Transcript The Future Direction of Monetary Policy Making in Small Open

The Future Direction of
Monetary Policy Making in
Small Open Economies:
The Case of Mauritius
Jeffrey Frankel
Harpel Professor
Harvard University
Fashions in international currency policy
1980-82: Monetarism (target the money supply)
1984-1997: Fixed exchange rates
(incl. currency boards)
1997-2001: The corners hypothesis
2002-2007: Inflation targeting (& currency
float)
– became the new conventional wisdom
Among academic economists
At the IMF
Among central bankers
Problems with the conventional
wisdom (floating)
Most who say they float don’t
– “Fear of floating” (Calvo & Reinhart)
– For example, the many central banks
experiencing upward pressure on their
currencies 2003-2008,
particularly Asians and commodity exporters,
intervened consistently in the same direction:
adding to reserves, to dampen appreciation.
Problems with the conventional
wisdom (Inflation Targeting)
Huge price shocks of 2008: worldwide spike in
prices of oil & other mineral & farm products
The price index chosen in IT is always the CPI
– For small countries that suffer from terms of trade
shocks, it would be better to target the PPI
When the $ oil import price rises, CPI targeting says to contract
M so much that % appreciation = % increase in $ oil price.
– Only then will rupee price (and so CPI) be unchanged.
– But proper response to adverse terms of hrade is depreciation.
When sugar export price falls, only PPI targeting (or Nominal
Income Targeting, or Peg the Export Price) says to expand
sufficiently that currency depreciates, which is needed.
Is Inflation Targeting Dead?
IT evaluated in light of recent crisis
Inflation targeting explicitly missed the
relevance of the run-up in asset prices
– securities & housing
– E.g. Borio, Goodhart…
Unexpectedly, the crisis has offered a bit of support for the
ECB’s “two pillar strategy,” i.e., continuing to pay attention to
monetary aggregates
– As compared to interest rates, broad aggregates, expecially credit,
seen to be
an indicator of coming troubles (“excessive credit creation)
Indicative of credit channel, which may be now more useful than I rates.
The Case of Mauritius: Some questions
Why has inflation remained persistently high?
– Most other countries have brought theirs down.
Even many with economic performance inferior to Mauritius.
Is it the lack of a nominal anchor
– whether exchange rate, inflation target or other?
– or is it collective setting of wage policy (“corporatist model”)?
If so, will it soon be time to commit to enhanced price stability
As part of a package that includes an agreement with labor
– to slow the rate of growth of nominal wages at the same time?
– Or else to move to a more market-oriented wage-setting policies?
“On the Mauritius rupee”
What is the exchange rate regime?
Peg usually makes sense for a small open country.
– Probably a basket peg, in the case of Mauritius
given trade patterns that are diversified across trading partners.
Most basket pegs keep the weights secret,
because they don’t in truth want to be bound by the equation.
But if the managed float is to continue, the popular
candidate for nominal anchor is inflation targeting.
I recommend targeting the PPI or GDP deflator, rather
than the standard CPI, or else nominal GDP, because
these alternatives, though novel, are more robust with
respect to terms of trade shocks & other supply shocks.
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