Limitations of monetary policies in open developing economies: external capital inflows and sterilisation policies

This chapter revises the discussion of the views of monetary policy dominant during the 21st century, looking at how developed and developing economies were affected, specifically in Mexico. It also analyses the alternative views that have been strengthened in light of the COVID-19 crisis. I argue that central banks will continue to determine an objective rate of interest, used as a policy instrument, guided by different objectives. Following the 2008 Global Financial Crisis and the COVID-19 pandemic, short- and long-term liquidity requirements need to be considered by the central bank reaction function, which means that central banks ought to recognise the need to stabilise the “yield curve”. To pursue this objective, the monetary and fiscal authorities need to resume coordination around economic growth objectives and financial stability. This discussion is of utmost importance in emerging economies since the yield curve can be stabilised only if the long-term financial segments are strengthened (stock market and the long-term bond segments); therefore, the financial sector needs to be strengthened to pursue this objective.