One Year of Inflation Targeting in Brazil Marvin Goodfriend Federal Reserve Bank of Richmond Central Bank of Brazil Rio de Janeiro July 10-11, 2000

2 Key Aspects of Inflation Targeting put price stability first announce numerical targets full information to set instrument transparency to support credibility accountability to discipline central bank challenges for Brazil

3 Put Price Stability First communicate rationale: experience, theory mandate priority for inflation goal CB responsible for price stability CB independence: financial, instrument implicit support from other institutions and policies

4 Announce Numerical Targets explicit commitment burden on CB to explain misses anchor expectations focus discussion of macroeconomic policies foundation for quantitative monetary policy analysis

5 Full Information To Set Instrument use all information to forecast future inflation pressures and to position interest rate policy improve quantitative econometric modeling techniques recognize estimation, simulation complications due to short regime history, imperfect credibility rely on market sentiment, indicators of inflation expectations

6 Transparency to Support Credibility use transparency to develop credibility convey comprehensive assessment of inflation pressures -- relate fiscal, monetary, exchange rate developments use Inflation Report to present coherent, unified view of short- run policy situation provide assessment of data provide quantitative understanding of policy speak out if fiscal, exchange rate, trade, banking policies conflict with inflation target central bank governor should act as go-between: enhance communication between markets and policymakers

7 Accountability to Discipline Central Bank disciplines CB reinforces CB responsibility for inflation gives CB opportunity to demand that fiscal, trade, credit policies conform to inflation target gives CB opportunity to point out costs of policies in conflict with inflation target

8 Challenges for Inflation Targeting in Brazil CB has responsibility without full authority for price stability fiscal policy, exchange rate policy must be made to conform to inflation target inflation targeting procedures provide window of opportunity to change institutional behavior

9 Challenges for Inflation Targeting in Brazil improve understanding of Brazilian laws, institutions, data, and fiscal, trade, banking policies to enhance credibility and reduce Brazil’s premium in capital markets fiscal dominance must be overcome for inflation targeting to succeed--provide a quantitative frame- work in the Inflation Report for understanding the relationship between fiscal policy, inflation targeting, interest rate policy, and economic growth

10 Challenges for Inflation Targeting in Brazil transparency, credibility of inflation target enhanced by outspoken, independent CB governor openly critical of economic policies that jeopardize inflation target Market concern that exchange rate policy could conflict with price stability could hurt credibility for the inflation target. What is policy behind CB acquisition and sales of foreign reserves?

11 Challenges for Inflation Targeting in Brazil create understanding of reasons for adjustment of flexible exchange rate (terms of trade shock, foreign growth, change of interest differential) bring down high bank reserve requirements and maintain strong supervision and regulation of banks

12 Challenges for Inflation Targeting in Brazil lengthen the maturity of the public debt explain principles behind managed price policy although widely used around the world, inflation targeting framework not yet tested by generally rising inflation