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1、L-2.Monetary and Exchange Rate Policy Frameworks and StrategiesPresenterRay BrooksJoint China-IMF Training ProgramCourse on Macroeconomic Management and Financial Sector IssuesCT 14.05OutlineI.Whataretheultimategoalsofmonetarypolicy?II.Whatarethealternativeframeworksandhowdotheywork?III.Howtochoosea
2、monetaryframework?IV.Whatchoicesweremadeinthepast?V.Howwelldidtheyperform?VI.Chinaschoices2ThistrainingmaterialisthepropertyoftheInternationalMonetaryFund(IMF)andisintendedforuseinIMFsInstituteforCapacitydevelopment(ICD)courses.AnyreuserequiresthepermissionofICD.I.Whataretheultimategoalsofmonetarypo
3、licy?1.Pricestability2.Outputandemployment3.Exchangeratestability4.Postglobalcrisis,callstoalsotargetfinancialstability3Cyclical unemploymentCore inflation0.00.51.01.52.02.5-0.5-1.0-1.5-2.002468101214Inflation and Cyclical Unemployment(Percent;average across advanced economies)1975841985-941995-pres
4、entSources:Organization for Economic Cooperation and Development;and IMF staff calculations(April 2013 WEO).TherelationshipbetweeninflationandcyclicalunemploymenthaschangedovertimeApparentthattheslopeofPhillipscurvehasfallenJV13.13.5Source:April2013WEOWhatcanmonetarypolicydo?Caneffectivelycontrolpri
5、cesandexchangeratesnominalvariablesCanserveasanominal anchorintheeconomyCancontributetoeconomicgrowthandhelpcreatejobsthroughlowandstableinflationButitcannotbearealanchorunemployment,growth,andrealexchangeratecannotbeaffectedpersistently6JV13.13.Monetarypolicyaffectsdemand,notsupplyToomuchdemandstim
6、ulusstokesinflationStabilizeoutputarounditspotentialandinflationaroundtheinflationtargetJointlyminimizevolatilityofoutputandinflationsy;sp7QuantityPriceADASLong-runASJV13.13.Exchange Rate Policy:OverviewIn the short run,the nominal ER level affects the real exchange rate:If domestic inflation is hig
7、h,a fixed exchange rate might appreciate the RER.“The real exchange rate is always flexible”An appreciated RER affects competitiveness of exports and can lead to current account deficits.A flexible ER might be a powerful tool to restore external equilibrium.8II.WHAT ARE THE ALTERNATIVE MONETARY AND
8、EXCHANGE RATE FRAMEWORKS AND HOW DO THEY WORK?“Therearemanywaystoskinacat”StoneandBhundiaclassification9JV13.13.10CompatiblechoicesCountriesneedtochooseamonetarypolicystrategy(e.g.,moneygrowthtargetsorinflationtargets)andanexchangeratearrangementThetwochoicesmustbecompatibleJV13.13.The Impossible Tr
9、inity11 CAPITAL CONTROLSMonetaryindependenceHard PegPUREFLOATCapital Mobilityincreasing increasing capital mobilitycapital mobilityExchange ratestabilityChinaU.S.,JapanEU12The“impossibletrinity”Itisimpossibletosimultaneouslymaintain:afixedexchangerateandautonomousmonetarypolicytopursuegoalsfordomest
10、iceconomicactivityandpricestabilityiftheeconomyreliesonalargevolumeofpotentiallyvolatileandinternationallymobilesourcesoffinanceJV13.13.FourViableAlternativeMonetaryandExchangeRateRegimes1.Exchangeratetargeting2.Monetaryaggregatestargeting3.Inflationtargeting4.Other“eclectic”frameworks13JV13.13.14 H
11、ARD PEGSExchange arrangements with no separate legal tender Currency union DollarizationCurrency board INTERMEDIATE(Soft Pegs)Conventional pegStabilized arrangementPeg with horizontal bandsCrawling pegCrawl-like arrangement FLOATINGFloatingFree floatingRange of Options for Exchange Rate1.Exchangerat
12、etargetingTheexchange rate isthenominalanchorPre-World-War-IgoldstandardBretton-Woodsregime(1945-71)AllcountriespeggingtogoldthroughtheU.S.dollarArgentinascurrencyboard(1991-2001)“Hard”pegDollarpeginSouthKorea,Thailand,Indonesia“Soft”pegWestAfricaMonetaryUnion,EuropeanMonetaryUnion(regionalsystem)15
13、JV13.13.HowdoesERtargetingwork?KeeptheERontarget(level,“crawl”,andsoon)Aslongasthecapitalaccountisatleastpartlyopen,domesticinterestrateworldinterestrate+riskpremiumThe“lawofoneprice”(PPP)willtakecareofinflationconvergence(dz=p*-p)MaintainliquidityinthebankingsystemItsacomparativelysimpleregimetoope
14、rate!16JV13.13.“Thedevilisinthedetail”Acountrymaysaythattheyaremaintainingacrawlingpeg/managedfloat/freefloat,but:1.HavenovolatilityoftheexchangerateWhileofficiallyfloating,somecentralbanksusedtophonecommercialbankwith“suggested”ERs2.AccumulateinternationalreservesDistinguishde jureandde factoregime
15、s!Chinaisde jure managedfloatingarrangementButde facto classifiedasa“crawl-likearrangement”byIMFin2013ArticleIV(astheRMB-U.S.$ratehasremainedina2percentcrawlingband)17JV13.13.ChinaspegwasstableagainstUS$mid-1990stomid2000sbutnominaleffectiveexchangeratemovedJV13.13.18Nominal effective exchange rates
16、RMD/US Dollar Exchange rate1992Q11995Q11998Q12001Q12004Q12007Q12010Q12013Q1506070809010011012013045678910US and China Exchange RatesInverse of NEER China,CPI,1996=100Inverse of NEER USA,CPI,1996=100RMB/US DollarSources:International Financial Statistics databaseChinasrealeffectiveexchangeratehasappr
17、eciatedmorethanthenominalrateJV13.13.191998Q42000Q42002Q42004Q42006Q42008Q42010Q42012Q480901001101201301408090100110120130140Nominal Effective Exchange Rate and Real Effective Exchange Rate(Index,2005=100)Nominal Effective Exchange RateReal Effective Exchange RateSources:International Financial Stat
18、istics database2.MonetaryaggregatestargetingMonetary growth isthenominalanchor.Basedonthequantitytheoryofmoney(Friedman,1956):MV=PYInflationfrom“manydollarsbehindfewgoods.”Monetarypolicyinstrumentsadjustedtotargetgrowthrateofmoneysupply(e.g.,broadmoney)20JV13.13.2.MonetaryaggregatestargetingTheexcha
19、ngeratehas tofloataslongasthecapitalaccountisopenThefiscalpositionmustbeundercontrol.Why?M2=NFA+NDA.Examples:Industrialcountries(thelate-1970stomid-1980s)About30countriestoday(mostlylow-income)InspiredtheECBsMonetary Pillar.21JV13.13.HowdoesMTwork?221.Provideliquidityconsistentwithyour2.intermediate
20、target(M2growth)3.toachieveyourultimateobjective(p*)Need to believe in p p =f(M)JV13.13.3.InflationtargetingInflation forecast isthenominalanchorAdjustmonetarypolicyinstrumentstokeepthecentralbanksforecastofinflationconsistentwithapre-announcedtargetExamples:NewZealand,Chile,U.K.,CzechRepublic,Polan
21、d,Romania,Thailand,Brazil,Ghana.23JV13.13.24Is the forecast of inflation on target?YesShould policy respond?No change in instrument Determine size of responseNoNo change in instrumentYesNo Change instrument“Escape clauses”permit departure from the target Communicate Communicate Communicate HowdoesIT
22、work?4.EclecticmonetarypolicyWhatisthenominalanchor?Adjustmonetarypolicyinstrumentstopursuestableeconomicgrowthandlowinflation,butwithnoformallypre-announcedtargetsExamples:U.S.,EuroArea,Japan,India,.25JV13.13.Howdoeseclecticpolicywork?Centralbankshaveinflationobjectives,butnotasexplicitontargetandh
23、orizonasformalITcountriesECB:“inflationbelow,butcloseto,2percent”Fed:“thegoalsofmaximumemployment,stableprices,andmoderatelong-terminterestrates”.DecisionsarealsobasedonforecastsofinflationGoodsystemtoforecastinflationandagoodunderstandingofthetransmissionmechanismiscrucialDifferencebetweenITsand“ec
24、lectics”isadifferentlevelofcommunication,althoughconvergence.26JV13.13.Group(Breakintogroupsof5-6todiscussquestionbelow.Nominateonepersonfromyourgroupwhowillsummarizethediscussion)WhatarethekeyfactorsbehindChinaschoiceofmonetaryandexchangerateframeworkinrecentyears?27III.HOW TO CHOOSE A MONETARY FRA
25、MEWORKTherearealwaysprosandcons28JV13.13.29Whatistheappropriatemonetaryandexchangeratepolicyregime?ManyconsiderationsarerelevantSimilarcountriessometimesmakedifferentchoicesThebestchoiceforanyparticularcountrymaychangeovertimeJV13.13.ChoiceofmonetaryframeworkEachmonetaryframeworkhasitsadvantagesandd
26、isadvantages.Thechoicedependsonpolicyobjectivesandtheirrelativeimportance:1.Reduce/stabilizeinflation2.StabilizeoutputfluctuationsU.S.:“maximumsustainableemploymentandlowinflation”3.Avoidfinancialcrises(financialstability)4.Internationalorregionaleconomicintegration30JV13.13.1.ExchangeratetargetingP
27、rovidedtheauthoritieshaveaclearcommitmenttoERstability,expectationsofinflationwillstabilizeShort-rundeviationsareinevitableAlonglistofrisks31JV13.13.RisksofexchangeratetargetingFiscaldominanceunderminestheregimeThepegcurrencymaynotbeconsistentwithtradepatterns(ex.ArgentineanandBrazilianpegstotheU.S.
28、$inthe1990sandsubsequentexits)PegsencouragebuildupofbalancesheetvulnerabilitiesPrivatesectorusedtostableexchangerateignoresexchangeraterisk(plusbailoutexpectations)Buildupinforeigncurrencydebt(Asiancrisis,HungaryandRomanialately)32JV13.13.ChinasCurrentAccountSurplushasfalleninrecentyearsandREERhasap
29、preciated33Current Account Balance as percent of GDPReal Effective Exchange Rate Index199019921994199619982000200220042006200820102012024681012-2-48090100110120130140China:Current Account Balance and Real Effective Exchange RateCurrentAccount(%ofGDP,lhs)RealEffectiveExchangeRate(Index,2005=100)Sourc
30、es:International Financial Statistics databaseImpossibletrinityagainLossofmonetarypolicyasastabilizationtoolWithinternationalcapitalmobility,impossibletotargetexchangerateandusemonetarypolicyforoutputstabilizationButthelossofindependentmonetarypolicymaybeoffsetbybenefitsofregionalintegratione.g.Euro
31、area,WAEMUEliminatingexchangeraterisklowerstransactionscostsandincreasestrade34JV13.13.BottomlineonERtargeting+Simpletooperate+“Gainsfromtrade”+canhelp“import”lowinflationFiscaldominanceNeedtofindtherightpegcurrency(orbasket)LossofmonetarypolicyasastabilizationtoolHigherriskofspeculativeattacksandcr
32、isesFinancialsectorvulnerabilitiesasprivatesectortakesonexchangerateriskCostsofsterilizationforcentralbanks35JV13.13.aJV13.13.36Source:AndrewCheng,2013PBCConferenceonCapitalFlows2.MonetaryAggregatestargetingFormonetarytargetingtoachievepricestability,theremustbeastablerelationshipbetweenmonetaryaggr
33、egatesandinflationInmanycountries,thishasbrokendownovertheyearsbecauseoffinancialinnovationsmakingvelocityunstableanddifficulttoforecast.Monetarytargetinghaslostmuchofitsappeal37JV13.13.VelocityofM2wasunstablein70sand80s,esp.inGermanyandJapanJV13.13.38Velocity of Money(Nominal GDP/M2)of Japan and US
34、Velocity of Money(Nominal GDP/M2)of Germany197019751980198519900.70.91.11.31.51.71.911.522.533.544.55Velocity of Money(Nominal GDP/M2)Japan(leftaxis)US(leftaxis)Germany(rightaxis)Source:InternationalFinancialStatisticsInChinatoo,thelinkbetweenmoneyandnominalGDPhasbeennotbeenstable3919982000200220042
35、00620082010201211.11.21.31.41.51.61.71.81.9211.11.21.31.41.51.61.71.81.92China:Broad Money/Nominal GDP and Bank Credit/Nominal GDPBroad Money/Nominal GDPBank credit/Nominal GDPSources:International Financial Statistics databaseBottomlineonmonetarytargeting+Operationalsimplicityandtheoreticallysoundb
36、uttheregimeisnotintuitiveThepublicdoesnotunderstandwhatis“broadmoney”,“narrowmoney”,etcEmpiricallydubiousTheshort-runmoney-to-inflationnexusdisappearedinthe1970sThecausalityfrommoneytooutput/pricesdoesnotholdinthedata40JV13.13.3.Flexibleexchangerate&inflationtargetingExplicitinflationtargetandtransp
37、arentframework,mayhelpestablishcredibilityMonetarypolicyneedstobefreetopursuetheinflationobjectiveAsisotherframeworks,fiscaldominancewoulddamagethesystem;butperhapstoalesserdegreethaninERtargeting41JV13.13.FlexibleERandITOperationallycomplex:needtoknowthewholemonetarytransmissionRequiresaworkinglink
38、frompolicyratesinterbankrateslongratesWithnoERanchor,thenominalERcanbevolatile(“fearoffloatingsyndrome”)WithaweakERpass-through,therealERisalsovolatileshockstooutputEmphasisonpricestabilitymaycloudotherCBresponsibilities(financialstability)42JV13.13.Need to Learn to FloatFear of floating exchange ra
39、te is a barrier to many emerging markets in adopting ITVoluntary transitionprior to the transition,countries tend to have:stronger banking supervision,including to reduce currency mismatches on balance sheetsmore developed securities markets;increased central bank independence,with emphasis on price
40、 stability then adopt inflation targeting.Crisis-driven transitionafter the transition,countries improve banking supervision and develop securities markets.43LessonsfromThreeCasesNewZealandCredibilityprobleminitiallyStartedwithstrictapproachBecamemoreflexibleovertime,asinflationexpectationsbecameanc
41、horedChileandIsraelwereabletouseinflationtargetingtodisinflatesuccessfullyIsraelshowedthatcanadoptinflationtargettingevenwithoutmeetingpreconditions4445BottomlineoninflationtargetingA“nominalanchor”withoutaERcommitmentMonetarypolicyretainsindependencyunderfullcapitalmobilityFosterstransparencyandacc
42、ountabilityTechnicallydemandingFocusonpricestabilitymaybeattheexpenseofotherobjectives“Fearoffloating”considerationsJV13.13.OnelessonfromtheGreatRecession:centralbanksmustdomorethanjusttargetinflation46JV13.13.IsInflationTargetingDead?Oldview:Monetarypolicyshouldaimforalowandstableinflationrate.Newv
43、iew:Stableinflationisnecessarybutnotsufficientformacroeconomicstability.Monetarypolicyshouldreactmorestronglytoindicatorsotherthanoutputandinflationtomitigatedamagingassetpriceboom-bustcycles.Lowinflationlimitsthescopeofmonetarypolicyindeflationaryrecessions.Raisetheinflationtarget?About2/3sofITcent
44、ralbankscurrentlytargetheadlineinflationoverthemedium-termoflessthan3percent474.Flexibleexchangerate&eclecticmonetarypolicy+Noexplicitcommitmenttoa“nominalanchor,suchasexchangerate,money,orinfaltion-Lotsofdiscretion+ItmayworkiftheCentralBankalreadyhasalotofcredibility(Fed,SwissNationalBank)Itmaynotw
45、orktoachievedisinflation48JV13.13.IV.WHAT CHOICES WERE MADE IN THE PAST49JV13.13.Bretton-Woodsera(1946-1971)FixedexchangeratescurrenciespeggedtotheU.S.dollar&U.S.dollarpeggedtogoldStabilizingthedomesticeconomywasaprimaryobjectiveofmonetarypolicyControlsoninternationalcapitalflows1950sto1970swasaperi
46、odoffinancial repressioninadvancedcountries50JV13.13.Industrialcountriesafter1971EuropeancountrieswentfrompegsnarrowbandswidebandsacommoncurrencyOtherindustrialcountriesadoptedmonetaryaggregatetargetsinthelate1970sorearly1980sbutabandonedthemafewyearslaterMostofnon-euroindustrialcountrieshaveadopted
47、formalinflationtargets(Australia,Canada,Iceland,NewZealand,Norway,Sweden,UnitedKingdom)Alsomorethan20emergingmarketcountries51JV13.13.MonetaryPolicyFramework(2000)Source:IMFAnnual Report on Exchange Arrangements and Exchange Restrictions(AREAER),2001Note:Themonetaryaggregatetargetcategoryincludescou
48、ntriesthatadoptmonetaryaggregatetargetframeworkinadditiontofundsupportedorothermonetarycountries,andalsocountriesthatonlyadoptfundsupportedorothermonetaryprograms.ExchangerateanchorandInflation-targetingframeworkcategoriesincludecountriesthatalsoadoptfundsupportedorothermonetaryinadditiontotheirresp
49、ectiveframeworkprogram(morethanonenominalanchor).MonetaryPolicyFramework(2011)Source:IMFAnnual Report on Exchange Arrangements and Exchange Restrictions(AREAER),2012EvolutionofmonetaryregimesThereissomede factobi-polarityAdvancedCountries:ExchangeRateRegimes,1991,1999,2006(Fischer,2008),and201255JV1
50、3.13.Source:2012advancecountrieslistisfromWorld Economic Outlook,April2013Percent of total countries Hard-pegIntermediateFloat00.10.20.30.40.50.60.71991199920062012Thereissomede factobi-polarity(2)Emerging MarketCountries:ExchangeRateRegimes,1991,1999,2006,and201256JV13.13.Source:EmergingmarketsisSP