Over the past two decades, many low- and lower-middle income countries (LLMICs) have improved control over fiscal policy, liberalized and deepened financial markets, and stabilized inflation at moderate levels. Monetary policy frameworks that have helped achieve these ends are being challenged by continued financial development and increased exposure to global capital markets. Many policymakers aspire to move beyond the basics of stability to implement monetary policy frameworks that better anchor inflation and promote macroeconomic stability and growth. Many of these LLMICs are thus considering and implementing improvements to their monetary policy frameworks. The recent successes of some LLMICs and the experiences of emerging and advanced economies, both early in their policy modernization process and following the global financial crisis, are valuable in identifying desirable features of such frameworks. This paper draws on those lessons to provide guidance on key elements of effective monetary policy frameworks for LLMICs.

This background paper focuses on the experiences of evolving monetary policy frameworks in nine individual countries and three thematic groupings of countries. The country case studies are complemented by analyses of common issues faced by countries in currency unions in the CFA franc zone, selected resource rich countries, and advanced economies and emerging markets during their modernization process of monetary policy regimes. Finally, the background paper also contains a discussion on the benefits of effective communication in conducting monetary policy.

We provide a multidimensional characterization of monetary policy frameworks across three pillars: Independence and Accountability, Policy and Operational Strategy, and Communications (IAPOC). We construct the IAPOC index by analyzing central banks’ laws and websites for 50 advanced economies, emerging markets, and low-income developing countries, from 2007 to 2018. Due to its scope and granularity, our index provides a holistic view of monetary policy frameworks which goes beyond existing measures of transparency or independence, as well as monetary policy or exchange rate regime classifications. Comparing the IAPOC index across countries and over time, we find that monetary policymaking is varied, fast-changing, and eclectic across the Policy and Operational Strategy and Communications pillars, especially in emerging markets and low-income developing countries.

With single-digit inflation and substantial financial deepening, developing countries are adopting more flexible and forward-looking monetary policy frameworks and ascribing a greater role to policy interest rates and inflation objectives. While some countries have adopted formal inflation targeting regimes, others have developed frameworks with greater target flexibility to accommodate changing money demand, use of policy rates to signal the monetary policy stance, and implicit inflation targets.

Monetary policy in Yemen is largely rudimentary and ad hoc in nature. The Central Bank of Yemen's (CBY) approach has been based on discretionary targeting of broad money without any clear target to anchor inflation expectations. This paper argues in favor of a new formal monetary policy framework for Yemen emphasizing a proactive and rule-based approach with a greater direct focus on price stability in the context of a flexible management of the exchange rate. Although, as in many developing countries, institutional capacity is a concern, adopting a more formal framework could impel the kind of changes that are required to strengthen the ability of the CBY in achieving low and stable rates of inflation over the medium term.

Low-income countries were hit especially hard by sharp increases in world food and fuel prices in 2007-08 and the global financial crisis that followed. In response, the International Monetary Fund scaled up its financial assistance to low-income countries and revamped its concessional lending facilities to make them more flexible in meeting the diverse needs of these countries. Creating Policy Space in Low-Income Countries during the Recent Crises assesses empirically the outcome of the IMF response, and provides insight into how IMF-supported programs in low-income countries have been adapted to the changing economic circumstances in these countries. The authors report that these programs have provided expanded policy space in the face of the global price shocks and financial crisis.

Considers possible adjustments in the design of Fund-supported programs, drawing on the experience of low-income countries that have successfully addressed the most apparent domestic macroeconomic imbalances.

This paper discusses operational issues for countries that want to reform their monetary policy frameworks. It argues that stabilizing short-term interest rates on a day-to-day basis has significant advantages, and thus that short-term interest rates, not reserve money, in most cases should be the daily operating target, including for countries relying on a money targeting policy strategy. The paper discusses how a policy formulation framework based on monetary aggregates can be combined with an operational framework that ensures more stable and predictable short-term rates to enhance policy transmission. It also discusses how to best configure an interest-rate-based operational framework when markets are underdeveloped and liqudity management capacity is weak.

This is the first comprehensive study in the context of EMDEs that covers, in one consistent framework, the evolution and global and domestic drivers of inflation, the role of expectations, exchange rate pass-through and policy implications. In addition, the report analyzes inflation and monetary policy related challenges in LICs. The report documents three major findings: In First, EMDE disinflation over the past four decades was to a significant degree a result of favorable external developments, pointing to the risk of rising EMDE inflation if global inflation were to increase. In particular, the decline in EMDE inflation has been supported by broad-based global disinflation amid rapid international trade and financial integration and the disruption caused by the global financial crisis. While domestic factors continue to be the main drivers of short-term movements in EMDE inflation, the role of global factors has risen by one-half between the 1970s and the 2000s. On average, global shocks, especially oil price swings and global demand shocks have accounted for more than one-quarter of domestic inflation variatio--and more in countries with stronger global linkages and greater reliance on commodity imports. In LICs, global food and energy price shocks accounted for another 12 percent of core inflation variatio--half more than in advanced economies and one-fifth more than in non-LIC EMDEs. Second, inflation expectations continue to be less well-anchored in EMDEs than in advanced economies, although a move to inflation targeting and better fiscal frameworks has helped strengthen monetary policy credibility. Lower monetary policy credibility and exchange rate flexibility have also been associated with higher pass-through of exchange rate shocks into domestic inflation in the event of global shocks, which have accounted for half of EMDE exchange rate variation. Third, in part because of poorly anchored inflation expectations, the transmission of global commodity price shocks to domestic LIC inflation (combined with unintended consequences of other government policies) can have material implications for poverty: the global food price spikes in 2010-11 tipped roughly 8 million people into poverty.

In recent years, many Low-Income Countries (LICs) have implemented substantial reforms to their monetary policy frameworks, but existing economic research has not provided a clear rationale to guide those efforts. In this paper we analyze the role of monetary policy frameworks in the propagation of aggregate shocks, using a large panel dataset of 79 LICs over the period 1990-2015 as well as event study analysis for a group of 28 sub-Saharan African LICs. We find highly significant differences in the propagation of external shocks between the LICs that target monetary aggregates or inflation compared to those that maintain rigid nominal exchange rates as a nominal anchor. We also find that the large surprise devaluation of the Central African Franc (CFA) in January 1994 had highly significant effects on the GDP growth of 10 CFA countries compared to 18 similar countries that were outside the CFA zone. Our empirical analysis provides strong support for the role of monetary policy frameworks in facilitating macroeconomic stability in LICs--a conclusion that is particularly relevant as LICs now face a multitude of similar shocks associated with the global COVID-19 pandemic.