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Inflation Targeting at 20: Achievements and Challenges By Scott Roger IMF Prepared for the 6 th Norges Bank Monetary Policy Conference Oslo, 11-12 June.

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Presentation on theme: "Inflation Targeting at 20: Achievements and Challenges By Scott Roger IMF Prepared for the 6 th Norges Bank Monetary Policy Conference Oslo, 11-12 June."— Presentation transcript:

1 Inflation Targeting at 20: Achievements and Challenges By Scott Roger IMF Prepared for the 6 th Norges Bank Monetary Policy Conference Oslo, June 2009

2 Overview Since start of IT in 1989, 29 countries adopting IT. Currently 26 IT countries of which 11 high income and 15 emerging market and developing countries Topics: IT frameworks Macroeconomic performance under IT Issues and challenges facing IT

3 Inflation Targeting Frameworks Main elements: Policy mandates Policy accountability Inflation targets Policy formulation

4 Inflation Targeting Frameworks Policy mandates Instrument autonomy, not goal autonomy Target specification usually set jointly or by central bank Accountability Corollary of instrument autonomy, but also reinforces it Standard mechanisms for providing accountability Increasingly forward-looking approach—emphasis on transparency of policy process and decision making

5 Inflation Targeting Frameworks Target specifications CPI 12 month rate as target Range or point target with bands Centered on 2 to 3 percent Bands typically +/- 1 percentage point; ranges 2 percentage points Target horizons 1 to 2 years Monitoring & reporting of a range of core inflation measures: CPI ex; trimmed means; median

6 Inflation Targeting Frameworks Policy formulation Flexible IT Forecast-based, but significant differences in capability; Standard New Keynesian models Differences in treatment of exchange rate Differences in implementation/operational frameworks— preference for market-based over rules-based instruments, but some countries actively using both.

7 Performance under IT Focus on three aspects of performance: Performance in achieving inflation targets Macroeconomic performance compared with alternative frameworks Resilience of framework in face of global commodity price and financial shocks

8 1. Performance in achieving inflation targets During disinflation: For high income countries, average outcome close to target, but target range missed 60% of time; For low income countries, average outcome 2.3% above target, target range missed 67% of time; Inflation outcomes during disinflation

9 1. Performance in achieving inflation targets During stable inflation: For high income countries, average outcome a little above target above target; miss target range 47% of the time For low income countries, average outcome a little above target; miss target ranges 36% of time Inflation outcomes during stable inflation

10 1. Performance in achieving inflation targets Assessment: Misses of target ranges very common—may undermine usefulness of ranges Harder to control inflation during disinflation Countries with weaker conditions may be too ambitious on pace of disinflation Countries might use wider bands during disinflation (+/- 2 to 2.5), narrowing during stable IT (+/ to 1.5) Supply shocks an important factor in misses by low income countries

11 2. Performance of IT compared to alternative frameworks vs based on median adoption of IT in low income countries Low income IT improvement greater than non-IT: growth gain of 0.7%; inflation down 5.8% High income IT: inflation unchanged, small growth gain Inflation and growth rates: vs

12 2. Performance of IT compared to alternative frameworks Low income IT experienced bigger declines in both inflation & growth than non-IT countries High income IT experienced smaller reductions in both inflation & output volatility Inflation and growth volatility vs

13 1. Performance in achieving inflation targets During stable inflation: For high income countries, average outcome a little above target above target; miss target range 47% of the time For low income countries, average outcome a little above target; miss target ranges 36% of time Inflation outcomes during stable inflation

14 2. Performance of IT compared to alternative frameworks Econometric analyses based on differences in differences, controlling for external factors: IMF (2005), Mishkin & Schmidt-Hebbel (2005); Vega & Winkelried (2005) Differences mainly in terms of selection of comparators Findings: IT associated with significant reduction in inflation and inflation volatility relative to non-IT, at least for non-industrial countries No trade-off of inflation or inflation volatility vs. output: shift of efficiency frontier, not a movement along it

15 3. Resilience to global commodity price and financial shocks Commodity price shock: Low income IT countries experienced less increase in inflation than in non-IT countries (2.3% vs. 4.7), but only slightly bigger fall in growth (-1.6% vs. -1.3%) High income IT have lower inflation rise (1.9%) but bigger growth decline (-2.8%) Need to disentangle from financial crisis & other factors Inflation and growth rates,

16 3. Resilience to global commodity price and financial shocks Financial shock: Several IT countries amongst hardest hit by crisis (Iceland, CEE countries), but not clear that IT made economies more vulnerable, or effects worse Deterioration in CDS spreads less for IT emerging markets, suggesting markets see less risk of crisis in these countries CDS spreads,

17 3. Resilience to global commodity price and financial shocks Consensus forecasts vs averages: Growth expected to fall less in low income IT countries than in non-IT (-3.7% vs. -4.8%), and inflation to fall by slightly more (-2% vs. -1.7%) Growth in high income IT countries expected to fall by 3.4%, and inflation by 1%, relative relative to averages Growth and inflation: forecasts vs performance

18 Issues & Challenges Conditions for IT Adapting IT to emerging market and developing countries Role of the exchange rate in IT IT and financial stability Price path targeting

19 Issues & Challenges Conditions for IT & adapting IT to emerging markets & developing countries Conditions fewer, but significant challenges: Fiscal dominance Weak credibility Dollarization Data weaknesses Limited human capital Limited financial market development Communications issues Cultural issues

20 Issues & Challenges Role of the exchange rate in IT Important issue in emerging markets & developing countries Conventional wisdom: exchange rate should not be a target in its own right because: Exchange rate taken into account indirectly through effects on inflation & output Appropriate response to exchange rate movements depends on cause, so policy should avoid automatic responses

21 Issues & Challenges More recent analysis more equivocal: With high dollarization, limited access to international capital markets, exchange rate can have perverse balance sheet effects which may justify leaning against the wind (Cespedes & others (2004), Moron & Winkelried (2005), Roger & others (2009)) Policy rule including exchange rate may be more robust to incorrect specification of model of exchange rate determination (Wolmershauser (2006)

22 Issues & Challenges IT and financial stability Mixed views on benefits of reacting directly to financial indicators: Arguments analogous to including exchange rate in policy reaction function—react indirectly to implications for output & inflation But most models do not adequately capture macro-financial interaction Extending policy horizon: How good are forecasts? Overburdening monetary policy: Should we focus on other policy instruments?

23 Takk!

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