Monetary Policy in the Post-Crisis Period

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1 Monetary Policy in the Post-Crisis Period A. Hakan Kara Research and Monetary Policy Department EAF Conference October 10, 2011

2 Contents I. Changing View of Central Banking II. Capital Flows to Emerging Markets III. Reflections on the Turkish Economy IV. Policy Measures and Outcomes 2

3 Emerging consensus after the global crisis More emphasis on financial stability, especially from a systemic risk and macro perspective Monetary policy should not ignore financial cycles and asset price booms. 3

4 Changing view of central banking Before crisis: single objective (price stability) single instrument (short term policy rate) After Crisis: multiple objectives (price stability, financial stability), multiple instruments (credit, liquidity and interest rate policy) Question: What does this imply for Emerging Market (EM) policy frameworks? 4

5 Post Crisis Dynamics, Global Imbalances, and Factors Driving Capital Flows to EMs 5

6 Growth Differentials GDP Growth Rates (YoY, per cent) 10 Advanced countries Developing countries Source: Bloomberg, CBRT calculations. 6

7 Inflation Differentials 6 Advanced countries Core Inflation (YoY, per cent) Developing countries Source: Bloomberg, CBRT calculations. 7

8 Policy Rates Policy Rates (per cent) 12 Advanced countries Developing countries Source: Bloomberg, CBRT calculations. 8

9 Quantitative Easing Central Bank Balance Sheets ECB (billion euro) FED (billion USD) Source: ECB, FED. 9

10 Relative Riskiness Implied by Credit Ratings Source: IIF 10

11 Relative Riskiness Implied by the Market CDS Rates for Selected Countries Emerging Economies Mature Economies Source: Bloomberg, CBRT calculations. Mature economies include Germany, France, Italy, Spain and Japan. Emerging economies include Brazil, Chile, Colombia, Peru, Mexico, Hungary, Poland, Russia, Turkey, Thailand, Indonesia, Philippines, China and Malaysia. 11

12 Resulting Dynamics in Emerging Markets Surging capital inflows Real exchange rate appreciation Rapid credit growth 12

13 Reflections on the Turkish Economy and the Policy Response of the CBRT 13

14 Macro Financial Risks Monthly Imports and Exports (Seasonally Adjusted, Million USD) Main Sources of Current Account Deficit Finance (12 months Cumulative, Billion USD) Portfolio and Short Term* FDI and Long Term Current Account Deficit : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : Exports (excluding gold) Imports *Source: TurkStat. *Short-term capital movements are sum of banking and real sectors' short term net credits and deposits in banks. Source: CBRT. Global imbalances combined with the post-crisis dynamics led to a divergence between external and domestic demand and a surge in short term capital inflows. 14

15 Defining the Problem Financial stability from a macro perspective: How to reduce the risk of a sudden stop? Main Task: Engineer a soft-landing without hampering the price stability objective. 15

16 Methodology Modifying the conventional IT framework: Enrich the set of policy instruments Supplementary objective: Financial Stability Rebalance the economy through a slowdown in credit growth and a realignment of the exchange rate 16

17 Multiple Instruments, Multiple Goals Credit Policy Reserve requirements Other macroprudential tools One-week repo rate Instruments Liquidity Policy Interest rate corridor Other liquidity facilities Transmission Channels PRICE STABILITY Goals FINANCIAL STABILITY

18 Selected Items from the CBRT Policy Toolkit One-week Repo Rate TL Required Reserve Ratios Remuneration strategy of TL required reserves Differentiating across maturities Changing the scope of liabilities subject to reserve requirements Flexibility in the currency denomination of required reserve balances FX Required Reserve Ratios Interest Rate Corridor Other Liquidity Facilities Changes in liqudity management strategies and operational rules FX Liquidity Facilities FX Purchasing/Selling Auctions Changes in the auction methods according to liquidity conditions Adjustments in the FX liquidity provision facilities Changes in the export rediscount credit facilities

19 Challenge: Communicating the New Approach 1. No clear definition of financial stability 2. Uncertain transmission mechanisms Solution: Communicate in terms of observables Current account deficit and its financing Exchange Rate Credit growth

20 Rebalancing Strategy Step 1: Keep short term rates as low as possible and use interest rate corridor to discourage short term capital inflows to allow an orderly realignment in exchange rates. Step 2: Tighten through macro prudential instruments to curb credit growth and domestic absorption ( in coordination with other authorities).

21 Implementing The Policy Mix CBRT Policy Rate and Interest Rate Corridor TL Reserve Requirement Ratios (RRR) 25 O/N Lending Borrowing Interest Rate Corridor 1 week Repo Rate 18 The range of RRR Weighted average RRR Adoption of 1 week repo rate as the policy rate Source: CBRT. Source: CBRT. 21

22 Impact of the Policy Mix on Exchange Rates TL and Other EM Currencies Against USD* (11 Nov. 2010=1) 1,3 CBRT Measures 1,2 1,1 TL Depreciation 1 0,9 EM Average Appreciation Average of EM countries: Brazil, Chile, Czech Republic, Hungary, Mexico, Poland, S. Africa, Indonesia, South Korea and Colombia. Latest observation: October 4, Source: CBRT and Bloomberg. 22

23 Impact of the Policy Mix on Consumer Credit Consumer Loans (Annualized growth, percent, 4 weeks moving average) Significant hikes in RRR BRSA Measures average Source: CBRT 23

24 Outcome: Rebalancing Current Account Balance (Seasonally Adjusted, Quarterly Average, Million USD ) Main Sources of Current Account Deficit Finance (12 months Cumulative, Billion USD) Current Account Current Account (Excluding Energy) * 80 Portfolio and Short Term* FDI and Long Term CBRT Measures *Forecast for August and September. Source: TURKSTAT, CBRT. Source: CBRT. *Short term capital movements consist of banking and real sector short term net borrowing and deposits in banks. 24

25 Outcome: Inflation and Inflation Expectations Inflation Medium Term Inflation Expectations Month Month Turkey EM Average Source: CBRT and Bloomberg. Average of EM countries: Brazil, Mexico, Czech Rep., Hungary, Poland, S. Africa, China, India, Russia. * CBRT Survey of Expectations. Source: CBRT. 25

26 Conclusion Post crisis dynamics have highlighted the crucial role of financial stability, leading central banks to be more "creative" in the conduct of monetary policy. The CBRT has formulated and implemented a new strategy to deal with macro financial risks posed by extraordinary global circumstances. The new policy mix has been effective in rebalancing the economy while controlling inflation expectations. 26

27 Monetary Policy in the Post-crisis Period A. Hakan Kara Research and Monetary Policy Department EAF Conference October 10, 2011

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