Let me now turn to the third and last topic of my remarks, that is … Inflation targeting in the post-crisis global economy As a growing and abundant new literature – together with new practices – is now showing, the 2008 crisis and its aftermath have called into question the balance and interaction between two components of macroeconomic stability: financial and price stability. They are both necessary, but taken individually, they are not sufficient to ensure overall macro stability that fosters sustainable growth. Therefore, the debate raises the issue of what new contours could take an inflation targeting framework for monetary policy that could also address financial stability when complemented by possibly the new macroprudential toolkit. Central banks and financial regulators both failed to counteract the buildup of systemic risk in the financial system. Therefore, this failure has brought the inflation targeting regime under scrutiny since it has been the monetary regime of choice in many central banks including in emerging markets. The first lesson of the crisis was a greater appreciation of the importance of financial stability as a component of macroeconomic stability. There are many directions in the ongoing debate3. One direction is to consider a division of labor along the lines of a separation principle: monetary policy using an IT framework would address price stability; and macroprudential policy would be used to mitigate financial systemic risk. Another direction is to ask whether monetary policy should explicitly incorporate a financial stability objective, and be more proactive in response to perceived risks to financial stability.
The adoption of specific measures of this new toolkit obviously depends on how each of us assesses its own local credit and asset market potential vulnerabilities. Some EMEs imposed tighter limits on financial institution and household leverage. In East Asia, for example, policies included loanto-value and debt-to-income ceilings on real estate lending. In Brazil, we increased capital requirements on riskier consumer loans and imposed a minimum payment floor on credit card balances. And we also imposed taxes on capital inflows and a reserve requirement on banks’ foreign exchange spot positions. The important outcome was that this pragmatic response worked. Therefore, macroprudential measures, including those that target specific capital flows directly, became an important part of the policy framework to address sudden floods and sudden stops. In complement to traditional macroeconomic policy responses, these measures showed that they can help ensure macro-financial stability. There are many quarters, ranging from academia to the IMF itself2 that are increasingly subscribing to this view. However, there are also reputational costs to implementing these policies, which I will address a little later. But what do we mean by “it worked”? In Brazil’s case, it means the following: (a) macroprudential policies contributed to bringing down the pace of credit expansion to more sustainable levels; (b) they were successful in improving the maturity and composition of international financing; and (c) they also reduced foreign exchange volatility.