Monetary analysis and the global financial cycle: an Asian central bank perspective

EM Asia has seen a transformation of its monetary policy environment over the past 2 decades. By far, the most relevant change has been the maturing of its financial systems and the growing relevance of the global financial cycle: financial inclusion has spread, financial markets have deepened and financial globalisation has linked domestic markets closer to international markets. One consequence of the maturing of the financial systems has been the weakening of the traditional case for the monetarist view of the roles of monetary and credit aggregates in the conduct of monetary policy: velocity has been unstable in ways similar to that in the advanced economies decades earlier; yet, longer-term monetary growth correlations with inflation are evident. In addition, the maturing of the financial systems has elevated concerns of financial stability, as both a source of shocks and as something central banks have a responsibility for. These developments have been further complicated by monetary policy spillovers from the advanced economies. The challenge now is how best to integrate mandates for financial stability into monetary policy frameworks, both conceptually and practically. Moreover, the exchange rate choice is particularly relevant in EM Asia. While managed exchange rate regimes in EM Asia have been implemented with mixed success, the risks associated with the choice can be seen through the lens of aggregates based on central bank balance sheets. The size and growth of central bank balance sheets suggest an ongoing build-up in risks. All this points to the need to consider alternatives to conventional inflation targeting frameworks. This paper lays out a policy framework based on a multi-pillar monetary policy approach as a potentially attractive alternative for EM Asia. The three pillars are based on economic, financial and exchange rate stability, respectively. This framework not only offers an alternative conceptual framework but also implies institutional reforms to ensure central banks take a longer term perspective when setting policy.