inflation targeting in romania: experience and … · inflation targeting in romania: experience...
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Inflation Targeting in Romania: Inflation Targeting in Romania: Experience and Future Experience and Future
DevelopmentsDevelopments
Cristian PopaCristian PopaDeputy GovernorDeputy Governor
National Bank of RomaniaNational Bank of Romania
Prague, April 2008Prague, April 2008
NATIONAL BANK OF ROMANIA
Initial ConditionsInitial Conditions•• In 1997In 1997--2004, Romania followed an eclectic monetary base targeting frame2004, Romania followed an eclectic monetary base targeting framework, work,
with increased reliance on interest rates + relatively frequent with increased reliance on interest rates + relatively frequent interventions within a interventions within a managed float regimemanaged float regime
•• High inflation rates, low financial depth/monetization, recourseHigh inflation rates, low financial depth/monetization, recourse to borrowing in fx, to borrowing in fx, fiscal dominance complicated choice of regime switch fiscal dominance complicated choice of regime switch
•• IT one of two choices envisaged in 2000 MT Economic Strategy (unIT one of two choices envisaged in 2000 MT Economic Strategy (underpinning EU derpinning EU accession effort) accession effort) –– other was a more predictable exchange rate arrangement, seen other was a more predictable exchange rate arrangement, seen risky in context of larger future capital inflows, likely shift risky in context of larger future capital inflows, likely shift in eq. real exchange ratein eq. real exchange rate
•• IT seen as constrained discretion, already successfully applied IT seen as constrained discretion, already successfully applied in EMs w. similar in EMs w. similar conditions (also in ECE), more likely to be robust to a variety conditions (also in ECE), more likely to be robust to a variety of shocks (incl. related of shocks (incl. related to rapid catchingto rapid catching--up, liberalization in context of upcoming accession), facilitateup, liberalization in context of upcoming accession), facilitateprogress towards euro adoption; possibly more favorable in termsprogress towards euro adoption; possibly more favorable in terms of sacrifice ratioof sacrifice ratio
•• IT viewed as least costly, most sustainable available means of sIT viewed as least costly, most sustainable available means of securing lasting ecuring lasting disinflation and conducing to eventual price stability: (i) statdisinflation and conducing to eventual price stability: (i) status quo not functional us quo not functional (breakdown of multiplier stability, eclecticism leading to incon(breakdown of multiplier stability, eclecticism leading to inconsistency); (ii) exchange sistency); (ii) exchange rate anchor risky in context of rapid credit growth, fast capitarate anchor risky in context of rapid credit growth, fast capital acct. liberalization w. l acct. liberalization w. high real rates, both on background of convergencehigh real rates, both on background of convergence--induced real appreciation trendinduced real appreciation trend
NATIONAL BANK OF ROMANIA
Source: National Institute of Statistics, National Bank of Romania
Inflation Rate
27 25 22 14 93.8
±1pp4
±1pp
5±1pp
7.5±1pp
3.5±1pp
30.3
17.8
14.1
9.3
4.84
22.5
34.5
6.569.0
11.9
15.3
45.7
6.574.87
8.6
40.7
0
5
10
15
20
25
30
35
40
45
50
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
target (Dec./Dec.)
actual (average)
actual (Dec./Dec.)
percent
February 2008 (yoy): 7.97% (Mar. 2007-Feb. 2008)/(Mar. 2006-Feb. 2007): 5.5%
NATIONAL BANK OF ROMANIA
Specifications & Preparatory WorkSpecifications & Preparatory Work•• IT framework defined in terms of:IT framework defined in terms of:
targeting 12M headline CPI (transparency/accountability, effectitargeting 12M headline CPI (transparency/accountability, effectiveness in veness in influencing expectations), despite limited capacity of monetary influencing expectations), despite limited capacity of monetary policy to influence policy to influence administered & volatile pricesadministered & volatile pricesdefining point central target w. narrow symmetrical variation bdefining point central target w. narrow symmetrical variation band (and (±±1 1 percentage points), again for effective anchoring of expectationpercentage points), again for effective anchoring of expectationsstwotwo--year overlapping targeting horizonyear overlapping targeting horizongradually declining annual targets, in line w. sustainability ofgradually declining annual targets, in line w. sustainability of disinflation (given disinflation (given substantial Bsubstantial B--S effect estimates, limited policy toolbox, improving but still S effect estimates, limited policy toolbox, improving but still constrained effectiveness of standard policy instrument, gradualconstrained effectiveness of standard policy instrument, gradual credibility gains)credibility gains)explanatory clauses, not used for copexplanatory clauses, not used for cop--outsoutsavoiding target revisions at all costsavoiding target revisions at all coststarget set by CB, announced jointly with governmenttarget set by CB, announced jointly with government
•• Valuable TA from IMF/CNB, 2003Valuable TA from IMF/CNB, 2003--4 and after: model 4 and after: model specification/calibration (full Board participation in final staspecification/calibration (full Board participation in final stages), further ges), further extensions, two quarterly cycles of dryextensions, two quarterly cycles of dry--run practice before going live (incl. run practice before going live (incl. fully fledged writing of QIR + attendant drafting of press releafully fledged writing of QIR + attendant drafting of press releases, etc.)ses, etc.)
•• Official introduction of IT in Romania: August 2005Official introduction of IT in Romania: August 2005
NATIONAL BANK OF ROMANIA
Initial Prerequisites & Challenges in Initial Prerequisites & Challenges in Implementing Inflation Targeting in RomaniaImplementing Inflation Targeting in Romania
•• Inflation at starting point already in single digitsInflation at starting point already in single digits•• Fiscal dominance no longer a threatFiscal dominance no longer a threat•• Increased effectiveness of interest rate instrumentIncreased effectiveness of interest rate instrument•• Soundness & stability of financial sector (w. low depth, howeverSoundness & stability of financial sector (w. low depth, however))•• Consolidation of CB full independence, transposition of EU acquiConsolidation of CB full independence, transposition of EU acquiss•• Increased forecasting capacity of CBIncreased forecasting capacity of CB•• Disinflation gains since 1999 improved credibility of monetary aDisinflation gains since 1999 improved credibility of monetary authorityuthority
•• Liberalisation of capital flows with large impact on forex markeLiberalisation of capital flows with large impact on forex market in the t in the context of significant interest rate differential & perspective context of significant interest rate differential & perspective of more of more appreciation (appreciation (ToToššovskovskýý dilemma)dilemma)
•• Significant level of currency substitution, net debtor position Significant level of currency substitution, net debtor position of the of the central bank hinder transmission of policy signalscentral bank hinder transmission of policy signals
•• Small open economy magnifies importance & visibility of exchangeSmall open economy magnifies importance & visibility of exchange raterate•• Persistently high current account deficitPersistently high current account deficit
NATIONAL BANK OF ROMANIA
Credit to Non-government*
61.5
23.0
58.2
20.8
49.3
37.6
16.4
76.0
112.0 113.8
31.7
94.4
71.7
0
20
40
60
80
100
120
140
CZ
(199
7)
PL (1
998)
HU
(200
1)
CL
(199
0)
BR (1
999)
MX
(199
9)
IS (1
992)
TH (2
000)
NZ
(199
0)
UK
(199
2)
SE (1
993)
ZA (2
000)
RO
(200
5)
percent of GDP
Source: EUROSTAT, NBR, NIS, IMF *) at the time of shifting to inflation targeting
NATIONAL BANK OF ROMANIA
Bank Assets*
56.069.1
53.9
127.2
104.4
229.0
92.5
45.2
138.0136.0
0
50
100
150
200
250
CZ
(199
7)
PL (1
998)
HU
(200
1)
BR (1
999)
IS (1
992)
TH (2
000)
NZ
(199
0)
UK
(199
2)
ZA (2
000)
RO
(200
5)
percent of GDP
Source: Websites of central banks and national statistics institutions *) at the time of shifting to inflation targeting
NATIONAL BANK OF ROMANIA
Fiscal Surplus/Deficit*
-4.4
-9.9
-2.2
-4.4
-6.4
-1.8
0.7
-2.2-1.1
-9.2
-11.4
-1.4-1.3
– 14
– 12
– 10
– 8
– 6
– 4
– 2
0
2 C
Z (1
997)
PL (1
998)
HU
(200
1)
CL
(199
0)
BR (1
999)
MX
(199
9)
IS (1
992)
TH (2
000)
NZ
(199
0)
UK
(199
2)
SE (1
993)
ZA (2
000)
RO
(200
5)
percent of GDP
Source: EIU, MPF, NIS *) at the time of shifting to inflation targeting
NATIONAL BANK OF ROMANIA
Increasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflation
-8
-6
-4
-2
0
2
4
6
2 4 6 8 10 12 14 16
Response of Core2 inflation to a monetary policy induced shockSample: 1998:08 - 2001:12
0
20
40
60
80
100
2 4 6 8 10 12 14 16
real interest rate gapreal exchange rate gap
output gapCore2 inflation
Variance Decomposition of Core2 inflation
0
20
40
60
80
100
2 4 6 8 10 12 14 16
real interest rate gapreal exchange rate gap
output gapCore2 inflation
Variance Decomposition of Core2 inflation
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
2 4 6 8 10 12 14 16
Response of Core2 inflation to a monetary policy induced shockSample: 2002:01 - 2007:12
Months
Contributions of shocks
(% of total variance)
Months
Contributions of shocks
(% of total variance)
NATIONAL BANK OF ROMANIA
Characteristics of IT in RomaniaCharacteristics of IT in Romania•• Flexible interpretation of IT: NBR use of all available instrumeFlexible interpretation of IT: NBR use of all available instruments, incl. exchange rate & nts, incl. exchange rate &
““unorthodoxunorthodox””, i.e. administrative/prudential policy tools employed for both , i.e. administrative/prudential policy tools employed for both macroeconomic macroeconomic & prudential reasons (differentiated reserve requirements, limit& prudential reasons (differentiated reserve requirements, limits for bank lending to s for bank lending to unhedged borrowers, loanunhedged borrowers, loan--toto--income limits for households, broadening scope of income limits for households, broadening scope of regulations outside credit institution sphere, etc.), but with eregulations outside credit institution sphere, etc.), but with ex ante awareness of their x ante awareness of their limited effectiveness over time and potential side effectslimited effectiveness over time and potential side effects
•• Emphasis on mediumEmphasis on medium--term disinflation path, not only pointterm disinflation path, not only point--attainment of annual targetsattainment of annual targets
•• Emphasis on sustainability, esp. in terms of nominal appreciatioEmphasis on sustainability, esp. in terms of nominal appreciation arising from potentially n arising from potentially volatile capital flows, need to ensure complementarity between pvolatile capital flows, need to ensure complementarity between price stability and financial rice stability and financial stability in context of persistent rapid credit expansion (fx bostability in context of persistent rapid credit expansion (fx borrowing, assetrrowing, asset--liability liability mismatches, increasing external private sector indebtedness) alsmismatches, increasing external private sector indebtedness) also as vehicle of carry tradeso as vehicle of carry trades
•• NBR implementation of IT focuses on ensuring compliance with medNBR implementation of IT focuses on ensuring compliance with mediumium--term path term path described by announced annual inflation targets, while not exacedescribed by announced annual inflation targets, while not exacerbating existing rbating existing macroeconomic vulnerabilities whose effects might compromise susmacroeconomic vulnerabilities whose effects might compromise sustainability of secured tainability of secured disinflation gains: disinflation gains: ‘‘macroeconomic riskmacroeconomic risk--management perspectivemanagement perspective’’
•• Explicit calls for consistency from other components of macro poExplicit calls for consistency from other components of macro policy mix (fiscal, incomes, licy mix (fiscal, incomes, structural reform) superseding constraints to monetary policy efstructural reform) superseding constraints to monetary policy effectiveness fectiveness
NATIONAL BANK OF ROMANIA
0
3
6
9
12
15
18Ja
n.05
Apr
.05
Jul.0
5O
ct.0
5Ja
n.06
Apr
.06
Jul.0
6O
ct.0
6Ja
n.07
Apr
.07
Jul.0
7O
ct.0
7Ja
n.08
0
5
10
15
20
25
30
sterilization operations (right-hand scale)NBR policy rate (% p.a.)inflation rate (annual percentage change)average actual interest rate on sterilization operations
RON billion; average daily stockpercent p.a.
NBR Policy Rate, NBR Sterilization Operations and Inflation Rate
Average Interest Ratesin the Banking System
0
5
10
15
20
25
30
Jan.
05A
pr.0
5Ju
l.05
Oct
.05
Jan.
06A
pr.0
6Ju
l.06
Oct
.06
Jan.
07A
pr.0
7Ju
l.07
Oct
.07
Jan.
08
new RON-denominated loans to non-financialcorporations and households
new RON-denominated time deposits from non-financial corporations and households
percent per annum
Source: National Bank of Romania, National Institute of Statistics
NATIONAL BANK OF ROMANIA
Financial Intermediation*
6.49.4
14.116.7
10.2
11.4
12.7
19.9
4.87.4
11.4
11.8
15.4
18.9
17.7
13.4
36.6
16.6
20.8
26.8
0
5
10
15
20
25
30
35
40
2004 2005 2006 2007Source: National Institute of Statistics, National Bank of Romania
percent
loans to non-financial corporations a.o.loans to households
foreign currency-denominated loansRON-denominated loans
*) loans to the private sector / GDP
NATIONAL BANK OF ROMANIA
Loans to the Private Sector
Source: National Bank of Romania, National Institute of Statistics
0
20
40
60
80
100
120D
ec.0
5Fe
b.06
Apr.0
6Ju
n.06
Aug.
06O
ct.0
6D
ec.0
6Fe
b.07
Apr.0
7Ju
n.07
Aug.
07O
ct.0
7D
ec.0
7Fe
b.08
RON-denominated loanstotalforeign currency-denominated loans
0
20
40
60
80
100
120
Dec
.05
Feb.
06Ap
r.06
Jun.
06Au
g.06
Oct
.06
Dec
.06
Feb.
07Ap
r.07
Jun.
07Au
g.07
Oct
.07
Dec
.07
Feb.
08
households
total
non-financial corporations & financialcorporations other than MFIs
real annual percentage change*
*) based on CPI
real annual percentage change*
NATIONAL BANK OF ROMANIA
Nominal Exchange Rate
2.7
2.9
3.1
3.3
3.5
3.7
3.9
4.1
4.3
Jan.
02Ap
r.02
Jul.0
2
Oct
.02
Jan.
03Ap
r.03
Jul.0
3
Oct
.03
Jan.
04
Apr.0
4Ju
l.04
Oct
.04
Jan.
05Ap
r.05
Jul.0
5
Oct
.05
Jan.
06Ap
r.06
Jul.0
6
Oct
.06
Jan.
07Ap
r.07
Jul.0
7
Oct
.07
Jan.
08
Source: National Bank of Romania
RON/EUR (daily data)
NBR's decision to pursue a more flexible exchange rate
NATIONAL BANK OF ROMANIA
Real Exchange Rate of the RON against the EUR
70
80
90
100
110
120
130
140
150
160
170Ja
n.01
May
.01
Sep.
01
Jan.
02
May
.02
Sep.
02
Jan.
03
May
.03
Sep.
03
Jan.
04
May
.04
Sep.
04
Jan.
05
May
.05
Sep.
05
Jan.
06
May
.06
Sep.
06
Jan.
07
May
.07
Sep.
07
Jan.
08
index, 2000 = 100
70
80
90
100
110
120
130
140
150
160
170monthly averages
based on CPI differential between Romania and Euro areabased on PPI differential between Romania and Euro areabased on ULC in industry
Appreciation (+)/Depreciation (–)
Source: National Bank of Romania calculations, National Institute of Statistics, International Financial Statistics
NATIONAL BANK OF ROMANIA
100
110
120
130
140
150
160
170
180
190
20020
01
2002
2003
2004
2005
2006
2007
2008
*
Source: National Institute of Statistics, National Bank of Romania calculations
labour productivity
gross real wage (based on PPI)
2000=100
Real Wage and Labour Productivity in Manufacturing
100
105
110
115
120
2001
2002
2003
2004
2005
2006
2007
2008
*
labour productivity
gross real wage (based on PPI)
previous year =100
*) January
NATIONAL BANK OF ROMANIA
0
50
100
150
200
250
300Fe
b.07
Mar
.07
Apr.0
7
May
.07
Jun.
07
Jul.0
7
Aug.
07
Sep.
07
Oct
.07
Nov
.07
Dec
.07
Jan.
08
Feb.
08
Mar
.08
Latvia Czech Rep. Lithuania
Poland Hungary Bulgaria
Romania
Spreads of Five-year CDS for Emerging Economiesin Central and Eastern Europe
Source: Bloomberg
basis points
NATIONAL BANK OF ROMANIA
Headline Inflation and CORE Inflation
2
3
4
5
6
7
8
9
10
11D
ec.0
4
Mar
.05
Jun.
05
Sep.
05
Dec
.05
Mar
.06
Jun.
06
Sep.
06
Dec
.06
Mar
.07
Jun.
07
Sep.
07
Dec
.07
annual percentage change
CPI (total)CORE1 (CPI – administered prices)CORE2 (CORE1 – volatile prices*)adjusted CORE2**
Source: National Institute of Statistics, National Bank of Romania calculations
*) products with volatile prices: vegetables, fruit, eggs, fuels**) the influence of excise duties and vice tax is removed
NATIONAL BANK OF ROMANIA
Tradables and Non-tradables* Prices
0
10
20
30
40M
ar.0
2
Jun.
02
Sep.
02
Dec
.02
Mar
.03
Jun.
03
Sep.
03
Dec
.03
Mar
.04
Jun.
04
Sep.
04
Dec
.04
Mar
.05
Jun.
05
Sep.
05
Dec
.05
Mar
.06
Jun.
06
Sep.
06
Dec
.06
Mar
.07
Jun.
07
Sep.
07
Dec
.07
Source: Eurostat; National Bank of Romania calculations
tradables (goods)
non-tradables (mainly services and goods with administered prices)
*) based on COICOP
annual change (%)
NATIONAL BANK OF ROMANIA
0
1
2
3
4
5
6Se
p.06
Nov
.06
Jan.
07
Mar
.07
May
.07
Jul.0
7
Sep.
07
Nov
.07
Jan.
08
percent
0
1
2
3
4
5
6
deviation (right-side scale)
expected annual inflation rateannual inflation target
percentage points12 months
0
1
2
3
4
5
6
Sep.
06
Nov
.06
Jan.
07
Mar
.07
May
.07
Jul.0
7
Sep.
07
Nov
.07
Jan.
08
percent
0
1
2
3
4
5
6
deviation (right-side scale)
expected annual inflation rate
annual inflation target
percentage points24 months
Inflation Expectations of Banks for the Next:
Source: survey conducted by the NBR
NATIONAL BANK OF ROMANIA
Inflation ProjectionsInflation Projections
2
4
6
8
10
2007III IV
2008I II III IV
2009I II III IV
Source: National Institute of Statistics, National Bank of Romania calculations
annual inflation rate*target band**target
annual percentage change
Inflation targets (Dec./Dec.) 2008: 3.8% 2009: 3.5%
**) ±1 percentage points around the (dis)inflation path
*) projection based on consumer basket composition for 2007
Note: according to the February 2008 Inflation Report
The NBR aims to achieve sustainable The NBR aims to achieve sustainable disinflation amid disinflation amid macroeconomicmacroeconomic risk risk
managementmanagement: : hencehence, , the NBR the NBR envisages the timely return of envisages the timely return of
inflation to the downward trajectory inflation to the downward trajectory compatible with the already compatible with the already
announced targets, without widening announced targets, without widening current macroeconomic imbalances current macroeconomic imbalances and by preserving financial stabilityand by preserving financial stability
The NBR does not envisage a change The NBR does not envisage a change in the established inflation targetsin the established inflation targets, ,
but strives towards achieving but strives towards achieving disinflation objectives in a sustainable disinflation objectives in a sustainable and timely manner,and timely manner, as any delay may as any delay may have a negative impact on the have a negative impact on the euroeuro
adoption calendaradoption calendar
NATIONAL BANK OF ROMANIA
Looking AheadLooking Ahead•• Further improvements in CB forecasting Further improvements in CB forecasting
capabilities: DGES model, extensions to capabilities: DGES model, extensions to current model, etc.current model, etc.
•• Ongoing discussion on improvements in Ongoing discussion on improvements in transparency transparency –– need for focus to remain need for focus to remain on issueson issues
•• IT framework in light of euro adoption IT framework in light of euro adoption efforts: choice of mediumefforts: choice of medium--run annual run annual targets, sequencingtargets, sequencing