Franziska Schobert

Monetary Policy Operations of Debtor Central Banks in MENA Countries

The paper analyses the monetary policy operations of central banks in the Middle East and North Africa (MENA). We distinguish the pattern of monetary policy operations of the liquidity providing central banks of the large industrialized countries (creditor central banks) and the liquidity absorbing central banks of emerging market economies (debtor central banks). Many debtor central banks provide liquidity through foreign exchange intervention in reaction to foreign exchange inflows. If the respective liquidity expansion is regarded as a threat to domestic price and financial stability, liquidity is partly absorbed through sterilization operations. The paper finds that most MENA countries are debtor central banks due to a general pattern of excessive liquidity creation as well as due to country specific reasons.

The Role of Reserve Requirements: The Case of Contemporary China Compared to Postwar Germany

The role of reserve requirements has evolved significantly over time and differs across countries, though there are two broad trends. For central banks that operate in highly developed financial markets the role of reserve requirements as the primary instrument of monetary policy has been decreasing over the past few decades. The role of mandatory reserves is reduced to smoothing fluctuations of short-term interest rates, which helps to communicate the operational target of the central banks more clearly. For central banks operating in emerging market economies, however, tweaking reserve requirements has gained importance. Reserve requirements supplement a policy mix that aims at stabilizing the exchange rate and combating high and volatile capital inflows, especially as the low interest rate environment of advanced economies has accelerated a global search for higher yield. We offer a comparison of the experience at the People’s Bank of China (PBC) during the recent past and that of the Bundesbank from the post-war period until the start of the European monetary union. It presents a case study suitable for explaining the different functions of reserve requirements and how characteristic features and external conditions influence the feasibility of each function. Reserve requirements have been most actively used in China and Germany during shifts in exchange rate regimes that coincided with periods of high and volatile capital inflows. Economic theory, however, can additionally drive visions of what reserve requirements should perform. We conclude that some misconceptions of the role of money, credit and liquidity influence the bias between theory and practice.

Limits of Monetary Policy Autonomy and Exchange Rate Flexibility by East Asian Central Banks

Given low interest rates in the large industrial countries and buoyant capital inflows into the emerging markets East Asian central banks have accumulated large stocks of foreign reserves. As the resulting easing of monetary conditions has become a threat to domestic price and financial stability, the East Asian central banks have embarked on substantial sterilization operations to absorb what we call surplus liquidity from the domestic banking systems. This has brought the East Asian central banks into debtor positions versus the domestic banking systems. We show based on a central bank loss function that given buoyant capital inflows and exchange rate stabilization the absorption of surplus liquidity leads either to financial repression, or rising inflation or both. Assuming that a debtor central bank moved towards a freely floating exchange rate to gain monetary policy independence, we show that monetary policy independence is undermined by sterilization costs and revaluation losses on foreign reserves.

Why is Financial Strength Important for Central Banks

Central bank financial strength matters at least for two reasons: First, the availability of financial resources enables the central bank to perform its tasks independently. Second, market expectations could be influenced by a financially weak central bank, which could compromise monetary policy credibility (Blejer and Schumacher, 1998, Stella, 2002). Some studies focus on the role of central bank capital as a buffer against financial risks (Stella, 1997, Bindseil et al. 2004). It is, however, not all that matters. Capital depends on the accounting and profit distribution rules of the central bank. As there is a remarkable diversity of practice in these areas among central banks, this means that what capital represents in one central bank is very different from what it represents in another (Stella, 2003). Furthermore, the composition of (on and off) balance sheet items and therefore, the financial risks to which the central bank is exposed is very heterogeneous. The chapter, therefore, will focus on two particular balance sheet items that bear financial risk to central banks, so called junk assets and sterilization instruments. Junk assets have been accumulated due to some form of government financing for example as the result of the participation of the central bank in the restructuring of the financial system or as the result of financial support to the government, staterelated banks or enterprises. These assets have in common that they bear no return or a return below market rates and therefore expose the central bank to substantial credit risk. Sterilization instruments are market-based means through which the central bank will conduct sterilized intervention in face of capital inflows, if it does not want to permit an exchange rate appreciation or an induced and possibly inflationary increase in base money (Mackenzie and Stella, 1996). The central bank, thus, aims at two goals, an exchange rate target and internal price stability. Sterilization, however, incurs costs, the difference between the interest cost paid by the central bank and the interest earned on the foreign assets acquired with the foreign exchange purchase. It therefore also exposes the central bank to financial