Monetary and financial policies

The Washington Consensus helped forge a world view in which opening borders to capital flows was seen as an important way to increase economic efficiency. In the past decades, evidence accumulated of the shortcomings of a largely unmanaged financial system in which the volatility of capital flows was still seen as an exogenous feature of the world economy. This chapter sets the stage by discussing the characteristics of the global financial cycle (GFC) and the role of the United States Federal Reserve, to then discuss the influence of this cycle on the pass-through of domestic monetary policy to market rates for emerging markets (EMs) and advanced economies. It then sets out the implications of limited monetary policy pass-through for the validity of the trilemma in international finance. The chapter calls for the systematic use of macroprudential policy tools in advanced and EMs alike to complement credible monetary policy frameworks. It also emphasises the importance of the development of local currency bond markets. In some cases, capital controls may also be useful.