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Unconventional Policies and Capital Flows

February 8, 2013

In our view, managing exchange-rate appreciation may become a focus for these central banks. Ultimately, the effect could be a reversal of capital “safety” flows, with the implication that these flows may go to other “safe harbors,” where central banks are actively stimulating their economies through their asset markets.
-Ben Emons, senior vice president, PIMCO

Although quantitative easing has grabbed the headlines, a number of central banks around the world have enacted other extraordinary measures in attempts to manage their economies. The Swiss National Bank (SNB), for example, adopted an exchange rate peg versus the euro while increasing its foreign exchange reserves to almost 80% of Swiss GDP. Sweden’s central bank, the Riksbank, established explicit policy rate guidance more than five years ago. The Reserve Bank of New Zealand (RBNZ) has an inflation target range and has applied “flexible inflation targeting”’ for quite some time. And the Hong Kong Monetary Authority (HKMA) and the Monetary Authority of Singapore (MAS) use exchange-rate management to set monetary policy. 

Each of these central banks has its own specific mandate, yet they have something in common: Their domestic asset markets are viewed as “safe harbors.” This phenomenon intensified during the European sovereign debt crisis and continues today. With increased capital inflows came high foreign ownership in their government bond markets, excessive exchange-rate appreciation, and rising equity and property markets. As shown in Figure 1, the real estate sector in some of these countries has become “bubbly.” As a result, the central banks in these economies may have to take more unconventional measures to stem the flow of capital and prevent asset bubbles.

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