Targeting inflation in Asia and the Pacific Andrew Filardo* Hans Genberg** *Bank for International Settlements **Hong Kong Monetary Authority The views expressed are those of the authors and do not necessarily represent those of the Bank for International Settlements or the Hong Kong Monetary Authority.

2 Inflation targeting vs. targeting inflation Inflation performance in the region has been good True for inflation targeting central banks but also for others Targeting inflation is important Inflation objective can be achieved in more ways than one.

3 Agenda A review of policy objectives and strategies of central banks in Asia and the Pacific Evolution of central bank independence and other aspects of governance The inflation record in IT and non-IT economies –Inflation rates –Inflation persistence –Properties of inflation forecasts –Effects of the recent commodity price cycle Policy implications

4 Central bank policy objectives JurisdictionPolicy objective AustraliaPrice stability ChinaValue of the currency Hong Kong SARExchange rate stability IndiaPrice stability and adequate credit supply IndonesiaPrice stability and exchange rate stability JapanPrice stability South KoreaPrice stability MalaysiaPrice stability and exchange rate stability New ZealandPrice stability PhilippinesPrice stability SingaporePrice stability ThailandPrice stability

5 Inflation targeting central banks Starting yearTargeting arrangement Australia1993Target for headline CPI consumer price inflation of 2-3 per cent per annum on average over the business cycle Indonesia2000Tnflation target for 2008, 2009, and 2010 is 5±1%, 4.5±1%, and 4±1% for y-o-y CPI inflation Korea1999Target range of 3±0.5% in terms of 3-year average of annual CPI inflation New Zealand1990Target range of 1 to 3% on average, over the medium term, defined in terms of the All Groups Consumers Price Index (CPI) Philippines2002Target range of 3.5±1% (2009), 4.5±1% (2010) for the avg year-on-year change in the CPI over the calendar year. Thailand2000Target range of 0-3.5% for quarterly average of core inflation.

6 Non-IT central banks Targeting arrangement ChinaReference to money growth targets Hong KongCurrency board: target range centered on HKD 7.8 = USD 1 IndiaMultiple objectives: price stability understanding - containing the perception of inflation in the range of % so that an inflation rate of 3.0% becomes the medium term objective. JapanMedium- to long-term price stability expressed in terms of year on year rate of change in the CPI (approximately between 0 and 2%). MalaysiaMultiple indicators and instruments SingaporeAs of mid-2009, zero percent appreciation of the undisclosed S$NEER policy band

7 Improved governance structures Greater legal and political independence Greater ability to carry out independent exchange rate policy Increased ability to carry out monetary policy independently of fiscal policy Increased transparency and accountability For IT central banks: Greater emphasis on price stability as the primary objective

8 Improved governance,

9 The inflation record

10 Some more detail Inflation persistence Properties of inflation forecasts Impact of commodity price cycle

11 Inflation persistence Inflation is less persistent in IT economies –Smaller AR coefficient –Transitory shocks relatively more important

12 Changing AR(1) inflation persistence.

13 Changing IMA(1) inflation persistence The greater, the greater the proportion of the inflation variance accounted for by the transitory component.

14 Properties of inflation forecasts Use Consensus Forecasts to investigate whether: –Better central bank governance reduces the dispersion of inflation forecasts –Inflation forecasts are more homogeneous in IT economies?

15 The Kullback-Leibler divergence measure

16 Table 4 The impact of the changes in CBGI on the cross-sectional distribution of inflation forecasts in Asia-Pacific Index βθ CBIG Nobs R2R2 Overall 0.62 (5.3) 0.30 (1.2) Monetary policy independence 0.62 (5.3) 0.30 (1.2) Notes: 1) Using January sample for 1991 to 2005; 2) estimated using fixed effects and t-statistics in parentheses based on robust standard errors.

17 The impact of the adoption of inflation targeting on the cross-sectional distribution of inflation forecasts in Asia-Pacific Using January sample (1)(2)(3)(4)(5)(6)(7)(8) KL in levelsΔKL β.62 (6.8).61 (6.8).59 (6.6).57 (6.3).60 (5.2).60 (5.1).54 (3.4).53 (3.4) γ IT.21 (4.2)-.31 (-2.4)-.18 (-0.9).09 (.14).06 (.52) γ AIT.05 (3.4).10 (4.4).12 (7.8).06 (.49).02 (3.3) β IT -.12 (-1.1)-.26 (-1.0).37 (1.8).39 (1.8) β AIT.03 (.52)-.12 (-4.1)-.12 (-4.2) Nobs

18 Impact of commodity price cycle AsiaMature economies Headline Excluding food and energy

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20 Summary or empirical evidence Admirable inflation performance Difficult to document differences between explicit IT economies and non-IT economies Why? Common shocks → Common outcomes Social consensus about importance of inflation control. –Central bank objectives –Governance structures

21 Policy challenges 1 How to reconcile primary focus on inflation with increasing concern in society about other objectives? –Volatility of capital flows/sudden stops –Exchange rate misalignments –Financial stability and economic growth Policy frameworks must be such as to prevent these factors from undermining the consensus in favour of inflation control.

22 Policy challenges 2 Need as many independent instruments as you have objectives. –Impeccable logic in theory but: In some cases the trade-off between objectives may translate into a trade-off between inflation in the near term vs. inflation later What if other instruments are not used? There may still be a case for coordination. Lexicographic approach –Assumes independence between objectives –Not what central banks have been observed to do recently

23 Policy challenges 3 Practice –Expanded perspectives. Pay attention to emerging imbalances Two pillars (ECB), two perspectives (BoJ) Theory: –State-dependent preferences?, escape clauses? Work in progress

24 Forecast accuracy Forecast Accuracy = F(governance indicator, IT dummy, controls) Preliminary results: –Better governance → smaller forecast errors –IT → smaller forecast errors –Governance indicator drives out IT dummy