Central Banking Issues in Fixed Exchange Rate Arrangements Without Capital Controls
- This course is dedicated to the central banking challenges in fixed exchange rate arrangements without capital controls. The course covers three topics:
- (i) managing systemic liquidity;
- (ii) setting up collateral frameworks as well as emergency liquidity assistance (ELA), and
- (iii) stress testing the central bank balance sheet.
While, in theory, capital flows alone could manage domestic liquidity and stabilize short-term rates at the right level, short-term rate volatility could arise in the absence of central bank intervention in the domestic market due to friction cost between the local and international money market, counterparty risk perception in the domestic market, and prudential liquidity regulations. Moreover, Central banks operating under a fixed exchange rate arrangement are exposed to exchange rate risk and negative carry trade on their assets that could be acute if domestic interest rate spread needs to widen to defend the exchange rate parity.
- The technical aspects of the course will focus on
- (i) the optimal operational set up to reduce domestic interest rate volatility, and to address bank liquidity risks effectively while protecting the central bank’s balance sheet, and
- (ii) the stress-testing of the central bank balance sheet items under adverse scenarios to pro-actively monitor and manage risks, and articulate monetary policy with financial stability.
The course gives participants the opportunity to learn and apply new tools for the purposes of calibrating open market operations and managing systemic liquidity risk, and stress testing central bank balance sheets, also incorporating the impact of the crisis. Moreover, the course allows participants to share their experiences on market operations, stress testing methodologies, and risk mitigation policies. Much of the course consists of lectures and of hands-on modules that expose participants to concrete experiences, including inputting data, designing scenarios, stress-testing the central bank balance sheets at different horizons and interpreting the results. You will then discuss how to articulate the outcome of the risk analysis with policy decision making. The concrete policy outcome could be to fine-tune the calibration open market operations and improve the structural liquidity management tools, as well as differentiating the usage of monetary policy instruments and depending on the stress scenarios.
Course Objectives:
- Manage liquidity in a way that is supportive of the exchange rate and monetary arrangements as well as market development;
- Develop collateral and emergency liquidity assistance frameworks that are robust to the constraints related to the monetary policy regime;
- Design different stress scenarios and estimate the central bank balance sheet at risk at different horizons.