Central Banks and Monetary Policies: What lessons have learned in the last twenty years?

Transcription

1 Central Banks and Monetary Policies: What lessons have learned in the last twenty years? Is it all as simple in practical life as it is written in textbooks?

2 Agenda: 1. Setting the scene 2. Rerminder of the basics 3. Discussion, lessons learned, challenges ahead

3 Inflation rate Czech Republic

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7 Role of monetary policy in economic policy instruments macroeconomic intervention: anti-cyclical, stabilisation framework: YES implementing of government structural priorities NO geo-political priorities NO correcting market failures YES, participate promoting political priorities (social welfare etc) NO combining, arbitrating or fine-tuning intervention instruments, held by various stakeholders (government, central bank, employers, trade-unions etc) Participate

8 A few observations to start with Usually, the goal of monetary policies is stated as: The stability of prices and if the stability is observed, then supporting economic growth The goal is often incorporated in law (in the Constitution): CNB and ECB are no exception Interesting variation: FED key objectives for monetary policy are maximum employment, stable prices (= the so-called dual mandate), and moderate long-term interest rates (and supervising and regulating banking institutions, maintaining the stability of the financial system)

9 Important observation It is not true that central banks are pursuing their main objective (of price stability) no matter how much it would cost (to the economy ) Central banks are of course interested in economic prosperity and a sound (= balanced) economic environment/growth However, the price stability needs to come first The trouble is, that there is no single view as to what price stability actually means (we will discuss this in a moment )

10 Why stability of prices? is this question so trivial? It is the most comprehensive indicator reflecting the overall balance and stability (internal, external) of economy If not maintained, this may become most detrimental to economic performance and prosperity If properly defined, it is comprehensible to a wide audience and thus helps to explain (and trust) the central bank's actions Economic growth and price stability are not antagonistic features or goals of economic policy, on the contrary, both theory and the practical policy demonstrate that these features are complementary and support each other ctd

11 Economic growth and inflation how are they linked? If growth is not balanced, then it will not be sustainable The Czech lesson : dynamic growth, but fuelled by excess domestic demand and capital inflows, economy still not adequately restructured, number of rigidities and institutional failures this has provoked a sudden correction, driven by the market: fluctuations of exchange and inflation rates, interest rates, government and household spending Output (and welfare) losses were the unavoidable consequence Issue for consideration: similarities and differences to events of

12 Conventional wisdom about high inflation A high inflation is volatile: this volatility has significant economic costs example: it erodes savings, increases real interest rates (risk premium), reduces investment horizons, changes proportions between consumption and investment, erodes the growth potential, and results in further imbalances It feeds (amplifies) inflationary expectations

13 Conventional wisdom about high inflation ctd If not dealt with carefully, inflationary expectations will become, themselves, a factor contributing to inflation ( inflation starts to feed itself ): try to figure out an example It creates tax distortions (of the tax burden distribution), it also changes the income distribution And, because of all that, it implies a continuously disproportionate mix of economic policies (output losses because of increased costs of maintaining stability): explain why/how

14 And, on the contrary A stable currency and a low inflation are fundamental to a sustainable, optimal economic growth Experience suggests that low inflation is less volatile that inspires confidence and It allows for planning and strategising

15 A factual note on the margin of the discussion: what is it that we are talking about how is inflation actually measured? PPI CPI GDP deflator Net inflation Monetary inflation (Annualised y/o/y, m/o/m) The discussion about whether we measure inflation correctly (or not) is as old as the measurement of inflation itself. It is very likely (actually it is certain) that no-one has (so far) ever been able to measure inflation correctly: furthermore, but no-one will ever be able to measure inflation correctly: discuss why Update about current discussion: how to include asset prices in inflation measurements (and should they be actually included at all)

16 Factors of price stability Internal: Aggregate supply and demand and their balance Output gap Structural characteristics of the economy (what is that?) Structure of prices (tradables/non-tradables, regulated/non-regulated, weight of indirect taxes in price changes) Flexibility of markets and production factors, efficiency of institutions Performance of the financial system External: How open the economy is Exogenous factors (and, eventually, shocks)

17 So, can price stability be quantified? Let s try a vote in the class It all depends on WHO articulates that opinion on price stability politicians, government, central bank, tradeunions, employers associations, independent consultants and experts, external institutions etc question: what vested interest do some of these have? It all depends on WHEN they articulate their views on price stability in WHICH economic context (economic recession, structural parameters of the economy ) In all these aspects, the central bank has the best prerequisites and qualifications to be the most neutral

18 Addendum: What is the difference between the price stability and inflation target? Are they the same thing? What is the difference between the inflation target and the inflation forecast? Are they the same thing? Question: what if they differ, can and should the central bank do something about it?

19 Let's be clear The inflation target is not a plan: it's value is in it's credibility, not in the fact that the central bank can (theoretically) impose its fulfillement no matter what the cost would be (in which case the target and the central bank - would loose it's credibility)

20 Summary: monetary policy challenges, determinants and premises (1) Evaluating a recognising trends, structural lay-out of the economy, structure of inflationary pressures Evaluating the economic performance, cycle, forecasting the economy Evaluating the equilibrium of the economy and it s various segments Evaluating the gaps (output, exchange rate ) Evaluating the endogenous and exogenous inflationary factors Evaluating economic policy Evaluating and forecasting all the previous

21 Summary: monetary policy challenges, determinants and premises (2) Combining models with expert views Evaluating the risks Evaluating the gap between the inflation forecast and inflation target Considering the regime and the goal (inflation targeting/low inflation, stable exchange rate, money supply, Euro adoption, explicit or implicit nominal anchor ) Implementation instrument available, conventional, nonconventional Special remark: Monetary policy is forward looking, the transmission horizon for the re-po is 4 to 6 quarters, for other instruments the transmission period may (and does) differ

22 The role of the exchange rate in monetary policy in the exchange rate targeting framework, the ambition is to import price stability through a fixed (stable) rate of the national to the anchor currency: the use of policy instruments is subordinated to achieving/protecting the exchange rate stability in the inflation targeting framework, the exchange rate is an important factor, however it is not the only factor: the exchange rate development is taken in consideration as one of elements (though an important one) determining the use of policy instruments normally, the role of the exchange rate would be considered in conjunction with the impact of the interest rates

23 Monetary conditions when assessing the combined effect of exchange rate and interest rate, we are talking about the monetary conditions these two elements can work in conjunction or their effects may diverge while changes in the interest rate will have an impact on the exchange rate, it does not necessarily work the other way fluctuations in the exchange rate may or may not induce a movement of the interest rate it all depends a) how the central bank will evaluate the exchange rate movement and b) what the exchange rate regime is (ex.: free or managed float)

24 Moreover the interest rate component of the monetary conditions is not constituted by the short rates (fixed directly by the central bank), but by the long rates (used by companies and households): the transmission of the short rates into the long ones on the financial market is thus a key indicator of the central bank s credibility when taking decisions, economic agents will not take into consideration nominal, but real interest rates (they consider the price developments): importance of the central bank s credibility

25 What have we learned in the past 20 years Early nineties: Liberalisation Financial market virtually non-existing Systemic and structural challenges ahead Severe inflationary risks Extraordinary circumstances require extraordinary measures: Administrative control of credit supply, interest rates Exchange rate peg Given the circumstances, it has actually worked remarkably well. Yet,l there is probably not much to learn

26 What have we learned in the past 20 years Mid nineties: Monetary policy on a double track (targeting the exchange rate and the money supply) Administrative controls terminated Exchange rate pegs remains in place Policy implementation: essentially through standard instruments (changes of policy interest rates ) Economy growing fast, yet: structural and systemic weaknesses unresolved, leading to growing tensions

27 What have we learned in the past 20 years Enterprises still awaiting restructuring Institutional and legal framework: lots of unfinished business Privatisation under way Loose fiscal policies, co-operative content of policies weakening Real wages out of control Mobility of capital ever increasing, speculative hot-money flows damaging economy Monetary policy instruments getting ineffective Exchange rate peg: stabilisation potential exhausted, becoming too an expensive tool It is no longer possible to aim at two targets in parallel Collapse of the monetary policy (and economic policy) framework

28 What have we learned in the past 20 years 1998 and beyond: Inflation targeting Forward looking approach No intermediate targets, directly aimed at infoation Need to stabilise inflationary expectations Multiple criteria to assess situation/prospects Understandable, big communication potential, transparent concept Flexibility of policy tools

29 What have we learned in the past 20 years Inflation targeting has been a success: Inflation went down Central bank credibility reinforced Monetary policy actively working with inflation expectations Overall macroeconomic environment stable Co-operative relationship with fiscal policy preserved (for most of the time) Has worked well at difficult moments (just after 1998, in 2002, again in 2008 and, after all, even today)

30 Challenges ahead: Monetary policy (and financial markets) have no room to reward fiscal policy for consolidation results Measurement of inflation (and content of target) permanent challenge Another test of independence possibly to be expected Eurozone entry perhaps not on the top of the agenda today, however sooner or later will reemerge Banking union, financial stability and monetary policy

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32 Textbooks about central banks A central bank, reserve bank, or monetary authority is an institution that manages a nation's currency, money supply, and interest rates Central banks also usually supervise the commercial banking system (and other parts of the financial system) and are acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis The goal of monetary policy is the stability of prices (low inflation), eventually also support to economic growth (if the primary goal is not threatened) The goal of supervisory activities is to preserve the stability of the financial system

33 However it is not all that simple "I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I said. Alan Greenspan, former chairman ( ) of the Board of Governors of the Federal Reserve System as well as the Federal Open Market Committee (FOMC) Why should central bankers be so cautious about what they say?

34 Selecting a few statements about monetary policies and the implied monetary policy stance On rates Governor Miroslav Singer said ( ) that the interest rates would rather stay stable this year, unless big surprises comes in. in November (the 2nd) 2012 the key repo rate was set at 0.05%, an all time low record CNB governor Singer says ( ) that the national bank will raise rates a little bit faster than according to their last forecast On exchange rate Governor Miroslav Singer said ( ) that the weakening koruna poses the only inflationary risk and if it further depreciates the central bank should probably respond to that Few months later, governor Singer said that the koruna level was not a big drama but the pace of strengthening was too fast. If the currency continues to firm so fast, the central bank might need to react, Singer said. The difficulty is that we are supposed to provide stability to a very unstable environment with a very unclear future, lots of unknown factors and external influences

35 Special item FEX intervention November 2013

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39 Exit strategy?