IMF.ORG/GFSR #GFSR

Financial Conditions and Growth At Risk

Dong He

Deputy Director, Monetary and Capital Markets Department

International Monetary Fund

CF40-PIIE Third Annual China Economic Forum

January 11, 2018

Global Financial Stability Report

The views expressed in this presentation are personal and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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Could The Global Recovery Be Derailed?

2017-2019 2020-2022

Continued search for yieldSpreads compressedLow volatilityIncreasing leverage

Increased risk aversionCredit spreads decompress

Volatility shifts higherDebt service pressures mount

2

Growth at Risk

• Value-at-risk of future GDP as a function of financial conditions

• The conditional distribution of GDP growth in the future, based on the current level of GDP growth and current financial conditions

3

Tighter global FCI Æ Higher global downside tail risk

One-Year Ahead Density Forecast

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

5th 25th 50th 75th 95thPercentile

Quantile Coefficient Estimates

4

-10-505101520253035

-16

-12

-8

-4

0

4

8

1991

:Q1

93:Q

1

95:Q

1

97:Q

1

99:Q

1

2001

:Q1

03:Q

1

05:Q

1

07:Q

1

09:Q

1

11:Q

1

13:Q

1

15:Q

1

Downside and upside risks (5th and 95th percentiles)MedianFCI (right scale)

One Year Ahead Density Forecast

(left scale = percent; right scale = std dev)

16:Q

4

4

Higher leverage Æ Higher downside risks at longer time horizons

Quantile Regression Coefficients

55

-0.4-0.3-0.2-0.10.00.10.2

-0.4-0.3-0.2-0.10.00.10.2

0.1 0.2 0.25 0.4 0.5 0.6 0.75 0.8 0.9Quantile

2. Emerging Market Economies: Three Years Ahead

-0.4-0.3-0.2-0.10.00.10.2

-0.4-0.3-0.2-0.10.00.10.2

0.1 0.2 0.25 0.4 0.5 0.6 0.75 0.8 0.9Quantile

1. Advanced Economies: Three Years Ahead

Which countercyclical policy to contain vulnerabilities?

• Macroprudential or monetary policy? Targeted therapy or chemotherapy?

• Macroprudential policies work on the assumption that different cells of the financial system have different interest rate elasticities

– macroprudential instruments aim to create differentiated shadow interest rates within the financial system

• Monetary (interest rate) policy sets a uniform risk-free interest rate for the entire economy, and gets into all the “cracks”

6

Effectiveness of macroprudential tools- synopsis

• Growing evidence that macroprudential policy tools can increase resilience (IMF-FSB-BIS 2016)

– across all macroprudential tools (capital buffers, LTV/DTI, liquidity tools)

• Ability to contain procyclical dynamics between asset prices and credit differs across tools

– Borrower-based tools (LTV/DTI) more effective at containing excessive credit than capital tools

– Effectiveness of some tools limited by

• Domestic leakage (provision of credit by non-banks)• Cross-border leakage (provision of credit from abroad)• Shift from bank-based towards market-based funding

– Especially when corporates are able to borrow from abroad and through markets

• Cross-border coordination of policies?

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• Both macroprudential policy and monetary policy work on financial conditions

• “The Committee will need to confront an ongoing probabilistic cost-benefit calculation. – On the one hand, raising the real interest rate will definitely lead to lower

employment and prices. – On the other hand, raising the real interest rate may reduce the risk of a

financial crisis—a crisis which could give rise to a much larger fall in employment and prices.

– Thus, the Committee has to weight the certainty of a costly deviation from its dual mandate objective against the benefit of reducing the probability of an even larger deviation from those objectives.” (Kocherlakota, 2013)

Intertemporal mean-variance tradeoffs

8

Should monetary policy lean against the wind?

• Generally, the tradeoff is likely to be less severe for macroprudential policy

• The tradeoff favors monetary policy only under very limited circumstances; benefits grow relative to costs when:– rapid credit growth, low unemployment, strong balance sheets,

high probability of crisis

• More research is needed– The GaR metric could help by quantifying risks to financial stability

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End of Presentation

…but vulnerabilitiesare building

underneath…

Conditions appear calmon the surface…

…that could putgrowth at

risk

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