Monetary Policy Divergence in Advanced Economies: Implications for Lesotho

Occasional Analytical Note May 2019 Monetary Policy Divergence in Advanced Economies: Implications for Lesotho By: Moeti Damane Senior Economist Department of Research Central Bank of Lesotho Outline 1. Introduction 2. Monetary Policy Landscape in Advanced Economies from 2015 to 2018 3. Implications of Advanced Economy Monetary Policy Divergence on Lesotho 4. Conclusion 5. References The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the Central Bank of Lesotho (CBL). 1. Introduction UMPs involved the introduction of concepts such In the immediate aftermath of the Great Financial as quantitative easing (QE) in conjunction with Crisis of 2007-8, the global economic environment what came to be known as negative interest rate was plagued with high levels of uncertainty and policies (NIRPs). Owing to the fact that most of the substantial downward revision of medium- the world’s economies were facing downturns term economic growth prospects in advanced during this time, the global monetary policy economies. Conventionally, given such periods landscape was generally synchronised and widely of economic downturn, a bank would employ understood to be accommodative. This was expansionary monetary policy to increase the certainly the case, up until September 2014 when supply of money into the economy and thus the FED Federal Open Market Committee (FOMC) stimulate investment and consumer spending. published its policy normalisation principles and For instance, in the United States (US), the plans. Federal Reserve System (FED) when faced with an economic slowdown would traditionally adopt The aim of this article is to provide an overview an accommodative monetary policy stance that of the monetary policy divergence in advanced involves three things; (i) lowering of the federal economies from 2015 to date and discuss its discount rate , (ii) lowering the level of reserve implications for Lesotho, a small open market requirements and (iii) the purchase of securities economy with a fixed exchange rate regime. The through open market operations. These measures rest of the paper is organised as follows; Section lead to declines in money market interest rates 2 explores the monetary policy landscape in such as commercial bank lending rates which in advanced economies from 2015 to 2018. Section turn encourage investment spending by firms; 3 presents implications of monetary policy labour market tightening, and a rise in aggregate divergence on Lesotho. Section 4 concludes. demand. However, following the 2007-8 financial crisis, a number of central banks, especially 2. Monetary Policy Landscape in those from advanced economies such as the US, Advanced Economies from 2015 had policy rates that were close to what was to 2018 historically considered as the zero lower bound In September 2014, the FED FOMC mulled over (ZLB). This meant that the effectiveness and ways to normalize its monetary policy stance indeed the feasibility of orthodox expansionary together with its securities holdings given QE. monetary policies would have to be reassessed. The deliberations resulted in the publication of the FED policy normalisation principles and Mindful of the challenge of monetary policy plans in the same month. Subsequent to that, in effectiveness given the ZLB, central banks from December 2015, the FED raised the federal funds advanced economies resorted to making use rate for the first time in nine years. of unconventional monetary policies (UMPs) to breathe life into their ailing economies. These 1 In the broadest sense, the aftereffects of severe financial crises share three characteristics. First, the asset market collapses. Second, the level of output declines .... while the level of unemployment increases. Third, the real value of government debt increases dramatically. 2 The FED is the central bank of the US. 3 The discount rate is the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve .....Bank’s lending facility--the discount window. 4 These are the amount of funds that a depository institution must hold in reserve against specified deposit liabilities. 5 This is the rate that is used by a central bank to implement or signal its monetary policy stance. 6 Quantitative easing or as it is sometimes called; large-scale asset purchases, is an expansionary monetary policy whereby a central bank attempts to .....stimulate the economy and increase liquidity through purchases of predetermined amounts of government bonds or other financial assets. 1 This move signalled two things; (i) a move away from developed countries) from the so called ultra-low (nearly 0%) interest rates that had taken synchronised and loose global monetary root since the 2007/08 financial crisis period, and (ii) policy stance that had been prevailing. Figure the clear departure or divergence of the US (among 1 offers an illustration of these two points. Figure 1: Global Central Bank Monetary Policy Landscape – 2015 vs 2016 conventional unconventional 2016 USA Mexico 2015 United Kingdom Tightening South Africa Tightening Brazil Brazil South Africa USA Mexico United Kingdom Canada Canada Australia Australia Switzerland Policy Stance India India Switzerland Russia Russia China Japan England Japan Easing Easing Euroland China conventional unconventional policy tools Source: Allianz Global Investors with the US maintaining a normalisation path while also taking steps towards unwinding From Figure 1, 2016 can also be characterised as the size of its balance sheet. The balance having exhibited divergence in monetary policy sheet taper signalled the start of the FED’s among developed countries. The difference gradual reversal of QE, leaving behind the likes this time around was that the US was joined of the BoJ and the ECB. At the time of this by the United Kingdom (UK), through the Bank article (March 2019), the FED raised rates to of England’s (BoE’s), normalisation path. This between 2.25% and 2.5% in their December meant leaving behind the likes of the European 2018 meeting. During the same time, the ECB Central Bank (ECB), the Bank of Japan (BoJ) announced that they would not be continuing and the Swiss National Bank (SNB) to name a with QE into 2019 . However, unlike the FED, few. It is worth noting that in 2016 both the the ECB does not expect to raise rates until FED and the BoE did not start scaling back their the summer of 2019. In the meantime, the BoJ asset purchase programmes. This continued to has maintained an unchanged accommodative render them in unconventional monetary policy monetary policy stance, one characterised by territory despite gradual normalisation of the LSAP and negative interest rates. policy rate. The global monetary policy landscape among advanced economies remained broadly unchanged and asynchronised throughout 2017 7 The FED funds rate target range was increased from 0 – 0.25% to 0.25 – 0.5%. 2 3. Implications of Advanced Economy Monetary Policy Divergence on Lesotho The transmission of monetary policy decisions the Republic of South Africa. To fully appreciate from advanced economies to other countries the indirect impact of changes in the monetary is usually through two broad channels; the policy stance of developed economies such price channel and the quantity channel (the as the US on Lesotho, it is important to briefly capital flows channel). In the case of Lesotho discuss Lesotho’s monetary policy regime. Table 1 (a small open economy that operates under a presents the monetary policy regime, operational fixed exchange rate regime), monetary policy target, intermediate target, ultimate target and developments in advanced economies are monetary policy instruments of the Central Bank transmitted to it indirectly via their influence on of Lesotho (CBL). Table 1: The Monetary Policy of the Central Bank of Lesotho Monetary Operational Intermediate Ultimate Target Monetary Policy Policy Regime Target Target Instruments Exchange rate Monetary Base One to One Price Stability • Open Market targeting (fixed parity (loti- Operations (Sale exchange rate rand) ensured and Repo of regime; maintain by keeping a Tbills) a 1 to 1 peg with minimum level of • Standing facility the South African net international (intraday loan Rand) reserves (NIR) facility, Lombard facility) • Minimum Reserves Requirement. The CBL follows a fixed exchange rate monetary country’s close relationship with South Africa. policy regime where the ultimate objective of price stability is achieved by influencing the operational As an example, loose monetary policy from the FED, target and maintaining a level of net international ECB and BoJ at the end of 2008 as characterised reserves (NIR) that supports the parity between by very low rates (close to / beyond the ZLB) and the Lesotho Loti and the South African Rand (ZAR). Large Scale Asset Purchase (LSAP) programmes / The exchange rate parity between the Loti and the QE were transmitted to South Africa through the Rand is crucial for Lesotho’s price stability since the price and quantity channels. bulk of Lesotho’s inflation is imported from South Africa. Monetary policy decisions from advanced economies affect Lesotho indirectly through the 8 The ECB intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase proramme (APP) for ....an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable ....liquidity conditions and an ample degree of monetary accommodation. 9 The price channel acts a transmission channel through any or all of following three ways; policy interest rate setting among central banks, global bond markets, ....and currency depreciation or appreciation. 3 Starting from a couple of years before the crisis, thus an appreciation of the ZAR against the dollar. net capital flows into South Africa as a percentage Consequently, this also meant an appreciation of GDP increased to 4.9 per cent in 2005 and in Lesotho’s Loti against the US dollar.

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