Transcript Devalvācijas efekts uz ārējo tirdzniecību un tekošo kontu

Advantage of Fixed Exchange
Rate Regime in Latvia
Konstantins Benkovskis
Head of Monetary Research and
Forecasting Division
Bank of Latvia monetary policy
• Final goal is to maintain the stability of prices
• Intermediate goal is fixed exchange rate of lat:
– From 1994 to 2004 lat was fixed to SDR currency basket:
0.7997 LVL = 1 SDR
– Allowed fluctuations of lat were +/-1%
• In January 2005 Latvia entered Exchange Rate
Mechanism II (ERM II)
– Lat is fixed to euro:
0.702804 LVL = 1 EUR
– Although required band was +/-15%, Latvia keeps a
narrower corridor of +/-1%
Reasoning for the fixed exchange rate
regime in Latvia
• Latvia is an extremely small and open economy
• Fixed exchange rate regime provides a clear nominal
anchor
• Changes in regime will lead to a loss in Central Bank
credibility
• Latvian business cycles are converging towards euro
area business cycles
• Exchange rate stability stimulates exports
• Foreign debt is mostly denominated in euros
• Inflation expectations in Latvia are adaptive
Latvia is an extremely small and open
economy
• Latvia’s economy is:
– Small (2.3 millions of inhabitants, nominal GDP in 2008
was 23.1 billion EUR)
– Open (ratio of exports and imports of goods and services to
GDP in 2008 was 97%)
• As a result, there is a high pass-through of exchange
rate fluctuations to domestic prices
• The best way to stabilize prices is to fix exchange
rate!
High exchange rate pass-through to prices
Response to exchange rate shock
(1% depreciation of national currency)
Deviations from baseline, %
1.4
1.2
1
CPI
GDP deflator
Exports deflator
Imports deflator
0.8
0.6
0.4
0.2
0
Year 1
Year 2
Year 3
Year 4
Year 5
Source: K.Benkovskis, D.Stikuts “Latvia’s Macroeconomic Model”, Bank of
Latvia, 2-2006
Fixed exchange rate regime and
credibility issue
• Fixed exchange rate regime provides a clear nominal
anchor:
0.702804 LVL = 1 EUR
• The stability of the exchange rate for almost 15 years
increase the credibility of the Bank of Latvia
• Changes in monetary policy regime will immediately
lead to a loss in the credibility of the Bank of Latvia
Latvian business cycles are converging
towards euro area business cycles
• According to the Optimal
Currency Area (OCA)
theory, country can join
currency zone (or imply
fixed exchange rate), if
business cycles are
sufficiently correlated
• The correlation between
Latvia’s and euro area’s
business cycle is increasing
Correlation between Latvia’s GDP growth
and the common factor for real GDP
growth in the euro area
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0.0
I III I III I III I III I III
2007
2006
2005
2004
2003
Source: A.Melihovs, A.Zasova “The Baltic States and Europe: Common Factors
of Economic Activity”, Bank of Latvia, 3-2008
Exchange rate stability stimulates exports
• More than a half of Latvia’s exports is going to euro
area or countries, which fixed their exchange rate to
euro (57.2% in 2008).
• Exports is negatively influenced by the volatility of
bilateral exchange rate
– Exchange rate volatility increase by 1% decreases exports
by 0.08%.
• Fixed exchange rate of lats to euro stimulates Latvia’s
exports
Source: M.Bitans, E.Kauzens “Impact of the Euro Adoption on the Economy of
Latvia”, Bank of Latvia, 2-2004
External debt is mostly denominated in
euros
External debt of Latvia
Long-term external debt of Latvia
25
16
Other sectors
10
Public sector in
foreign currency
5
Banks in foreign
currency
2008
2007
0
Other
10
LVL
8
XDR
6
USD
4
EUR
2
0
2008
15
billions of lats
Banks in lats
12
2007
20
billions of lats
14
Public sector in
lats
Effectiveness of monetary policy is
constrained by the high degree of loans in
euro
Currency composition of domestic credit to private sector (millions of lats)
15000
12000
9000
6000
3000
0
I
III
2007
LVL
V
VII
IX
XI
I
III
2008
EUR
V
VII
IX
XI
I
III
2009
Other currencies
Inflation expectations in Latvia are
adaptive
Perceived inflation
Inflation expectations
Source: K.Benkovskis, D.Paula “Inflation Expectations in Latvia: Consumer
Survey Based Results”, Bank of Latvia, 1-2007
2009
2008
2007
2006
2005
2004
• Adaptive expectations make
it harder to target inflation,
as larger changes in interest
rate are needed
2003
– Expectations for the next 12
months are to a large extent
driven by perceived inflation
in the current period
18
16
14
12
10
8
6
4
2
0
-2
2002
• According to research of the
Bank of Latvia, inflation
expectations are adaptive
Households’ perceptions and
expectations of inflation
Evidence from the small open economy
DSGE model for Latvia
• One way to compare two different exchange rate
regimes is to estimate a Dynamic Stochastic General
Equilibrium (DSGE) model
• Short model description:
– Small economy and world economy, modelled as a
continuum of small economies
– Representative household, maximizing consumption and
leisure
– Firms maximize their profits, reoptimising their price
(Calvo price setting mechanism)
– Monetary policy is defined by an interest rate rule
Source: V.Ajevskis, K.Vitola “Advantages of fixed exchange rate regime from
general equilibrium scope”, Bank of Latvia, mimeo
Interest rate rule describes monetary
policy in the model
• Interest rate rule:
– Central Bank’s monetary policy adjusts for movements in
inflation, output and nominal exchange rate
– For the case of fixed exchange rate Ψ3 will be high, while
Ψ1 and Ψ2 will be low
– For the case of inflation targeting Ψ1 will be higher, while
Ψ2 and Ψ3 will be lower
rt   R rt 1  1   R  1 t   2 yt   3et 
Policy rate
Inflation
Output
Exchange
rate
Estimated coefficients of the small open
economy DSGE model for Latvia
• Model coefficients are estimated for Latvia
using Bayesian technique
• Most important parameters:
– Openness ratio (α): 0.665
– Phillips-curve parameter (λ): 1.6
– Interest rate rule for fixed exchange rate regime:
• Sensitivity to inflation (Ψ1): 1.26
• Sensitivity to output (Ψ2): 0.03
• Sensitivity to exchange rate (Ψ3): 44.8
Fixed exchange rate Vs flexible exchange
rate
What if we change fixed exchange rate regime for a
flexible exchange rate with additional concern about
inflation and output?
Fixed exchange rate
Flexible exchange rate
Ψ1=1.26, Ψ2=0.03, Ψ3=44.8
Ψ1=2.5, Ψ2=0.6, Ψ3=0.6
Volatility of
exchange rate
0.336
3.321
Volatility of
output
4.917
5.179
Volatility of
inflation
4.652
12.249
Fixed exchange rate Vs flexible exchange
rate
• Small open economy DSGE model results:
– According to estimations, fixed exchange rate
regime provides the smallest inflation volatility in
Latvia
– Switch to a flexible exchange rate with more
concern about inflation (inflation targeting) would
increase exchange rate volatility and also inflation
volatility
THANK YOU!