monetary policy in emerging markets: key current it themes leonardo leiderman tel-aviv university
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1
Monetary Policy in Emerging Markets:
Key Current IT Themes
Leonardo Leiderman
Tel-Aviv UniversityE-mail:lleiderman@leoleiderman.com
OECD and CCBS/Bank of England Conference, Paris, Feb. 28, 2007
2
Current Global Conditions Provide Strong Support for IT in
Emerging Markets Globalization has resulted in lower
inflation rates World interest rates have remained low Rapid growth and reforms have improved
EM’s fiscal stance EM external accounts have improved Capital mobility has contributed to
monetary/fiscal policy discipline A diminishing role of political
uncertainties for market movements?
3
A Marked Decline in EM Budget Deficits (% of GDP)
0%
1%
2%
3%
4%
1999 2007
Source: WEO 9/2006, IMF. The figures correspond to the central government budget deficit of “other emerging market and developing countries.” The figure for 2007 is an IMF forecast..
4
Rapid GDP Growth Helped Reduce Public Debt to GDP
Ratios (% of GDP change from end 2001 to end 2005)
-8%
-6%
-4%
-2%
0%
2%
4%
6%
Total change Primary balance GDP growth Other
Source: WEO 9/2006, IMF. “Other” includes: exchange rate and interest rate effects, the stock-flow adjustment and statistical discrepancy
5
Changes in Global Risk Aversion Have Been Key for
EEM Volatility in 2006
80
90
100
110
120
130
140
30/12/2005 30/06/2006 30/12/2006
Note: index for the EEM ETF (end of 2005=100).
6
The Current Account/Monetary Policy Link: Larger Currency Depreciation Under Weaker
External Accounts(Mid ’06 Episode of Global Risk Aversion)
-5%
0%
5%
10%
15%
20%
25%
-10% -5% 0% 5% 10% 15%
RUSARGISR
BRL
THACZE
PLNHUN
ROM
TUR
Current account/GDP
Cu
rren
cy d
epre
ciat
ion
10.
5.06
-22.
6.06
7
The Main Risk Ahead
Slower economic growth and weaker fundamentals could make monetary policy in emerging-market economies more vulnerable to adverse shocks.
8
An Illustration of Current IT Themes Based on Israel’s
Experience
9
-3%
-1%
1%
3%
5%
7%
1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07
0 CPI YoY Official inflation targets
Inflation Volatility has Resulted in Deviations from IT…
10
-3%
-1%
1%
3%
5%
7%
1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07
0CPI YoYOfficial inflation targets12-month break-even inflation
…Yet Inflation Expectations Have Remained Within
Targets
11
-5%
-3%
-1%
1%
3%
5%
7%
9%
11%
1.97 1.98 1.99 1.00 1.01 1.02 1.03 1.04 1.05 1.06 1.07
0CPI YoYOfficial inflation targets12-month break-even inflation
Inflation Expectations Appear Now
Less Adaptive than in the Past
12
-15%
-10%
-5%
0%
5%
10%
15%
20%
1.00 1.01 1.02 1.03 1.04 1.05 1.06
CPI YoY $/NIS - YoY
Although the Pass-through has Diminished, The Nominal Exchange Rate Still has a Dominant Role in
the Transmission Mechanism
13
ILS Recent Strength Resulted from Improved Current Account
Performance…(Israel’s current account surplus)
-3.2%
-1.6%
5.2%
2.9%
-0.6%
-5.2%-5.1%
-1.2%-1.1% -1.3%
1.4%
2.6%
-7,000
-5,000
-3,000
-1,000
1,000
3,000
5,000
199519961997199819992000200120022003200420052006
-7%
-5%
-3%
-1%
1%
3%
5%
$millions %of GDP
14
…as well as from USD weakness
3.8
3.9
4.0
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
02/01/2006 27/03/2006 19/06/2006 11/09/2006 04/12/2006
0.70
0.72
0.74
0.76
0.78
0.80
0.82
0.84
0.86
USD/ILS USD/EUR
15
-3%
-1%
1%
3%
5%
1.04 1.05 1.06
CPICore inflation (excl. housing and energy)קו 3קו 4
Should the IT Rely on Core Inflation?
16
Entering New Territory for Monetary Policy: The BoI Rate is Lower than the
FedFunds Rate…
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
1.02 1.03 1.04 1.05 1.06 1.07
BoI
Fed
Bank of Israel and Federal Reserve policy rates.
17
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
2002 2003 2004 2005 2006 2007
BoI interest rate12 months break-even inflationReal - ex-ante interest rate
…Yet Ex-Ante Real Interest Rates Remain Reasonable
Source: Bank of Israel.
18
Looking Back at the 2002 Monetary/Fiscal Policy
Mistake
Inflation target: 2-3%
Actual inflation: 6.5%
19
0%
2%
4%
6%
8%
10%
12%
2000.01 2001.01 2002.01 2003.01 2004.01 2005.01 2006.01 2007.01
Expected RealNominal
Policy Rate: A Surprise Move to Easy Money in 12.2001
(central bank interest rates)
20
The Budget Deficit in 2002:
Revising the Target Frequently
(Ratios of Budget Deficit to GDP)
0%
1%
2%
3%
4%
5%
Target 1 4.2001 Target 212.2001
Target 3 5.2002 Actual
21
4.0
4.2
4.4
4.6
4.8
5.0
1/ 1/ 01 1/ 7/ 01 1/ 1/ 02 1/ 7/ 02 1/ 1/ 03 1/ 7/ 03
Fiscal and Monetary Expansion Resulted in Rapid ILS
Depreciation Against the USDUSD/ILS
22
Concluding Remarks The need for flexibility in
implementing IT in emerging-market economies…
…yet credibility is especially needed in a ‘flexible’ IT regime
The need for defining the IT horizon “over the medium term”
Less benign global conditions and weaker fundamentals could pose more difficult tradeoffs for EM monetary policies ahead
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