Source: Bank for International Settlements
Introduction
Welcome, everyone, and thank you for attending the first edition of the Chapultepec Conference. The aim of this event is to allow central bank Governors to reflect and share perspectives on the major economic and financial issues facing the Americas. I am sure that today’s meeting will be followed by many others.
Today’s conference has a rich agenda. We started this morning by discussing global financial conditions and digital innovations. After lunch, we will turn to monetary policy.
I will use my time today to give some background to this afternoon’s discussions. I will aim to provide some perspective on the course of monetary policy in the Americas over the past few years. I will then turn to what I see as the key challenges facing central banks in the region in the coming years. My comments will focus on Latin America, although many of the themes have broader relevance.
Latin America’s response to the Covid crisis
Monetary policy developments in recent years have been profoundly shaped by the events of the Covid-19 pandemic and its immediate aftermath.
When the pandemic struck in 2020, central banks throughout the world took decisive measures. They lowered interest rates to record lows, offered new liquidity facilities and expanded existing ones. Many central banks also made asset purchases.
For advanced economy central banks, including the Federal Reserve and the Bank of Canada, the policy response followed a broadly familiar playbook, although the size of the response was unusually large.
But for many emerging market economy central banks, including those in Latin America, such a strong, countercyclical policy response marked a departure. In past crises, policy had often responded procyclically, not least due to concerns about possible currency depreciation.
Two factors contributed to this different response in Latin America during the pandemic. First, monetary policy frameworks in Latin America had been strengthened over the previous decades. In particular, the autonomy obtained in the 1990s was a rock-solid foundation, without which a countercyclical policy response would not have been possible. Second, the pandemic was a global shock. The fact that central banks worldwide, including the Federal Reserve, were loosening their policy stances no doubt made it easier for central banks in Latin America to follow suit.
While the policy easing at the start of the pandemic was highly synchronous, the tightening in its aftermath was less so. Central banks in Latin America, in particular, were relatively quick to unwind emergency policy settings in response to emerging inflationary pressures in early 2021. In doing so, they drew on the experiences of the 1970s and 1980s, when high inflation and wage-price spirals were prevalent. Monetary policy in advanced economies was, in my view, more heavily influenced by the extended period of below-target inflation that preceded the pandemic.
Early and forceful policy tightening worked. By slowing demand, it contributed directly to lowering inflation. Just as importantly, decisive tightening helped keep long-term inflation expectations anchored. Even when inflation initially rose, the public never lost confidence in central banks’ commitment and ability to bring inflation back to target. In countries with a history of high and volatile inflation, like many in Latin America, this is a clear success. It has helped to prevent a wage-price spiral similar to that experienced during previous episodes. Moreover, unlike in many episodes of the 1980s and 1990s, there was no financial or banking crisis.
The job is not done, however. In much of the Americas, inflation remains above target. And the road back to price stability looks bumpier than it did even six months ago, not least due to heightened policy uncertainty. Over the past few years, central banks were able to draw on their accumulated credibility to limit the rise in inflation and bring it down at relatively little cost to economic activity. But to safeguard their credibility for the future, they have to see the job through and deliver on their mandates.
Challenges ahead
Let me spend the rest of my speech discussing some of the challenges that I believe will affect the conduct of monetary policy in the coming years.
The first challenge is policy uncertainty. Trade policy is the most prominent example. But the future evolution of fiscal policy, regulation and immigration policy is also open to many questions at present. Moreover, the geopolitical backdrop remains in flux.
Such pervasive policy uncertainty will affect central banks in several ways.
Uncertainty itself is likely to weigh on growth. Firms will postpone investment. Households may avoid large purchases. In isolation, these effects would weigh on inflation.
But an uncertain world is also likely to be a more volatile one, particularly for financial markets. Already in recent weeks, we have seen sizeable swings in asset prices, including exchange rates, as market participants struggled to determine how policy settings would evolve, and how to position themselves accordingly. Some of these asset price movements, particularly exchange rate depreciations, could be inflationary.
At some point, of course, many of today’s policy uncertainties are likely to be resolved. Depending on the policies adopted, these choices will have their own consequences for growth and inflation.
The second challenge is high public debt and, in some countries, unsustainable fiscal positions. Public debt was already high in much of the world before the Covid-19 pandemic. It has increased further since then. And the widening of budget deficits at the start of the pandemic has still not been fully unwound.
Loose fiscal policy complicates the task of central banks in several, well known, ways. By contributing to aggregate demand, it adds to inflationary pressures, complicating the return to price stability. By raising doubts about the long-term sustainability of public finances it can increase interest rate risk premia and can lead to currency depreciation, further raising inflation while weighing on growth. In the extreme, an abrupt repricing of public debt could put financial stability at risk, especially in countries where banks and non-bank financial institutions hold large shares of the public debt. But even if these channels are familiar, central banks will still need to navigate the consequences.
The third challenge is international divergence. As I mentioned before, the pandemic was a global shock, leading almost all central banks to ease policy at about the same time. The subsequent inflationary outbreak saw most tighten policy, even if many emerging market economy central banks started to do so ahead of their advanced economy peers.
Going forward, economic conditions, and hence appropriate policy settings, are likely to be less synchronous. In particular, economic growth in the United States has been much stronger than in much of the rest of the world of late. Should this continue, we could see greater variability in policy settings, with flow-on effects to capital flows, exchange rates and global financial conditions.
A fourth, and related, challenge is continued sluggish productivity growth in most countries of the Americas, except the United States. Some factors behind this problem are insufficient investment in infrastructure, education and technology. Many countries face structural inefficiencies, such as rigid labour markets and bureaucratic hurdles, which hinder businesses’ ability to innovate and expand. A retreat from globalisation and widening trade fragmentation could weigh on productivity growth further.
Low productivity growth makes central banks’ lives much harder. In particular, it creates pressure to keep policy settings loose in order to sustain economic growth in the face of weak fundamentals. I don’t need to tell this audience that this policy prescription is all wrong.
Addressing low productivity growth requires structural reforms that make it easier to open a business, compete and invest. Regrettably, structural reforms had been lagging in many economies well before the pandemic. Consolidating fiscal positions and rationalising public expenditure may also free up resources to improve public investment to develop necessary infrastructure and improve human capital. Such policies, of course, lie outside central banks’ toolkit.
The task for central banks
Faced with all of these challenges, many of which are beyond their control, what can central banks do?
A first task is to ensure that at least one key prerequisite for sustained economic growth – price stability – is beyond question. In doing so, they can help remove one potentially destabilising source of policy uncertainty. The history of this region regrettably features many examples of the adverse consequences when the public loses confidence in central banks’ ability and willingness to achieve their mandates. The experience of the Covid pandemic showed us how much better outcomes can be if such confidence is maintained.
That said, the specific policy settings to deliver monetary and financial stability are themselves uncertain. Much will depend upon how policy uncertainty evolves, and on the specific constellation of policies that are ultimately adopted. Appropriate policy settings will also change over time. In the meantime, bouts of market volatility are likely. At such times, central banks may need to act, in a judicious and limited manner, to safeguard market stability.
So central banks will need to remain on their toes, be attuned to recent developments and stand ready to act firmly and decisively when required. While central banks’ ultimate objectives – monetary and financial stability – should be steadfast, commitment to specific policy settings should be avoided. Maintaining flexibility to adjust policy settings rapidly in response to changing circumstances will be at a premium.
Beyond the immediate conjuncture, I believe the time is also opportune for central banks to build on the lessons of the past few years, in order to better prepare themselves for the future. The policy reviews currently being undertaken in a number of economies represent such an opportunity.
In particular, a key lesson that I draw is how quickly and fundamentally seemingly pervasive features of the economic landscape can change. Before the pandemic, there was broad-based agreement that the global economy would face strong deflationary pressures for the foreseeable future. Real rates were expected to remain at historical lows, raising the risk of persistent liquidity traps.
Today it is clear that inflation risks are much more two-sided than we had previously thought. And it is also clear that the general public is much more resentful of even a relatively brief period of high inflation than a prolonged period of modestly below-target inflation. Our policy frameworks should take these lessons into account. But they will also need to be robust to a future that could look very different from even the immediate past. A key reason for the success of many Latin American central banks in navigating the post-pandemic inflation surge was their ability to adapt rapidly in the face of changing circumstances. Such adaptability is a trait to which all policy frameworks aspire.
Let me close with a plea for central bank cooperation. Central banking is not a zero-sum game. Above-target inflation or low growth in one country does not benefit others, but makes their life more difficult. This means there is significant scope for cooperation. It will be much easier to meet the challenges of tomorrow together than alone.
The BIS will be there to support you in this endeavour. The BIS’s mission is to support central banks’ pursuit of monetary and financial stability through international cooperation, and to act as a bank for central banks. The BIS Representative Office for the Americas will continue to promote cooperation among central banks in the Americas and the Caribbean and to link central banks in the region to those in other regions.
