Fiscal Policy, Public Debt and Monetary Policy in EMEs: An Overview

Abstract

During the 1980s and 1990s, the vulnerability of EMEs to shocks was often exacerbated by high fiscal deficits, underdeveloped domestic bond markets, and large currency and maturity mismatches. In many cases fiscal and monetary responses were procyclical. Debt management policy played very little part in either the choice of an optimal debt maturity or in stabilising the economy.

Since the beginning of 2000s, however, the role of fiscal and monetary policy has started to become more active. Fiscal deficits and public debt levels in EMEs as a whole have declined substantially. Domestic financing has increased, and the share of foreign currency debt has fallen dramatically. And the average public debt maturity has lengthened significantly. What do these developments mean for monetary policy, particularly in the context of the recent global financial crisis? Has the threat of fiscal dominance in EMEs lessened, just when it has grown in the advanced economies (BIS (2012))? Have fiscal and monetary policies in EMEs become more countercyclical than in the past? Has the development of domestic bond markets helped? What role have central banks played in debt management and what are the implications for monetary policy?

These questions were the focus of discussion at the 17th Annual Meeting of Deputy Governors from major EMEs held at the BIS in Basel on 16–17 February 2012. The meeting addressed three issues: (i) the fiscal constraints on monetary policy; (ii) the impact of local currency bond markets on central bank policies; and (iii) the role of central banks in public debt management. The current volume brings together the papers prepared by the BIS staff for the meeting as well as the contributions of central banks.

One major finding emerging from the meeting was that improved fiscal positions helped many EMEs to rely on countercyclical fiscal and monetary policies to stabilise their economies during the recent global financial crisis. Anchoring medium-term fiscal expectations was crucial, but it was not by itself sufficient to insulate the economy from the shock. Greater access to domestic financing and the consequent reduction of currency mismatches, enabled by the domestic currency bond market, played an important role.

Yet these conclusions came with a number of caveats. Although fiscal dominance has fallen in many EMEs, contingent liabilities and the costs of ageing populations pose serious medium- to long-term fiscal risks to many EMEs. In addition, although government debt levels have moderated, the volume of securities issued by central banks has expanded substantially, largely reflecting interventions in the foreign exchange market. Not only is the combined gross debt of the official sector (the government and the central bank) now large in many countries, but a considerable part of this debt consists of short-term securities, which are not characteristically very different from monetary financing. The implications of these balance sheet developments for price and financial stability require careful monitoring.

The rest of this overview summarises the key points from the discussion and the background papers along the three organising themes of the meeting.

Full publication: Fiscal policy, Public Debt and Monetary Policy in Emerging Market Economies