Transcript IT will not work in EM

Challenges for Inflation Targeting in EM
in View of the Current Global Crisis
by
Leonardo Leiderman
Berglas School of Economics, Tel-Aviv University, Israel
([email protected])
To be presented at the National Bank of Georgia’s international
conference, Tbilisi, June 26-27, 2009
Initial concerns about using IT in EM…
Once upon a time it was argued that:
• “IT will not work in EM”
• “There is a very high pass-through from
exchange rates to prices”
• “To stabilize inflation it is essential to
have a nominal exchange-rate anchor”
• “EM lack monetary policy credibility and
transparency”
• “De facto, central banks will not have
operational independence”
• “EM inflation dynamics will be mainly
governed by fiscal dominance and not by
monetary policy”
Yet, it is common to find EM where…
• IT is being used as the monetary policy
framework for reducing and stabilizing
inflation
• The nominal exchange rate has become
flexible
• Fiscal discipline has been tightened
• Monetary policy has gained credibility
• Fiscal and monetary policy have become
more transparent
• No immediate changes in this monetary
regime (i.e., IT) are being contemplated
Brazil as a case where inflation targets
are highly credible
Source: Banco Central Do Brasil
Israel: strong IT credibility in spite of frequent deviations of
inflation from target
8%
Inflation rate – year over year
12-month ahead break-even
inflation
6%
4%
2%
0%
-2%
-4%
1.02
1.03
1.04
1.05
Sources: Bank of Israel and Central Bureau of Statistics
1.06
1.07
1.08
1.09
Some ‘good news’ for EM in the
context of the current global crisis
• EM are playing a stabilizing role for
the global economy
• No major crises or imbalances in
most EM; decoupling…
• Good functioning of FX markets
• Substantial gains in EM stock and
bond markets YTD
• Inflation has remained under control
EM Growth is Expected to Lead the Global Recovery
GDP growth rates – The figures for 2009/10 are IMF
forecasts
8.3%
Emerging Economies
World
Advanced Economies
8%
6%
5.2%
4.0%
4%
2.7%
1.9%
1.6%
2%
0.0%
0%
-1.3%
-2%
-4%
2007
Sources: IMF
-3.8%
2009F
2010F
Single-digit inflation rates in EM: here to stay?
Testing time ahead for monetary policy
9%
7.9%
8%
7%
6%
5.9%
5.7%
4.7%
5%
4%
3%
2%
1%
0%
2003-2006
Source: IMF
2007-2008
2009F
2010F
Weaker fiscal discipline ahead:
EM budget deficits as percent of GDP
5.0%
4.4%
4.0%
3.6%
3.0%
2.0%
1.0%
0.9%
0.0%
-0.1%
-1.0%
2003-2006
Source: IMF
2007-2008
2009F
2010F
The nominal exchange rate as a shock absorber: currency
depreciation since the Lehman event of Sept. 15, 2008…
% nominal exchange rate depreciation up to June 19, 2009 (LTD) and up to mid March (LTMAX)
43%
44%
39%
40%
LTMAX
LTD
30%
24%
26%
25%
19%
20%
10%
11%
10%
2%
0%
Turkey
Sources: Bloomberg
Mexico
Brazil
Israel
Colombia
…points to regime change in terms of a key
monetary policy tradeoff
Exchange
Rate
Variability
B
Now: Rely on ER
flexibility
Before the current crisis:
fear of floating
A
Interest Rate Variability
Major difficulties and challenges ahead
• The return of fiscal dominance?
• A larger role for central banks as lenders of last
resort?
• How to deal with growing risks of corporate debt
defaults?
• Is there room for quantitative easing as a policy
instrument?
• A larger role of asset prices in setting the policy rate?
• How to deal with commodity-price fluctuations?
• Weak growth but higher inflation: back to the Phillips
curve dilemmas?
In summary: the next few years will be a severe
testing time for inflation targeting not only in
emerging-market economies
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