The Appropriate Financial Policy Toolkit in an Integrated World

Answers from the recently revised OECD Code of Liberalisation of Capital Movements

By Michael Williams, Chair of the Advisory Task Force on the OECD Codes of Liberalisation

Since the Global Financial Crisis, challenges related to capital flow management and financial stability have evolved, leading policymakers to broaden the policy toolkit available to deal with those challenges. In this context, the time was ripe for a review of the OECD Code of Liberalisation of Capital Movements, the only multilateral agreement covering the full capital account. The updated Code was adopted by OECD Ministers in May 2019 and launched at the G20 Finance meeting in Fukuoka. It is not only more flexible, to better deal with current financial stability requirements, but it also makes an important contribution to the global debate on the international financial architecture.

Cross-border financial positions more than tripled as a share of world GDP between the mid-1990s and the global financial crisis, bringing the global economy to an unprecedented level of financial integration. However, increased integration has changed the transmission channels of external shocks and macroeconomic policies. Volatility of capital inflows has, at times, become a policy challenge, with several countries experiencing capital inflow surges on the back of massive global liquidity and unconventional monetary policy in advanced economies.

The aftermath of the Global Financial Crisis thus saw important changes in the way central banks, ministries of finance, and regulators use their policy toolkit, as highlighted in recent OECD research and illustrated in the Figure below. First, policymakers moved from a purely micro-prudential approach to a “macro-prudential” perspective of financial regulation and tools, setting out macroprudential mandates, designating the respective authorities, and expanding the macro-prudential policy toolkit. Second, while the bulwark against restrictive tendencies for the most part held up during the crisis, some countries reintroduced capital flow management measures, discriminating by the residency of the parties to a transaction. For some countries, these were a necessary part of domestic crisis fighting, for others they were used with a prudential intent to mitigate large capital inflows. These policy moves have revived the international debate on the desirability of capital flow management tools and whether they should be an integral part of the policy toolkit. Thirdly, policymakers have increasingly used measures that differentiate by the currency of denomination of the transaction, “currency-based measures”, triggering a debate on whether such measures have more macroprudential or capital flow management characteristics.

Quarterly easing and tightening of financial policies

Note: Residency Based Measures (RBMs)= residency based measures; Currency Based Measures (CBMs) = FX-differentiated measures; Macro-prudential Measures (MPMs) = neither residency- nor FX-differentiated. T= tightening, L=loosening. Sample of 62 countries, among which the 36 OECD countries and 26 Emerging economies. MPM/CBM not available in 2017

Source: Lepers and Mehigan (2019); De Crescenzio et al (2015), Alam et al (2019)

The question naturally arose as to whether the OECD Code, last reviewed in the 1990’s, was up to date in light of such developments. The Review of the Code, started in 2016, has now been completed and has produced important answers and updates in a number of areas:

  • First, it was clarified that non-discriminatory measures (typical macro-prudential measures) generally fall outside the scope of the Code, as they do not target or impact capital flows.
  • Second, the Review introduced more flexibility and transparency regarding currency-based measures. While they are often used with the prudential aim of reducing FX mismatches in sectoral balance sheets or in the context of de-dollarization strategies, they may also act as capital flow management tools as OECD research has demonstrated. The updated Code provides that various national applications by currency of the Basel III Liquidity Coverage Ratios (LCR) and Net Stable Funding Ratio (NSFR) should not be considered capital flow restrictions. More generally, the revised Code states that measures on FX liabilities, like differentiated reserve requirements or taxes, should be assessed on a case by case basis, departing from a purely legal conformity assessment to take into account country-specific circumstances.
  • Finally, when non-discriminatory measures are not enough to limit vulnerabilities from excessive external borrowing, the revised Code explicitly recognises the possibility for members to reintroduce controls and derogate from their Code’s commitments, not only in the case of crisis-related capital outflows but also for economic and financial disturbances in an environment of capital inflow surges.

In addition, the Review has considered how, in an integrated world, shifts in domestic financial policies can themselves be a source of international spillovers, potentially leading to negative collective outcomes for the global financial system. Such issues may require a multilateral response and highlight the value of multilateral agreements and fora that discuss the appropriate use of instruments influencing capital flows, such as the Code and  the Advisory Task Force on the Codes (ATFC).

The Review of the Code has also proved timely, as countries are debating, at the G20 and elsewhere, the future of the international financial architecture and which reforms and frameworks would be needed to ensure a stable and efficient global financial system. The Review provided the opportunity to advance consensus on the desirable features of a multilateral regime for cross-border capital movements. Going forward, it is the aim of the ATFC to continue to serve as the multileral platform of reference on capital flow issues and policies.

Finally, the updated Code and the work of the Task Force will be all the more relevant as more and more countries engage in this debate and value the instrument. As highlighted by OECD Secretary-General Gurria at the occasion of the recent G20 Finance meeting, at a time when major emerging economies are opening up their capital accounts, the expectation is that countries will leverage on the revised Code to help them drive their policy reforms.

References

For a more general description of the outcomes of the Review of the Code, see OECD Report to the G20 Finance of June 2019.

The Eminent Persons Group report, commissioned by the G20, is a recent example of efforts to move the debate on the global financial governance.

The ATFC meets bi-annually and is open to participation also by non-OECD G20 members.

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