used to support the most vulnerable without jeopardizing inflation goals.
Additional steps are also needed to address several downside risks on the horizon. Importantly, we could see far greater turmoil in financial markets, including a sudden loss of appetite for emerging market assets that prompts large capital outflows, as investors retreat to safe assets.
Enhance resilience
In this fragile environment, it is prudent to enhance resilience. Although emerging market central banks have stockpiled dollar reserves in recent years, reflecting lessons learned from earlier crises, these buffers are limited and should be used prudently.
Countries must preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future. Those that are able should reinstate swap lines with advanced-economy central banks. Countries with sound economic policies in need of addressing moderate vulnerabilities should proactively avail themselves of the IMF’s precautionary lines to meet future liquidity needs. Those with large foreign-currency debts should reduce foreign-exchange mismatches by using capital-flow management or macroprudential policies, in addition to debt management operations to smooth repayment profiles.
In addition to fundamentals, with financial markets tightening, some countries are seeing signs of market disruptions such as rising currency hedging premia and local currency financing premia. Severe disruptions in shallow currency markets would trigger large changes in these premia, potentially causing macroeconomic and financial instability.
In such cases, temporary foreign exchange intervention may be appropriate. This can also help prevent adverse financial amplification if a large depreciation increases financial stability risks, such as corporate defaults, due to mismatches. Finally, temporary intervention can also support monetary policy in the rare circumstances where a large exchange rate depreciation could de-anchor inflation expectations, and monetary policy alone cannot restore price stability.

For the United States, despite the global fallout from a strong dollar and tighter global financial conditions, monetary tightening remains the appropriate policy while US inflation remains so far above target. Not doing so would damage central bank credibility, de-anchor inflation expectations, and necessitate even more tightening later—and greater spillovers to the rest of the world.
That said, the Fed should keep in mind that large spillovers are likely to spill back into the US economy. In addition, as a global provider of the world’s safe asset, the US could reactivate currency swap lines to eligible countries, as it extended at the start of the pandemic, to provide an important safety valve in times of currency market stress. These would usefully complement dollar funding provided by the Fed’s standing Foreign and International Monetary Authorities Repo Facility.
The IMF will continue to work closely with our members to craft appropriate macroeconomic policies in these turbulent times, relying on our Integrated Policy Framework. Beyond precautionary financing facilities available for eligible countries, the IMF stands ready to extend our lending resources to member countries experiencing balance of payments problems.
Authors:

Gita Gopinath
Pierre-Olivier Gourinchas

Compliments of the IMF.
The post IMF | How Countries Should Respond to the Strong Dollar first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

The OECD delivered today a new global tax transparency framework to provide for the reporting and exchange of information with respect to crypto-assets. The Crypto-Asset Reporting Framework (CARF) responds to a G20 request that the OECD develop a framework for the automatic exchange of information between countries on crypto-assets. The CARF will be presented to G20 Finance Ministers and Central Bank Governors for discussion at their next meeting on 12-13 October in Washington D.C, as part of the latest OECD Secretary-General’s Tax Report.
The new transparency initiative, developed together with G20 countries, comes against the backdrop of a rapid adoption of the use of crypto-assets for a wide range of investment and financial uses. Unlike traditional financial products, crypto-assets can be transferred and held without the intervention of traditional financial intermediaries, such as banks, and without any central administrator having full visibility on either the transactions carried out or on crypto-asset holdings. The crypto market has also given rise to new intermediaries and service providers, such as crypto-asset exchanges and wallet providers, many of which currently remain unregulated.
These developments mean that crypto-assets and related transactions are not comprehensively covered by the OECD/G20 Common Reporting Standard (CRS), increasing the likelihood of their use for tax evasion while undermining the progress made in tax transparency through the adoption of the CRS.
“The Common Reporting Standard has been very successful in the fight against international tax evasion. In 2021, over 100 jurisdictions exchanged information on 111 million financial accounts, covering total assets of EUR 11 trillion,” OECD Secretary-General Mathias Cormann said. “Today’s presentation of the new crypto-asset reporting framework and amendments to the Common Reporting Standard will ensure that the tax transparency architecture remains up-to-date and effective.”
In this vein, the CARF will ensure transparency with respect to crypto-asset transactions, through automatically exchanging such information with the jurisdictions of residence of taxpayers on an annual basis, in a standardised manner similar to the CRS.
The CARF will target any digital representation of value that relies on a cryptographically secured distributed ledger or a similar technology to validate and secure transactions. Carve-outs are foreseen for assets that cannot be used for payment or investment purposes and for assets already fully covered by the CRS. Entities or individuals that provide services effectuating exchange transactions in crypto-assets for, or on behalf of customers would be obliged to report under the CARF.
The CARF contains model rules that can be transposed into domestic legislation, and commentary to help administrations with implementation. Over the next months, the OECD will be taking forward work on the legal and operational instruments to facilitate the international exchange of information collected on that basis of the CARF and to ensure its effective and widespread implementation, including the timing for starting exchanges under the CARF.
The OECD has also put forward to the G20 a set of further amendments to the CRS, intended to modernise its scope to comprehensively cover digital financial products and to improve its operation, taking into account the experience gained by countries and business. As with  the CARF, this work will be complemented with an update to the international legal and operational mechanisms for the automatic exchange of information pursuant to the amended CRS, as well as with a coordinated timelines to bring the agreed amendments into effect.
 
Compliments of the OECD.
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Growth is projected to slow to 2.7% as the war in Ukraine, inflation, and Covid recovery weigh on the world economy.
Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than seen in several decades. The cost-of-living crisis, tightening financial conditions in most regions, Russia’s invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on the outlook. Global growth is forecast to slow from 6.0 percent in 2021 to 3.2 percent in 2022 and 2.7 percent in 2023. This is the weakest growth profile since 2001 except for the global financial crisis and the acute phase of the COVID-19 pandemic.
Global inflation is forecast to rise from 4.7 percent in 2021 to 8.8 percent in 2022 but to decline to 6.5 percent in 2023 and to 4.1 percent by 2024. Monetary policy should stay the course to restore price stability, and fiscal policy should aim to alleviate the cost-of-living pressures while maintaining a sufficiently tight stance aligned with monetary policy. Structural reforms can further support the fight against inflation by improving productivity and easing supply constraints, while multilateral cooperation is necessary for fast-tracking the green energy transition and preventing fragmentation.
To access the World Economic Outlook Report October 2022, visit https://www.imf.org/en/Publications/WEO/Issues/2022/10/11/world-economic-outlook-october-2022
Compliments of the IMF.
The post IMF | The IMF cut its 2023 global economic forecast to 2.7% first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

The European Investment Bank (EIB) and the five biggest European national promotional banks met to discuss the progress of existing joint initiatives, such as the Joint Initiative on Circular Economy (JICE), Quick Response — Care for Ukrainian Refugees in Europe, and Fund Marguerite. KfW CEO Stefan Wintels hosted EIB President Werner Hoyer and the other CEOs at the German promotional bank’s Berlin building.
The heads of the respective institutions also exchanged views on the various national and European initiatives for supporting energy sovereignty in Europe.
The leaders attending the meeting were:

Beata Daszynska-Muzyczka, CEO Bank Gospodarstwa Krajowego, BGK – Poland
Dario Scannapieco, CEO CDP Cassa Depositi e Prestiti, CDP – Italy
Laurent Zylberberg, Executive VP Groupe Caisse des Dépôts, CDC – France
Jose Carlos Garcia de Quevedo, CEO, Istituto de Credito Oficial, ICO – Spain
Stefan Wintels, CEO KFW-Bank – Germany
Werner Hoyer, President European Investmentbank (EIB) – EU

€2.9 billion has already been raised for the Quick Response — Care for Ukrainian Refugees in Europe programme launched in Paris this spring. This far exceeds the target of €2 billion.
The Joint Initiative on Circular Economy (JICE) partners reported a total volume of financed projects and programmes of €6.3 billion until the end of 2021. The initiative — launched in Luxembourg in 2019 — supports circular economy projects and programmes in the European Union and has a total volume of €10 billion until 2023.
Compliments of the European Investment Bank – A Member of the EACCNY.The post EIB and the European Union’s largest national promotional banks meet in Berlin to discuss recent initiatives and common challenges in Europe first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Scaling up private capital is crucial to finance vital low-carbon infrastructure projects, particularly in less developed economies
Private climate financing must play a pivotal role as emerging markets and developing economies seek to curb greenhouse gas emissions and contain climate change while coping with its effects.
Estimates vary, but these economies must collectively invest at least $1 trillion in energy infrastructure by 2030 and $3 trillion to $6 trillion across all sectors per year by 2050 to mitigate climate change by substantially reducing greenhouse gas emissions. In addition, a further $140 billion to $300 billion a year by 2030 is needed to adapt to the physical consequences of climate change, such as rising seas and intensifying droughts. This could sharply rise to between $520 billion and $1.75 trillion annually after 2050 depending on how effective climate mitigation measures have been.
Boosting private climate financing quickly is essential, as we detail in an analytical chapter of our latest Global Financial Stability Report. Key solutions include adequate pricing of climate risks, innovative financing instruments, broadening the investor base, expanding the involvement of multilateral development banks and development finance institutions, and strengthening climate information.
Encouragingly, private sustainable finance in emerging market and developing economies rose to a record $250 billion last year. But private finance must at least double by 2030, at a time when investable low-carbon infrastructure projects are often in short supply and funding of the fossil fuel industry has soared since the Paris Agreement.A lack of effective carbon pricing reduces the incentive and ability of investors to channel more funds into climate-beneficial projects, as does a patchy climate information architecture with incomplete climate data, disclosure standards, taxonomies and other alignment approaches.
It’s also unclear whether very large and quickly growing environmental, social, and governance, or ESG, investment flows alone could have a real impact in scaling up private climate finance. In addition to the still-uncertain climate benefits of ESG investing, such scores for companies in emerging market and developing economies are systematically lower than those for advanced counterparts. As a result, ESG-focused investment funds allocate much less to emerging market assets. What’s more, the risks associated with investing in emerging market and developing economy assets are often deemed too high by investors.
Innovative financing instruments can help overcome some of these challenges, together with broadening the investors base to include global banks, investment funds, institutional investors such as insurance companies, impact investors, philanthropic capital, and others.
In larger emerging markets with more-functional bond markets, investment funds—such as the Amundi green bond fund backed by the World Bank’s private-sector financing arm—provide a good example of how to draw in institutional investors such as pension funds. Such funds should be replicated and expanded to incentivize issuers in emerging markets to generate a greater supply of green assets to finance low-carbon projects and attract a wide range on international investors.
For less-developed economies, multilateral development banks will play a key role in financing vital low-carbon infrastructure projects. More climate financing resources should be channeled through such institutions.
An important first step would be to increase their capital base and reconsider approaches to risk appetite via partnerships with the private sector, supported by transparent governance and management oversight.
Multilateral development banks could then make greater use of equity finance—currently only about 1.8 percent of their commitments to climate finance in emerging market and developing economies. And their equity can draw in much larger amounts of private finance, which currently is equal to only about 1.2 times the resources these institutions commit themselves.

An important tool needed to help incentivize private investment is the development of transition taxonomies and other alignment approaches, which identify financial assets that can reduce emissions over time and incentivize firms to transition towards emission reduction goals.
Importantly, they include a focus on innovation in industries like cement, steel, chemicals, and heavy transport that cannot easily cut emissions because of technological and cost constraints. This helps ensure these carbon-intensive industries—those with the greatest potential to reduce greenhouse gas emissions—are not sidelined by investors but rather incentivized to reduce their carbon impact over time.
The IMF is playing an increasingly important role, including through its new Resilience and Sustainability Trust which is intended to provide affordable, long-term financing to help countries build resilience to climate change and other long-term structural challenges. We have pledges totaling $40 billion and staff-level agreements on the first two programs—Barbados and Costa Rica. This trust could catalyze official and private sector investments for climate finance.
The IMF is also promoting the availability of quality climate data and fostering the adoption of disclosure standards and transition taxonomies to create an attractive investment climate.
More broadly, we are helping to strengthen the climate information architecture through the Network for Greening the Financial System and other international bodies to support emerging market and developing economies with climate policies, including carbon pricing. As the move to greater private climate financing takes hold, the Fund will engage partners and promote solutions wherever possible.
Authors:

Torsten Ehlers
Charlotte Gardes-Landolfini
Fabio Natalucci
Ananthakrishnan Prasad

—This blog is based on Chapter 2 of the October 2022 Global Financial Stability Report, “Scaling Up Private Climate Finance in Emerging Market and Developing Economies: Challenges and Opportunities.” The post IMF | How to Scale Up Private Climate Finance in Emerging Economies first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

One single charger for all mobile phones and tablets – beneficial for the environment and for consumers
USB Type-C port will be the new standard for portable devices, offering high-quality charging and data transfers
Buyers will be able to choose whether to purchase a new device with or without a charging device

Following Parliament’s approval, EU consumers will soon be able to use a single charging solution for their electronic devices.
By the end of 2024, all mobile phones, tablets and cameras sold in the EU will have to be equipped with a USB Type-C charging port. From spring 2026, the obligation will extend to laptops. The new law, adopted by plenary on Tuesday with 602 votes in favour, 13 against and 8 abstentions, is part of a broader EU effort to reduce e-waste and to empower consumers to make more sustainable choices.
Under the new rules, consumers will no longer need a different charger every time they purchase a new device, as they will be able to use one single charger for a whole range of small and medium-sized portable electronic devices.
Regardless of their manufacturer, all new mobile phones, tablets, digital cameras, headphones and headsets, handheld videogame consoles and portable speakers, e-readers, keyboards, mice, portable navigation systems, earbuds and laptops that are rechargeable via a wired cable, operating with a power delivery of up to 100 Watts, will have to be equipped with a USB Type-C port.
All devices that support fast charging will now have the same charging speed, allowing users to charge their devices at the same speed with any compatible charger.
Encouraging technological innovation
As wireless charging becomes more prevalent, the European Commission will have to harmonise interoperability requirements by the end of 2024, to avoid having a negative impact on consumers and the environment. This will also get rid of the so-called technological “lock-in” effect, whereby a consumer becomes dependent on a single manufacturer.
Better information and choice for consumers
Dedicated labels will inform consumers about the charging characteristics of new devices, making it easier for them to see whether their existing chargers are compatible. Buyers will also be able to make an informed choice about whether or not to purchase a new charging device with a new product.
These new obligations will lead to more re-use of chargers and will help consumers save up to 250 million euro a year on unnecessary charger purchases. Disposed of and unused chargers account for about 11 000 tonnes of e-waste annually in the EU.
Quote
Parliament’s rapporteur Alex Agius Saliba (S&D, MT) said: “The common charger will finally become a reality in Europe. We have waited more than ten years for these rules, but we can finally leave the current plethora of chargers in the past. This future-proof law allows for the development of innovative charging solutions in the future, and it will benefit everyone – from frustrated consumers to our vulnerable environment. These are difficult times for politics, but we have shown that the EU has not run out of ideas or solutions to improve the lives of millions in Europe and inspire other parts of the world to follow suit”
Press conference
Today, 4 October from 14.30 CEST, the rapporteur will brief journalists on the outcome of the final plenary vote and the next steps. Click here for more information on how to follow.
Next steps
Council will have to formally approve the Directive before it is published in the EU Official Journal. It will enter into force 20 days after publication. Member states will then have 12 months to transpose the rules and 12 months after the transposition period ends to apply them. The new rules would not apply to products placed on the market before the date of application.
Background
In the past decade, Parliament has repeatedly called for the introduction of a common charger. Despite previous efforts to work with industry to bring down the number of mobile chargers, voluntary measures failed to produce concrete results for EU consumers. The legislative proposal was finally tabled by the Commission on 23 September 2021.
Contact:

Yasmina Yakimova, Press Officer | yasmina.yakimova@europarl.europa.eu

Compliments of the European Parliament.The post Long-awaited common charger for mobile devices will be a reality in 2024 first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Mutual funds holding hard-to-sell assets but offering daily redemptions can spark volatility and magnify the impact of shocks, especially in periods of market stress
Mutual funds that allow investors to buy or sell their shares daily are an important component of the financial system, offering investment opportunities to investors and providing financing to companies and governments.
Open-end investment funds, as they are known, have grown significantly in the past two decades, with $41 trillion in assets globally this year. That represents about one-fifth of the nonbank financial sector’s holdings.
These funds may invest in relatively liquid assets such as stocks and government bonds, or in less-frequently-traded securities like corporate bonds. Those with less-liquid holdings, however, have a major potential vulnerability. Investors can sell shares daily at a price set at the end of each trading session, but it may take fund managers several days to sell assets to meet these redemptions, especially when financial markets are volatile.
Such liquidity mismatch can be a big problem for fund managers during periods of outflows because the price paid to investors may not fully reflect all trading costs associated with the assets they sold. Instead, the remaining investors bear those costs, creating an incentive for redeeming shares before others do, which may lead to outflow pressures if market sentiment dims.
Pressures from these investor runs could force funds to sell assets quickly, which would further depress valuations. That in turn would amplify the impact of the initial shock and potentially undermine the stability of the financial system.
Illiquidity and volatility
That’s likely the dynamic we saw at play during the market turmoil at the start of the pandemic, as we write in an analytical chapter of the Global Financial Stability Report. Open-end funds were forced to sell assets amid outflows of about 5 percent of their total net asset value, which topped global financial crisis redemptions a decade and a half earlier.
Consequently, assets such as corporate bonds that were held by open-end funds with less-liquid assets in their portfolios fell more sharply in value than those held by liquid funds. Such dislocations posed a serious risk to financial stability, which were addressed only after central banks intervened by purchasing corporate bonds and taking other actions.
Looking beyond the pandemic-induced market turmoil, our analysis shows that the returns of assets held by relatively illiquid funds are generally more volatile than comparable holdings that are less exposed to these funds—especially in periods of market stress. For example, if liquidity dries up the way it did in March 2020, the volatility of bonds held by these funds could increase by 20 percent.
This is also of concern to emerging market economies. A decline in the liquidity of funds domiciled in advanced economies can have significant cross-border spillover effects and increase the return volatility of emerging market corporate bonds.
Now the resilience of the open-end fund sector may again be tested, this time amid rising interest rates and high economic uncertainty. Outflows from open-end bond funds have increased in recent months, and a sudden, adverse shock like a disorderly tightening of financial conditions could trigger further outflows and amplify stress in asset markets.

As IMF Managing Director Kristalina Georgieva said in a speech last year, “policymakers worked together to make banks safer after the global financial crisis—now we must do the same for investment funds.”
How should those risks be curbed?
As we write in the chapter, asset volatility induced by open-end funds can be reduced if funds pass on transaction costs to redeeming investors. For example, a practice known as swing pricing allows funds to adjust their end-of-day price downward when facing outflows. This reduces the incentive for investors to redeem before others. Doing so eases outflow pressures faced by funds in times of stress, and the likelihood of forced asset sales.
But while swing pricing—and similar tools such as antidilution levies, which pass on transaction costs to redeeming investors by charging a fee—can help mitigate financial stability risks, they must be appropriately calibrated to do so, and that’s not the case right now.
The adjustments that funds can make to the end-of-day prices—known as swing factors—are often capped at insufficient levels, especially in times of market stress. Policymakers therefore need to provide guidance on how to calibrate these tools and monitor their implementation.
For funds holding very illiquid assets, such as real estate, calibrating swing-pricing or similar tools may be difficult even in normal times. In these cases, alternative policies should be considered, like limiting the frequency of investor redemptions. Such policies may also be suitable for funds based in jurisdictions where swing pricing cannot be implemented for operational reasons.
Policymakers should also consider tighter monitoring of liquidity management practices by supervisors and requiring additional disclosures by open-end funds to better assess vulnerabilities. Furthermore, encouraging more trading through central clearinghouses and making bond trades more transparent could help boost liquidity. These actions would reduce risks from liquidity mismatches in open-end funds and make markets more robust in times of stress.
Authors:

Fabio Natalucci
Mahvash S. Qureshi
Felix Suntheim

Compliments of the IMF.The post IMF | How Illiquid Open-End Funds Can Amplify Shocks and Destabilize Asset Prices first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Global Financial Stability Considerations for Monetary Policy in a High-Inflation Environment by Vice Chair Lael Brainard at “Financial Stability Considerations for Monetary Policy,” a research conference organized by the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of New York, New York, New York |
I want to start by thanking Anna Kovner, Rochelle Edge, and Bill Bassett for organizing this conference. The current global environment highlights the importance of having strong analytic and empirical foundations to understand financial stability considerations for monetary policy, and the research presented today will help strengthen those foundations.1 The global environment of high inflation and rising interest rates highlights the importance of paying attention to financial stability considerations for monetary policy. As monetary policy tightens globally to combat high inflation, it is important to consider how cross-border spillovers and spillbacks might interact with financial vulnerabilities.
Inflation is very high in the United States and abroad, and the risk of additional inflationary shocks cannot be ruled out. In August, CPI (consumer price index) inflation on a 12-month basis was 8.3 percent in the United States, 9.9 percent in the United Kingdom, 9.8 percent in Sweden, 9.1 percent in the euro area, 8.7 percent in Mexico, 7.0 percent in Canada, and 5.7 percent in Korea.
Central banks facing high inflation are tightening monetary policy rapidly to damp demand and bring it into alignment with supply, which is constrained in a variety of sectors. The process of resolving imbalances will be easier the more supply improves in markets for commodities, labor, and key intermediate inputs, as is generally expected, but there is a risk that supply disruptions could be prolonged or aggravated by Russia’s war against Ukraine, COVID‑19 lockdowns in China, or weather disruptions. Russia’s war against Ukraine has generated spikes in prices for energy, food, and agricultural inputs. Most recently, inflation in Europe was pushed higher by Russia’s cessation of natural gas deliveries through the Nord Stream 1 pipeline, creating hardships for households and risking disruptions for some industries in the affected countries. China’s COVID lockdown policy could also lead to supply disruptions if cases again increase. Separately, weather conditions in several areas, including China, Europe, and the United States, are exacerbating price pressures through disruptions to agriculture, shipping, and utilities.
Many central banks around the world have pivoted monetary policy strongly in order to maintain anchored expectations and forestall second-round effects from high inflation becoming embedded in wage and price setting. In the United States, the Federal Reserve has increased the federal funds rate target range by 300 basis points in the past seven months—a rapid pace by historical standards—and the Federal Open Market Committee’s most recent Summary of Economic Projections indicates additional increases through the end of this year and into next year. In addition, beginning this month, balance sheet shrinkage accelerated to its maximum rate of up to $60 billion in Treasury securities per month, and up to $35 billion in agency mortgage-backed securities per month. Broader U.S. financial conditions have tightened rapidly: The 10-year Treasury yield has risen more than 200 basis points since the beginning of the year and is near its highest level in over a decade at 3.8 percent.
At a global level, monetary policy tightening is also proceeding at a rapid pace by historical standards. Including the Federal Reserve, nine central banks in advanced economies accounting for half of global GDP have raised rates by 125 basis points or more in the past six months.2 Global financial conditions have likewise tightened. Yields on 10-year sovereign debt in the United States, Canada, the United Kingdom, and the largest euro area economies are higher year to date between 170 and 350 basis points.
It will take some time for the global tightening to have its full effect in many sectors. While the effect on financial conditions tends to be immediate or even anticipatory, the effects on activity and price setting in different sectors may occur with a lag, with highly interest-sensitive sectors such as housing adjusting quickly and less rate-sensitive sectors such as consumer spending on services adjusting more slowly.
In addition to the domestic effects from domestic tightening, there are cross-border effects of tightening through both trade and financial channels. U.S. monetary policy tightening reduces U.S. demand for foreign products, thus amplifying the effects of monetary tightening by foreign central banks. The same is true in reverse: Tightening in large jurisdictions abroad amplifies U.S. tightening by damping foreign demand for U.S. products.
Tightening in financial conditions similarly spills over to financial conditions elsewhere, which amplifies the tightening effects. These spillovers across jurisdictions are present for decreases in the size of the central bank balance sheet as well as for increases in the policy rate.3 Some estimates suggest that the spillovers of monetary policy surprises between more tightly linked advanced economies such as the United States and Europe could be about half the size of the own-country effect when measured in terms of relative changes in local currency bond yields.4
In contrast, spillovers through exchange rate channels tend to go in opposite directions. The Federal Reserve’s broad nominal U.S. dollar index has appreciated over 10 percent year to date.5 On balance, dollar appreciation tends to reduce import prices in the United States. But in some other jurisdictions, the corresponding currency depreciation may contribute to inflationary pressures and require additional tightening to offset.
We are attentive to financial vulnerabilities that could be exacerbated by the advent of additional adverse shocks. For instance, in countries where sovereign or corporate debt levels are high, higher interest rates could increase debt-servicing burdens and concerns about debt sustainability, which could be exacerbated by currency depreciation. An increase in risk premiums could kick off deleveraging dynamics as financial intermediaries de-risk. And shallow liquidity in some markets could become an amplification channel in the event of further adverse shocks.
For some emerging economies, high interest rates in combination with weaker demand in advanced economies could increase capital outflow pressures, particularly commodity importers facing higher commodity prices and weaker exchange rates. And these pressures would be particularly challenging for borrowers with currency mismatches between their assets and liabilities.
This is especially true at times when fiscal, macroprudential, and monetary buffers are more limited. Fiscal and monetary policy were both supportive in response to the pandemic, and both were naturally expected to reverse course as the recovery gathered steam. But the advent of the war has led to a significant hit to real incomes from large price increases in energy and other commodities in some of the most severely affected economies.
With respect to macroprudential buffers, nearly all of the jurisdictions that built countercyclical capital buffers before the pandemic released those buffers at the outset of the pandemic, and the buffers have not been fully replenished so far. A European Central Bank analysis concluded that the release of capital buffers increased headroom for banks relative to not only their regulatory thresholds, but also their internal risk controls, and enabled banks to continue providing credit to households and businesses.6
And of course, monetary policy is focused on restoring price stability in a high-inflation environment. As the program’s first research paper illustrates, in circumstances in which macroprudential policy cannot on its own eliminate the amplification of shocks through financial vulnerabilities, in a low-inflation environment, monetary policy has been relatively more accommodative than would be prescribed by a conventional monetary policy rule in order to reduce the likelihood of adverse output and employment outcomes.7 But in a high-inflation environment, monetary policy is restrictive to restore price stability and maintain anchored inflation expectations.
The Federal Reserve’s policy deliberations are informed by analysis of how U.S. developments may affect the global financial system and how foreign developments in turn affect the U.S. economic outlook and risks to the financial system. We engage in frequent and transparent communications with monetary policy officials from other countries about the evolution of the outlook in each economy and the implications for policy. We meet regularly not only with monetary policy officials from different countries, but also with fiscal and financial stability officials in a variety of international settings, which helps us to take into account cross-border spillovers and financial vulnerabilities in our respective forecasts, risk scenarios, and policy deliberations.8
High inflation imposes significant hardships by eroding purchasing power, especially for those households that spend the greatest share of their incomes on essentials like food, housing, and transportation.9 Following a period where a combination of high demand and a lengthy sequence of adverse supply shocks to goods, labor, and commodities drove inflation to multidecade highs, monetary policymakers are taking a risk-management posture to guard against risks of longer-term inflation expectations moving above target, which would make it more difficult to bring inflation down.
In the modal outlook, monetary policy tightening to temper demand, in combination with improvements in supply, is expected to reduce demand–supply imbalances and reduce inflation over time.10 The real yield curve is now in solidly positive territory at all but the very shortest maturities, and with the additional tightening and deceleration in inflation that is expected over coming quarters, the entire real curve will soon move into positive territory.
It will take time for the full effect of tighter financial conditions to work through different sectors and to bring inflation down. Monetary policy will need to be restrictive for some time to have confidence that inflation is moving back to target. For these reasons, we are committed to avoiding pulling back prematurely. We also recognize that risks may become more two sided at some point. Uncertainty is currently high, and there are a range of estimates around the appropriate destination of the target range for the cycle. Proceeding deliberately and in a data-dependent manner will enable us to learn how economic activity and inflation are adjusting to the cumulative tightening and to update our assessments of the level of the policy rate that will need to be maintained for some time to bring inflation back to 2 percent.
Compliments of the U.S. Federal Reserve.

1. I want to thank Kurt Lewis and Shaghil Ahmed of the Federal Reserve Board for their assistance on these remarks. These views are my own and do not necessarily reflect those of the Federal Reserve Board or the Federal Open Market Committee. Return to text

2. The central banks of the United States, the United Kingdom, Canada, the euro area, Australia, New Zealand, Norway, Sweden, and Switzerland together account for 49 percent of nominal global GDP measured in dollars at market exchange rates. Each of these central banks has raised its policy rate by at least 125 basis points in the past six months. Return to text

3. See Lael Brainard (2015), “Unconventional Monetary Policy and Cross-Border Spillovers,” speech delivered at “Unconventional Monetary and Exchange Rate Policies,” 16th International Monetary Fund Jacques Polak Research Conference, Washington, November 6; and Lael Brainard (2017), “Cross-Border Spillovers of Balance Sheet Normalization,” speech delivered at the National Bureau of Economic Research’s Monetary Economics Summer Institute, Cambridge, Mass., July 13. Return to text

4. A paper based on data between 2005 and 2017 found that about half of the reaction in German domestic yields spills over to U.S. yields following ECB announcements, which was nearly identical to the spillover from U.S. yields to German bund yields measured following Federal Open Market Committee announcements. See Stephanie E. Curcuru, Michiel De Pooter, and George Eckerd (2018), “Measuring Monetary Policy Spillovers between U.S. and German Bond Yields,” International Finance Discussion Papers 1226 (Washington: Board of Governors of the Federal Reserve System, April). Return to text

5. The Federal Reserve’s broad trade-weighted dollar index is based on 26 currencies of major U.S. trading partners. It is published in Statistical Release H.10, “Foreign Exchange Rates,” available on the Board’s website at https://www.federalreserve.gov/releases/h10/current/default.htm. Return to text

6. These findings were part of a box in the ECB’s May 2022 Financial Stability Review titled “Transmission and Effectiveness of Capital-Based Macroprudential Policies.” See European Central Bank (2022), Financial Stability Review (Frankfurt: ECB, May), pp. 93–95. The countercyclical buffer has not been activated in the United States. Return to text

7. See Tobias Adrian and Fernando Duarte (2016), “Financial Vulnerability and Monetary Policy (PDF),” Staff Reports 804 (New York: Federal Reserve Bank of New York, December; revised November 2020). Return to text

8. See Richard H. Clarida (2021), “Perspectives on Global Monetary Policy Coordination, Cooperation, and Correlation,” speech delivered at the “Macroeconomic Policy and Global Economic Recovery” 2021 Asia Economic Policy Conference, sponsored by the Federal Reserve Bank of San Francisco Center for Pacific Basin Studies, San Francisco (via webcast), November 19. Return to text

9. See Lael Brainard (2022), “Variation in the Inflation Experiences of Households,” speech delivered at the Spring 2022 Institute Research Conference, Opportunity and Inclusive Growth Institute, Federal Reserve Bank of Minneapolis, Minneapolis (via webcast), April 5. Return to text

10. See, for example, the year-to-date improvement in the Federal Reserve Bank of New York’s Global Supply Chain Pressure Index, available on the Bank’s website at https://www.newyorkfed.org/research/policy/gscpi#/interactive. Return to text
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Remarks by Luis de Guindos, Vice-President of the ECB, at a panel at the conference “Future of Central Banking” organised by Lietuvos bankas and the Bank for International Settlements | Frankfurt am Main, 29 September 2022 |
I am very pleased to participate in this conference to mark the centenary of Lietuvos bankas. Building on the ECB’s recent strategy review and our reflections on the policy mix, I will outline my views on the interplay between monetary, macroprudential and fiscal policy.
Academic research points to the need for monetary and fiscal policy to work together in times of crisis. This runs contrary to previous wisdom suggesting fiscal policy should mainly support economic outcomes by playing the role of an “automatic stabiliser.” For example, in recessions, government expenditure would automatically increase and tax revenue would automatically decrease. It has become evident that strong, discretionary countercyclical fiscal policy is needed in a crisis. Furthermore, research shows fiscal policy is particularly effective close to the lower bound of interest rates. In this way, fiscal policy not only effectively stabilises the economy, but also contributes to the ECB’s objective of maintaining price stability. Structural fiscal policy[1] could also help raise the natural or equilibrium real rate of interest[2]. This rate of interest has been falling in recent decades and has made the pursuit of price stability much more challenging for central banks. Complementarity between monetary and fiscal policy was greatly effective following a long period of too low inflation. But how is this interaction in an inflationary environment? Or more generally, how does the level of inflation affect the fiscal-monetary policy mix?
Macroprudential policy addresses risks to financial stability. Our strategy review acknowledges that financial stability is a necessary condition for price stability. With an impaired transmission mechanism in times of financial turmoil, maintaining price stability is not possible. At the same time, monetary policy itself can have implications for financial stability. Accommodative monetary policy can reduce credit risk and prevent debt deflation. But it could also trigger excessive risk taking or encourage higher leverage in the financial system. In times of monetary policy tightening, the converse arguments apply.
We therefore decided to implement a new integrated analytical framework, which takes financial stability considerations explicitly into account in our monetary policy decisions. Our focus is threefold: detecting impairments to the transmission mechanism, such as fragmentation risk, monitoring a possible build-up of financial imbalances, and identifying how far macroprudential policy addresses financial imbalances.
Let me summarise how I see the complementarities between fiscal and macroprudential policies with monetary policy:

Fiscal and macroprudential policy should be the first lines of defence for economic stabilisation and fostering financial stability, respectively. This leaves monetary policy to focus exclusively on price stability.

The importance of both fiscal and macroprudential policy has recently increased. Fiscal policy became more important because of its role in times of crises, and its enhanced effectiveness at the lower bound. Macroprudential policy became more relevant given its capacity to contain the potential side effects of monetary policy – both in the accommodative and tightening phases.

Both fiscal and macroprudential policy need to be strongly countercyclical: this entails building up “buffers” during good times[3] for use in bad times.[4] While sovereign debt must be sustainable to be used countercyclically, macroprudential capital buffers need to first be built up so that they can be released when risks materialise.

In the Economic and Monetary Union (EMU), both fiscal and macroprudential policy can be targeted at the country, sector or industry level. They can therefore account for heterogeneity within EMU by alleviating the occasional one-size-fits-all problem.

Thus, both fiscal and macroprudential policy can support monetary policy in its aim to achieve price stability. In the same way, successful monetary policy supports economic stabilisation and financial stability. All three policies have the potential to be mutually complementary in their respective fields of responsibility.
The recent pandemic crisis and the current challenges of soaring energy and commodity prices coupled with high overall inflation have underlined the case for these policy complementarities. The successful interplay between accommodative monetary policy, fiscal support measures and prudential relief safeguarded the real economy and the financial system across the euro area during the pandemic crisis. It succeeded in protecting nominal incomes, thereby supporting a fast recovery of demand when our economies reopened.
Subsequently, to combat steadily rising inflation, in December 2021 we started normalising our monetary policy by announcing the end of our asset purchases, in tandem with targeted fiscal measures aimed at mitigating the hardship of soaring prices for the most vulnerable households and firms. The scope and nature of fiscal measures needs to be different now than it was at the height of the pandemic, following a long period of too low inflation. Fiscal policy should not stoke inflation. It needs to be temporary and tailored to the most vulnerable households and businesses, who are being hardest hit by high inflation.
The Transmission Protection Instrument (TPI) was introduced in July 2022. It aims to ensure that the monetary policy stance is transmitted smoothly across all euro area countries. The TPI therefore supports price stability while safeguarding financial stability by addressing unwarranted, disorderly market dynamics. At the same time, certain euro area countries are applying macroprudential policy for a targeted build-up of resilience. This targeted build-up of capital buffers and the application of borrower-based measures takes into account heterogeneous cyclical developments across countries and sectors in the euro area. It fine-tunes the overall policy mix and complements the single monetary policy in support of overall financial stability across the euro area.
Despite the overall good resilience of the euro area banking sector, certain countries have in recent years seen a build-up of financial vulnerabilities, notably related to residential real estate prices and growing household and firm indebtedness. Some further careful and targeted tightening of macroprudential policy would be beneficial in selected countries at present. Given the deteriorated outlook for economic growth, some countries might benefit from further increasing the resilience of their financial sectors before credit risks start materialising. This includes for example taking measures to preserve capital in the banking sector which could then be used to absorb losses. Lithuania has been active in applying a comprehensive set of macroprudential policies to address current vulnerabilities. This year, authorities have activated a sectoral systemic risk buffer of 2% on residential real estate exposures and have tightened the loan-to-value limit for second and subsequent housing loans to 70%. Of course, the benefits of further policy action across countries, would need to be evaluated against the risk of procyclical effects, which is becoming more likely as the economic outlook worsens.
Let me conclude. Policy interaction has been a critical element for navigating the pandemic. Complementary actions of fiscal, macroprudential and monetary policy, in their respective fields of responsibility, continue to be essential in dealing with the current inflation shock and financial system imbalances.
In the current challenging macro-financial environment, macroprudential buffers contribute to preserving and strengthening banking sector resilience. Hence, I very much welcome that some national authorities – in close collaboration with the ECB – currently assess the extent to which there is merit in implementing additional macroprudential measures. The macroprudential policy response should consider the current near-term headwinds to economic growth since policy tightening should not result in an unintended tightening of credit conditions.
Interactions between monetary and macroprudential policy become even more pronounced in a monetary union where monetary policy, by definition, will be focusing on area-wide economic and financial conditions. In fact, macroprudential policy targeting imbalances building up at national level within the monetary union can help to achieve better policy outcomes in terms of price and financial stability.
Compliments of the European Central Bank.
Footnotes:
1. An important example of such structural fiscal policy is the Next Generation EU (NGEU) programme, with a strong focus on the green transition comprising an expected €401 billion to be invested in euro area countries (around 3.3% of 2021 euro area GDP) over 2021-27, See also Bańkowski et al. (2022), “The economic impact of Next Generation EU: a euro area perspective” Occasional Paper Series, No 291, European Central Bank.
2. This is the rate of interest where monetary policy is neither accommodative nor tightening and where the economy is operating at its potential output.
3. Before the pandemic, the countercyclical capital buffer in the euro area accounted for only 0.2% of the capital stock. See also De Guindos, L. (2019) ”Macroprudential policy after the COVID-19 pandemic”, panel contribution at the Banque de France / Sciences Po Financial Stability Review Conference “Is macroprudential policy resilient to the pandemic?”, 1 March.
4. Estimates for energy-related fiscal support by euro area countries were at 0.8% of GDP for 2022 in July this year and may further rise depending on global developments. See also European Central Bank (2022), Economic Bulletin, Issue 5, Box 7: “Euro area fiscal policy to the war in Ukraine and its macroeconomic impact”, footnote 3.The post ECB | Policy mix of the future: the role of monetary, fiscal and macroprudential policies first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.