Transcript English title

Open-Economy Inflation Targeting
Tomáš Holub
International Macroeconomics
3 May 2016
Outline
• MP regimes – some traditional alternatives
• Inflation targeting in theory
• Performance of inflation targeting
• Inflation targeting and the recent crisis
• Summary and conclusions
Some Alternatives of MP Regimes
(with Floating ER)
Money targeting
Infl. targeting
Two pillars
Just do it
OMOs
Repo rate
Refi rate
Fed funds
Monetary
base
Money market
rates
Money market
rates
Money market
rates
Money supply
(target)
Monetary
transmission
Inflation
(goal)
Inflation
(goal+target)
Econ.
outlook
Money
supply
Inflation
(goal)
Monetary
transmission
Inflation, growth
etc. (goals)
Monetary Policy Regimes (i)
Source: IMF; Batini, et al. (2006)
• Exchange rate pegs and multiple targets still quite
numerous, but IT gaining increasing share.
Monetary Policy Regimes (ii)
Share of alternative MP regimes in the world (IMF de facto, sample of 125 countries)
100%
90%
euro area
80%
70%
pegged exchange rate
60%
50%
other
40%
30%
20%
10%
money targeting / IMF program
(often with elements of M-targeting)
Inflation targeting
0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
• IT‘s share above 20% (around 32 countries now; i.e. still
a minority in practice, but state-of-the art in theory before
the crisis).
Monetary Policy Regimes (iii)
• Inflation targeting + ECB‘s 2-pillar strategy dominate for
freely floating countries.
• But IT also most frequent for (managed) floating countries.
Advantages of Inflation Targeting
• Embodies all the modern trend in central banking:
independence, rules, transparency and accountability;
• Combines a policy rule with discretion (flexible rule);
• The target and the ultimate goal are identical;
• Does not rely on stable money demand;
• Takes into account all available information;
• A direct emphasis put on market expectations;
• Strengthens internal discipline and forecasting of CB.
Theoretical Background
Inflation
var(inflation)
F
S
Unemployment
var(output)
• Trying to reach both low inflation (primary goal – can be
controlled by MP in the long run) and optimal stabilisation
in the presence of (often unforeseen) shocks.
Closed-Economy Inflation Targeting
Phillips Curve
 t 1  Et t 1  1 yt   2 xt   t 1
Et t 1   t 
Aggregate Demand
yt 1  1 yt   2 it  Et t 1   3 xt  t 1
Loss Function

MinE t  
s t
s t
t ; 
strict
t
 2
 [ t   t ] ; 
Policy rule
flex
t
 2
 [ t   t ]  y

Et t  2   ; Et t  2    c Et t 1  
*
*
2
t
*

Policy Rule under Inflation Targeting
Strict Inflation Targeting: equate the forecast of inflation
with your target at the horizon of transmission (Svensson:
“inflation-forecast targeting”).
Current inflation
forecast
actual (1)
target
actual (2)
0
1
change in IR
change in AD, GDP, employment
2
change in inflation
• Beware: no one actually does strict inflation targeting!
Policy Rule under Inflation Targeting
Flexible Inflation Targeting: gradually return the forecast
of inflation to target, taking into account the variability
of output.
Current inflation
forecast
actual (1)
target
actual (2)
0
1
change IR
change in AD, GDP, uneployment
2
change in inflation
• In practice: setting the monetary policy horizon, choice
of targeted index, escape clauses, IR smoothing, etc.
Open-Economy Inflation Targeting
Phillips Curve
D
F


 tD1  Et tD1  1 yt   2 xt   3qt   t 1;  tCPI

1





1
t 1
t 1
Aggregate Demand
D
*
yt 1  1 yt   2 it  Et t 1   3 xt   4 qt  5 yt  t 1
Exchange Rate
*
it  it  st 1  st   t

MCI t   2 it  Et
D
t 1
 
4
Loss Function

CPI
t
 [
CPI
t
 2
 t ]
 2
vs.   [   t ]
D
t
D
t
qt
UIP and the MP Transmission
Exchange rate ( = appreciation)
unexpected IR increase
time
• An unexpected domestic IR increase should lead to a jump
appreciation, which creates expectations of future depreciation.
• In practice, the adjustment is often more gradual.
Exchange Rate Transmission
• A richer set of transmission channels with different speeds.
0
change in IR+ER
prices of imported goods
 change in inflation
0
1
change in IR+ER
prices of imported inputs
0
change in IR+ER
change in inflation
1
change in AD, GDP, employment
2
change in inflation
• The exchange rate may also be a source of shocks.
Performance of IT before the crisis
… the lessons to draw from the empirical evidence
are what might be described as
“non-negative”. The contribution of inflation
targeting to low and stable inflation among industrial
countries is weak, but it also has not had negative
effects on real activity. It does seem to have
anchored inflation expectations. For the developing
economies, inflation targeting has been associated
with lower and more stable inflation and real activity.
(Walsh, 2009)
(for more on this, see the seminar)
IT Performance in the Crisis
Rose (2013)
• Inflation targeting has proven quite durable – no one has
left it except for the euro adoption.
(ht http://faculty.haas.berkeley.edu/arose/Spill.pdf).
IT Performance in the Crisis
Rose (2013)
• Not much difference between IT and hard pegs (but better inflation
performance than the other regimes).
• See also Irineu E. de Carvalho Filho (2011) – seminar topic.
IT and the Recent Crisis
• When IT was being introduced, it was often criticised as
too tight („inflation freaks“).
• Before the crisis, some people were saying that the IT
alone is not enough, and that it might actually be too
loose, thus „blowing with the wind“
(e.g. W. White, BIS).
• After the crisis broke out, this camp was joined by many
others, but:


Was it due to IT per se?
Or was the MP too loose even by the IT standard
(failure of implementation vs. failure of regime)?
MP in Major Economies – Deviations
from the Taylor Rule
10
9
Euro area - actual rate
Euro area - Taylor rule
8
7
6
5
4
3
2
1
0
I/99
Source: IMF, WEO, April 2009.
I/00
I/01
I/02
I/03
I/04
I/05
I/06
I/07
I/08
Source: Eurostat, CNB calculations.
• The MP was quite loose even by the traditional (IT) standards.
• Response to the dot.com bubble and September 11; too much
focus on core inflation, output gap etc.?
Deviations from the Taylor Rule
and Housing Booms
Source: Ahrend, et al. (2008)
IT and the Recent Crisis (cont.)
• Now some people are actually once again suggesting that IT is
too tight, and that central banks need to „commit to
irresponsibility“ to overcome the ZLB / deflation threat.
• Price level targeting or nominal GDP level targeting have been
suggested as alternatives.
• No country has actually adopted these regimes yet (just some
temporary elements of it within the IT framework).
• Japan: has recently increased its inflation target to 2% to
overcome deflation.
IT vs. Price Level Targeting
inflation targeting
price-level targeting
110
110
108
108
106
106
104
104
102
102
100
100
6
4
2
0
-2
6
4
2
0
-2
1
2
3
period
4
target
price level and inflation after price shock
Source: Böhm, et al. (2012)
5
1
2
3
period
4
target
price level and inflation after price shock
5
Conclusions
• Inflation targeting focused on building credibility and anchoring
expectations (”constrained discretion“);
• IT has gained bigger ”market share“ among MP regimes;
• Strict vs. flexible inflation targeting (no one does the strict one);
• In open economies, the exchange rate is an important part of
the transmission mechanisms, as well as a source of shocks;
• The performance seems to be good (or at least non-negative)
so far;
• The current crisis has challenged the paradigm, but IT may
survive it – with modifications – better than most other known
alternatives (and PLT is so far a textbook debate).
Thank you
for your attention.
Some References
•
•
•
•
•
•
•
•
•
•
•
•
Benecká, S. (2011): ”International reserves and the financial crisis: monetary policy matters,“ CNB mimeo.
Benecká, S., Holub, T., Kadlčáková, N.L., and Kubicová, I. (2012): ” Does Central Bank Financial Strength Matter for Inflation?
An Empirical Analysis“ CNB WP (forthcoming).
BoC (2011): ”Renewal of the Inflation-Control Target: Background Information - November 2011“, Bank of Canada,
http://www.bankofcanada.ca/wp-content/uploads/2011/11/background_nov11.pdf.
Böhm, J., Filáček, J., Kubicová, I., and Zamazalová, R.(2012): ”Price-Level Targeting - A Real Alternative to Inflation
Targeting?“ Czech Journal of Economics and Finance, vol. 62, no. 1, pp. 2-26,
http://journal.fsv.cuni.cz/mag/article/show/id/1237.
Gonçalves, C.E.S, and Salles, J.M. (2008): ”Inflation targeting in emerging economies: What do the data say?“ Journal of
Development Economics, 85, pp. 312–318, http://www.sciencedirect.com/science/article/pii/S0304387806001283.
IMF, Batini et al. (2006): ”Inflation Targeting and the IMF“, http://www.imf.org/external/np/pp/eng/2006/031606.pdf.
Irineu E. de Carvalho Filho (2011): ”28 Months Later: How Inflation Targeters Outperformed Their Peers in the Great
Recession,” The B.E. Journal of Macroeconomics: Vol. 11: Iss. 1 (Topics), Article 22,
http://www.bepress.com/bejm/vol11/iss1/art22.
Mishkin, F. S., Schmidt-Hebbel, K. (2006): “Does Inflation Targeting Make a Difference?“ CNB WP, no. 13/2006
http://www.cnb.cz/www.cnb.cz/en/research/research_publications/cnb_wp/2006/cnbwp_2006_13.html.
Svensson, L. E. O. (1999a): “Inflation Targeting as a Monetary Policy Rule,” Journal of Monetary Economics, 43, pp. 607–654.
Svensson, L. E. O. (1999b): “Price Level Targeting vs. Inflation Targeting: A Free Lunch?” Journal of Money, Credit and
Banking, no. 31, pp. 277–295.
Svensson, L. E. O. (2000): “Open-Economy Inflation Targeting”. London, CEPR Discussion Paper, no. 1989 (October).
Walsh, C.E. (2009): ”Inflation targeting: What have we learned?“ The John Kuszczak Memorial Lecture, prepared for
"International Experience with the Conduct of Monetary Policy under Inflation Targeting," Bank of Canada, July 22-23, 2008,
http://people.ucsc.edu/~walshc/MyPapers/Kuszczak_Lecture_20090131.pdf.