The IMF Research Bulletin, a quarterly publication, selectively summarizes research and analytical work done by various departments at the IMF, and also provides a listing of research documents and other research-related activities, including conferences and seminars. The Bulletin is intended to serve as a summary guide to research done at the IMF on various topics, and to provide a better perspective on the analytical underpinnings of the IMF’s operational work.


The IMF Research Bulletin, a quarterly publication, selectively summarizes research and analytical work done by various departments at the IMF, and also provides a listing of research documents and other research-related activities, including conferences and seminars. The Bulletin is intended to serve as a summary guide to research done at the IMF on various topics, and to provide a better perspective on the analytical underpinnings of the IMF’s operational work.

Summary by Andrea Schaechter, Mark Stone, and Marco Arnone

For central banks seeking to preserve or to attain low inflation and financial stability, increasing global financial market integration presents new challenges. What is the appropriate nominal anchor for countries susceptible to shifts in capital flows? What can central banks do to prevent crises, or to deal decisively with ones that do occur? To address these and related questions, the IMF Monetary and Exchange Affairs Department and the IMF Institute jointly hosted a conference in September 2002 on Challenges to Central Banking from Globalized Financial Systems, which was attended by central bank governors and senior officials from over 45 countries. The gathering highlighted the difficult decisions central bankers face when the twin objectives of monetary and financial stability come into conflict.

Choosing the right exchange rate regime is a traditional dilemma central banks face. Richard Webb (Central Reserve Bank of Peru) observed that there are additional complications, though, when a country has a partially dollarized economy. For Peru, the limited use of U.S. dollars for transactions and wages (currency substitution or real dollarization) coupled with the vulnerability of Peru’s open economy to external shocks suggested that a floating exchange rate would be appropriate. But with a large share of private sector liabilities denominated in U.S. dollars (financial dollarization), a large depreciation could translate into financial instability, and that implies a fixed exchange rate is best. In Peru’s case, monetary policy options are further constrained by a lack of domestic-currency-denominated financial instruments. Webb noted that Peru has been able to adopt a floating exchange rate and an explicit inflation targeting framework because its low degree of real dollarization—and thus low “pass-through” from exchange rate movements to domestic prices—allows an independent monetary policy. Alain Ize (IMF) remarked that dollarization can build in a vicious circle from currency instability to financial instability to excessive foreign exchange intervention, which can lead to more dollarization. For dollarization to be “cured,” a gradual commitment to the currency in the form of an inflation target and better prudential regulation are needed.

The challenges for monetary policy from globalized financial markets may enhance the advantages of monetary unions, but this option comes with its own set of practical difficulties, according to Gert Jan Hogeweg (European Central Bank). He laid out a list of preconditions for the success of a monetary union such as the creation of common market, harmonized legal systems, areawide large value payment systems and security settlement systems, economic convergence, fiscal consolidation, and the creation of an independent central bank with a clear monetary policy framework. In particular, the importance of the latter two conditions for the success of a monetary union was also highlighted by K. Dwight Venner (Eastern Caribbean Central Bank).

There are special challenges, too, for countries that want to use an inflation target as an anchor for monetary policy but cannot fully commit to a full-fledged inflation targeting regime. Mark Stone (IMF), in his presentation, termed this policy option “inflation targeting lite.” Countries that opt for inflation targeting lite generally aim to bring inflation down to single digits and maintain financial stability by using a relatively interventionist exchange rate policy. Their central banks may want to announce a long-term commitment to either a hard exchange rate or a full-fledged inflation target to bring forward the benefits of a single-anchor monetary regime. In his comments, Jerzy Pruski (National Bank of Poland) described inflation targeting lite as a means of buying time to make the structural reforms needed for adopting a single nominal anchor.

For a small open economy, the central banks’ role in managing both international debt and reserves provides an important element of financial stability as discussed for the case of Denmark by Hugo Frey Jensen (National Bank of Denmark). Central bank responsibility for both debt and reserve management is an efficient way to utilize scarce resources in a small country and establishes knowledge of most aspects of the financial markets within a single institution. Potential conflicts between monetary policy and public debt management are, however, mostly of concern for countries with a floating exchange rate, as was noted by Michael Reddell (Reserve Bank of New Zealand), who described New Zealand’s experience.

However, should financial stability be an explicit central bank objective on par with other objectives? Roger W. Ferguson, Jr. (Board of Governors, U.S. Federal Reserve System) noted that the U.S. central bank views its financial stability objectives primarily through the lens of its macroeconomic goals—price stability and sustainable long-run growth. Today, he said, it is more important than ever for central banks and other financial authorities to share information, coordinate crisis prevention measures, and cooperate in crisis management actions.

In Ferguson’s view, some of the more urgent central bank issues are whether a central bank should take preemptive actions to head off potential financial instability, even when such policy actions may not be fully justified by the outlook for inflation and output; how much weight to give to financial stability versus other objectives; and whether a high degree of activism could lead to higher variability of economic variables. In his comments, André Icard (Bank for International Settlements) came down on the side of more central bank activism in financial stability concerns, although he did stress the potential difficulties arising from the shorter time horizon that exists for monetary objectives than for financial objectives, as well as the risk of moral hazard.

The role of financial soundness indicators (FSIs) in crisis prevention was discussed by V. Sundararajan (IMF) and R. Sean Craig (IMF). Their paper outlined the need for an integrated framework that links three key dimensions of financial stability. First, FSIs can be used to monitor the financial system’s strengths and vulnerabilities and the risks originating in the nonfinancial sector. Second, codes and standards assessments of the supervisory framework and the financial infrastructure provide important information to assess financial sector stability. Third, the analysis of FSIs can help to highlight the key prudential risks and vulnerabilities on which the scope and themes of supervision and its assessments should focus. An example of how a central bank assesses financial stability was given by Jarle Bergo (Bank of Norway). The Bank of Norway uses FSIs for the financial and nonfinancial sectors and links them to macroeconomic models to make forecasts and perform stress tests.

Finally, Mario Blejer (Governor of the Central Bank of Argentina, January–June 2002) provided a lively, first-hand account of what transpires on the frontlines of a financial crisis. According to Blejer, the collapse of Argentina’s peso had its roots in inconsistencies between the currency board and the country’s fiscal stance. The subsequent banking crisis was largely caused by sovereign risk and by the government forcing the banks to hold government securities at below market prices.

In November 2001, Argentina imposed partial withdrawal restrictions for deposits (the corralito), abandoned the currency board, devalued the currency, and “pesoified” bank assets and liabilities at different rates. While pesoification put the central bank in a position to act as a lender-of-last resort, it had no money market or debt instruments to sterilize open market operations. Therefore, the central bank introduced short-term central bank papers in pesos and dollars. With the central bank stressing the risk differences between its instruments and those of the rest of the public sector, a demand for these papers developed, even though it was initially at very high costs for the central bank in interest rates of up to 140 percent. Meanwhile, the central bank kept up payments on its own foreign obligations and intervened in the foreign exchange market to slow the pace of depreciation and avoid chaotic conditions. By mid-June 2002, Blejer noted, the trends started to reverse. Thereafter, deposit withdrawals slowed; the need for liquidity from the central bank largely declined; central bank interest rates fell to 40–50 percent; and the central bank regained about half of the initial stock of foreign reserves. The bottom line for a central bank in crisis, Blejer said, is to persevere to the point where “greed exceeds panic”—providing investors with high-enough returns makes them forget the panic. Another account of the challenges in handling a financial crisis was given by Kyu Yung Chung (Bank of Korea), who reported on the lessons from the Korean crisis.

The conference papers are posted at the Research at the IMF website at Follow the link to IMF Seminar, Conferences, and Workshops.