MONETARY POLICY: THEORETICAL FRAME AND EMPIRIC EVIDENCE IN A SCHEME OF EXPLICIT INFLATION GOALS

Transcription

1 MONETARY POLICY: THEORETICAL FRAME AND EMPIRIC EVIDENCE IN A SCHEME OF EXPLICIT INFLATION GOALS I. THE PRESENTATION OF THE IMPOSSIBLE TRINITY OF THE OPEN MACROECONOMY The process of globalizaion ha has characerized he world economy during he las decade has propiiaed greaer capial mobiliy, which as redounded in greaer availabiliy of funds o finance he invesmen in emerging economies. Also, he echnological process induced by he menioned globalizaion has propiiaed he creaion of new and varied financial insrumens ha allow diversifying he risk and reducing ransacion coss in financial markes. Said echnological process has also faciliaed he availabiliy of informaion in real ime a a low cos. The beer and greaer availabiliy has propiiaed, a he same ime, a greaer ineracion beween he diverse financial markes around he world, which has declared an increase in he volume of mobilized financial resources as in he speed in which hese are ransferred from one counry o anoher. In he described conex, he design and managemen of he macroeconomic policy have benefied from he increase in he quaniy and qualiy of available informaion, wih which i has been possible o sophisicae and improve he operaional procedures wih which said policy is implemened. Conrasing he indicaed, he globalizaion of he world economy has also generaed resricions in he managemen and implemenaion of he macroeconomic policy, which have been he objec of profound analysis and debae in he framework of he conemporary economic heory. The mos eviden resricion is expressed in he posulae known as he Impossible Triniy of he Open Macro economy, which esablishes ha, in he presence of a subsanial capial movemen (phenomenon ha given he evoluion of he financial marke is irre versible) i is no possible o adop a regimen of he fixed exchange rae and, a he same ime implemen an independen moneary policy ha has as is objecive he sabiliy in he general level of prices. In effec, according o said posulae an economy canno have wo nominal anchors, in his case: he nominal exchange rae and he inflaion. From here anchoring he economy in an only nominal variable is a fundamenal

2 requiremen o observe effecive managemen of he macroeconomic policy; as a maer of fac, in modern macroeconomic lieraure he nominal anchor is considered a public asse, since on he same here ress he susainabiliy of all effors of macroeconomic sabilizaion of a counry, aspec ha is fundamenal o promoing growh and orderly developmen of an economy.. A. THE NOMINAL ANCHOR LESSON The counries ha choose an exchange rae as a moneary policy nominal anchor, adop, eiher a dollarizaion scheme, as in he case of Panama, Ecuador and El Salvador, or a he scheme of he super fixed exchange rae, which is he case of he Currency Board in Argenina ( ) 1. I is worh indicaing ha he adopion of he scheme of he super fixed exchange rae looks o sabilize he inernal inflaion a inernaional levels. On he oher hand, he counries ha choose a moneary aggregae as a nominal anchor or hose who adop an explici inflaion goals scheme 2, also avoid incurring in he macroeconomic inconsisencies derived from he impossible riniy; in oher words, respec he nominal anchor, allowing he moneary auhoriies o consisenly sabilize he general level of he inernal prices, which posiively influence in he expecaions of he economic agens, aspec ha srenghens and gives susainabiliy o he macroeconomic sabiliy 3, bu mainly o he moneary policy. B. THE LOSS OF THE NOMINAL ANCHOR I is imporan o poin ou ha when he impossible riniy posulae is no observed, he moneary auhoriy loses conrol over he nominal anchor and, herefore, incurs in macroeconomic inconsisencies. In ha regard, following are wo possible cases in which he nominal anchor is los in a small and open economy. 1 The susainabiliy and effeciveness of he Currency Board requires fiscal discipline, price flexibiliy and salaries and a high level of inernaional moneary reserves. I is worh poining ou ha he collapse of he Currency Board in Argenina is basically due o he lack of fiscal discipline and salary rigidiy. 2 In his moneary scheme i is fundamenal o give solidariy o he fiscal consolidaion effors. 3 The focus of explici inflaion goals he advanage had ha even when a counry does no have he adequae capial marke ha allows implemening a susained moneary policy according o he Taylor Rule, he moneary managemen can accompany he radiional financing programming scheme, bu ha i balances he effeciveness of said focus, as in he case of Guaemala. 2

3 1. When in he presence of an independen moneary policy ha allows he sabiliy in he general level of prices, adop he objecive of a nominal exchange rae The loss of he nominal anchor in he economy can happen when a counry has been adoping a moneary policy ha pursues he sabiliy in he general level of prices, in a conex of he flexible exchange rae simulaneously decides he nominal exchange rae anchor; in oher words, decides o pursue he objecive of he nominal exchange rae. When adoping an objecive of he adminisered exchange rae, he nominal exchange rae becomes an exogenous variable; in oher words, ha he cenral bank fixes a value and, herefore, he res of he macroeconomic variables, especially Money offer, mus adjus auomaically o he prevalen real and financial condiions in he economy. In he conex of an adminisered exchange rae, he endogenisiy of he moneary offer means ha he same is deermined by he resul of he paymen balance. So when he paymen balance experimens an increase in he inernaional moneary reserve, he moneary auhoriy has o acquire he excess of foreign currency in he moneary exchange, in exchange for inernal currency, which ranslaes ino an increase in he moneary offer. On he conrary, when he paymen balance exhibis a decrease of inernaional moneary reserve, he cenral bank mus provide he foreign currency exchange marke, which implies a reducion of he inernal moneary offer. The fac ha he Money offer is deermined by he resul of he paymen balance implies ha he cenral bank is no fully able o use he moneary policy o sabilize he inernal level of prices. In effec, he income (expendiure) of foreign capial would ranslae ino increases (decreases) of he inernaional moneary reserves and, herefore, in increases (reducions) of inernal moneary offer, which could propiiae, a he same ime, a marked variabiliy in he inernal prices, in he ineres raes and in producion. Addiionally, when he capial expendiure is significan, for example, he high mobiliy of capial can generae he depleion of he inernaional moneary 3

4 reserves of he cenral bank and induce he economic agens ino modifying heir expecaions regarding he funcions of local currency, which, according o inernaional experience, regularly, ranslae ino he abandonmen of he adminisered exchange rae. On he oher hand, when an excess income of foreign capial is given, he economy will experimen an inflaionary process accompanied by he appreciaion of he real exchange rae, which, when eroding he compeiiveness of he exporaions, could also induce auhoriies o abandon he adminisered exchange rae. Of he previous analysis i is possible o infer ha i is impossible o simulaneously and susainably mainain, an objecive of he adminisered exchange rae and an independen moneary policy, since, as was poined ou, he mobiliy of capial (common elemen in small and open economies) induce an unsable behavior in he money offer. In ha sense, o avoid incurring in he inconsisency of he impossible riniy, several counries have adoped a flexible exchange sysem, given ha under said scheme he cenral bank has direc conrol on he moneary offer and, herefore, an dedicae is effors oward sabilizing he inernal prices (Inflaion Targeing), so ha he exernal secor adjusmen is made by auonomous movemens of he nominal exchange rae, according o he supply and demand condiions of he exchange marke. 2. When in he presence of an independen moneary policy ha pursues he sabiliy in he general level of prices, in he framework of a flexible exchange rae, using he exchange policy for he real exchange rae anchor I is worh menioning he fac ha he moneary policy has been assigned he objecive of sabilizing he general level of prices, susained ha, in he long erm, a nominal variable (moneary offer) can only affec anoher nominal variable (inernal prices) and, from no poin of view, a nominal variable can influence in he behavior of a real variable, like he real exchange rae. 4

5 In he following we will go over some of he relaive aspecs of he exchange policy and he exchange rae, nominal as well as real. a) Exchange Policy and Nominal Exchange Rae The paricipaion (o r, if i were he case, he lack of paricipaion) of he cenral bank in he exchange marke has a deermining effec in he level he nominal exchange reaches in said marke. This fac is someimes called on o recommend he applicaion of an exchange policy ha pursues he nominal depreciaion o favor he compeiiviy of he exporing secor. In ha regard, i is recommended ha he exchange policy be acive in some cases, in ha sense ha he paricipaion of he cenral bank in he exchange marke leads o a nominal depreciaion ha, as a minimum, compensaes he exporing secor due o loss of compeiiviy ha is derived of he differenial beween inernal inflaion and commercial parners inflaion. The problem ha he recommendaion of he menioned policy encloses is ha he acive exchange policy in ha sense implies he adopion of a nominal exchange rae goal, which is compaible wih he adopion of any oher nominal goal (for example as an inflaion goal or a growh goal of a moneary aggregae). Therefore, he acive exchange policy in quesion is incompaible wih he adopion of a scheme of explici inflaion goals (independen moneary policy), which makes inflaion become an endogenous variable and no in a variable deermined by he moneary policy; in oher words, he inflaion goal is no longer a nominal anchor of he moneary policy. Addiionally, i mus be indicaed ha he acive exchange policy referred o does no look for consecuion of a deermined nominal exchange rae (in oher words, no using he exchange rae as a nominal anchor), bu looking o generae a nominal depreciaion ha compensaes, as was indicaed, he differenial beween inernal inflaion and exernal inflaion; bu, said differenial does no exane deermine, since, as i was menioned, he same policy makes inernal inflaion be deermined endogenously. Therefore, an acive 5

6 exchange rae implies he absence of a well defined nominal anchor in he moneary policy. In a siuaion of nominal indeerminaion as is he case, inflaion levels and exchange depreciaion would be deermined by self-fulfilled expecaions of he economic agens, in an environmen moneary exchange growh insabiliy and, in general, macro economically. In summary he acive exchange policy ha would wan o improve he compeiiviy of he exporing secor generaes fundamenal inconsisencies beween moneary and exchange policies, avoiding ha he cenral bank fulfills is fundamenal objecive, which is he sabiliy in he general level of prices. b) Exchange policy and he real exchange rae According o he expressed, he acive exchange policy ha seeks he nominal depreciaion does no have an enduring effec on he exporing secor and, herefore, in he compeiiviy of he economy, because said policy implies a loss of inflaion conrol and, herefore, does no lead o a real depreciaion (excep, possibly in he very shor erm). The reason why he exchange policy does no affec he real exchange rae in a susained manner, is ha said policy essenially affecs nominal variables (he nominal exchange rae and he moneary offer), so much so ha he real exchange rae is, as is name indicaes, a real variable. As a maer of fac, he real exchange rae reflecs he price of exernal goods in erms of inernal goods. So ha he real exchange rae increases (in oher words, for a real depreciaion), i is necessary ha he level of prices of exernal goods increase regarding he level of inernal prices of goods; his in pracice, implies ha he level of prices of inernal goods increase less han he level of prices of exernal goods. For ha o occur, he macroeconomic policy mus sufficienly resric he aggregae demand of goods produced inernally. Said resricion of aggregae demand are compleely ou of reach of cenral bank policies (moneary and exchange), aken as isolaed, due o he fac ha he same can only be achieved hrough he combined effec of macroeconomic policies, 6

7 among which are he fiscal policy (ha deermines he level of savings of he public secor and affecs he level of privae savings secors) and he srucural policies ha affec he relaive prices of he inernal and exernal goods (like he foreign commerce policy) and hose ha affec he decision of savings and invesmen (like financial and foreseeable policies). In conclusion, i is convenien o have he lack of viabiliy and inconsisency of assigning he exchange policy he objecive of he compeiiviy of he exporing secor in mind. Said objecive should be assigned o a more inegral presenaion of he macroeconomic policy, so much so ha he exchange policy should be limied o be compaible wih he search of he fundamenal objecive of he moneary policy, which is o propiiae he sabiliy in he general level of prices. As long as he moneary policy concenraes on propiiaing he consecuion of a well defined inflaion goal, he exchange policy, o be consisen, mus allow ha he nominal exchange rae is freely deermined in he marke wihou he paricipaion of he cenral bank, expec, in he paricular case, o avoid he excess exchange volailiy. II. THE ORIENTATION OF THE MONETARY POLICY During he las en years he macroeconomic policy around he world has experimened deep ransformaions, due, among ohers aspecs, o he new economic and financial srucure of he world economy, which is characerized by a greaer inegraion and real inerdependence and financial among economies. In effec, he process of globalizaion in he world economy demands macroeconomic discipline so he economic agens can exrac greaer benefi in said process. In ha sense, here is consensus referring o he sabiliy in he general level of prices is a basic condiion o promoe growh and economic developmen. This is due o he fac ha he sabiliy in he general level of prices reduces he volailiy in he relaive prices, which promoes a more efficien assignmen of economic resources. 7

8 The menioned implies ha a cenral bank mus concenrae and direc heir acions and achieve he sabiliy in he general level of prices, since his consiues a greaer conribuion han he moneary policy can give o promoe a macroeconomic environmen in which he markes of loanable funds, goods and services, of Money and work can operae efficienly, promoing producion and employmen. I is also worh indicaing ha he sabiliy in prices reduces he uncerainy and, herefore, cooperaes wih he economic agens in adequae decision making in maers of savings, invesmen and employmen. The effeciveness in he reducion of he uncerainy implies ha a cenral bank mus be ransparen and render accouns on heir acions. In ha sense, mus provide he public wih opporune informaion and rue on he inflaion goal ha srives for a deermined horizon, whic h implies ha he inflaion rae becomes he nominal anchor of he moneary policy 4. The fac ha he fundamenal objecive of a cenral bank consiss of reaching and preserving he sabiliy in he general level of prices is susained no only in he convincing ha he high and volaile inflaion is damaging o he economic growh, bu also, in he simulaneous search of oher objecives on behalf of he moneary auhoriy (for example, he exchange rae) is economically inefficien and can se he consecuion of he sabiliy objecive a risk. Tha is why he use of he general level of prices as a nominal anchor of he moneary policy implies and demands he adopion of a regimen of exchange flexibiliy, so ha he nominal exchange rae be deermined by he supply and demand, which means ha he adjusmen of he exernal secor basically fall back on he nominal exchange rae. The imporance of focusing he moneary managemen oward achieving he sabiliy of he inernal general level of prices, and makes he exernal adjusmen fall back on he nominal exchange rae, implying ha a cenral bank hrough he combinaion of is differen insrumens implemens he moneary policy hrough changes in he ineres rae, which guaranees ha he same keep conrol on is nominal anchor. 4 I is imporan o poin ou ha he loss of he nominal anchor of he moneary policy has high economic and social coss, since i can lead an economy oward a process of high economic and financial inflaion and insabiliy, such as is shown in he evidence of counries ha ried o use he moneary policy o reach various objecives. 8

9 The deepening of sabiliy and efficiency of he macro economy also requires he consolidaion of public finance. If effec, he fiscal discipline is imporan no only o avoid he weigh of sabilizaion falls exclusively on he moneary policy, which could generae disorions in he main macroeconomic variables, bu also o cooperae in producing an efficien adjusmen o he exernal secor, since he excessive public expense ranslaes ino an increase of he aggregae demand and inernal ineres rae, as well as ino an excess of appreciaion of he real exchange rae. In pracice, he fiscal lack of income produces an excess of aggregae demand ha, a he same ime, ranslaes ino an increase in imporaions of paymens. Also, he excess of public produces an increase in he price of inernaionally non-radable goods, aspec ha generaes an appreciaion of he real exchange rae, which influences negaively in he compeiiviy of naional exporaions and, herefore, cooperaes in he deepening, as was indicaed, he lack of balance in he paymen balance accoun. Anoher probable negaive effec of fiscal indiscipline is ha he same can propiiae he so called displacemen effec, which a he same ime ranslaes in an increase of he inernal ineres rae, propiiaing he income of exernal speculaive capial ha can place he exchange and financial sabiliy a risk. The menioned implies ha he consolidaion of fiscal discipline is imporan so ha he moneary policy efficienly reaches is fundamenal objecive, as well as o produce an adequae adjusmen of he exernal secor. In ha sense, he inensificaion of is effors o keep he moneary and fiscal discipline is fundamenal o propiiae he reducion of he differenial of he inernal ineres rae regarding he exernal, aspec ha propiiaes a gradual mobiliy of capial oward he exerior, leading o an adjusmen, also gradual in he nominal exchange rae, which, a he same ime cooperaes in he adjusmen of he exernal secor. As can be appreciaed, he consisency of he moneary policy, based on he exisen of a nominal anchor, is of fundamenal imporance o creae he ideal condiions for he orderly and susainable growh of he economy; however, i is necessary o highligh ha said policies on heir own are no a 9

10 sufficien condiion o permanenly generae he economic growh and developmen. In effec, he generaion of growh and developmen also requires disciplined moneary and fiscal policies ha coincide wih srucural characer policies, like commercial, work and ohers ha promoe a beer use of he producion facors, increasing economic produciviy, all of which will redound in greaer compeiiviy of i in inernaional markes and, in ha way, favor he economic growh in he long erm ha allows a susained elevaion of he level of life of he populaion. III. THE MONETARY POLICY IN GUATEMALA IN A SCHEME OF EXPLICIT INFLATION GOALS A. OF MONETARY GOALS TO EXPLICIT INFLATION GOALS The Moneary Board resolved o approve he process of adoping a scheme of explici inflaion goals 5 in order o consolidae he sabiliy in he general level of prices in Resoluion JM , among oher aspecs; i is also rue ha he esablishmen of inflaion goals goes back o he beginning of he nineies. In effec, in 1991, wihin he moneary scheme of goals 6, for he firs ime defines and announces an inflaion goal, fixed a 15% for his year. In 1992, an expeced inflaion rae of 8% was made known. I is worh indicaing ha in said year subsidies and exchange resricions were eliminaed and a more flexible process of he nominal exchange rae was begun. In 1993, an inflaion goal of 8% was esablished. I is worh menioning ha in he referred year a public sale mechanism for foreign currency was adoped ha fixed prices according o he exchange marke condiions. In 1994, an inflaion goal was fixed and he foreign exchange marke was made more flexible. In 1995 and 1996, for he firs ime i was explicily announced ha he cenral objecive of he moneary 5 The Scheme of Explici Inflaion Goals is a reference framework of moneary policy characerized by he public announcemen of quaniaive goals (or ranges) of official characer (inflaion raes) regarding one or more emporary horizons, wih he explici cerainy ha a low and sable inflaion is he main long erm objecive. 6 The moneary goals scheme is fundamenal in he quaniaive heory of Money, in which when conrolling he growh of he moneary offer, i influences in he general level of prices. In ha sense, said scheme says ha a goal can be esablished for a paricular moneary aggregae (for example, paymen means and moneary issue) and inermediae goals for oher relevan moneary aggregaes, in order o reach he final objecive of he moneary policy. 10

11 policy would consis in achieving he sabiliy in he level of prices, for ha he inflaion goal was fixed in a range of 8% and 10%; esablishing inermediae goals for exernal asses, inernal asses and money offer, as o he operaion of he moneary program. In boh years, he exchange scheme coninued being flexible, esablishing, in 1996, he Elecronic Sysem of Negoiaion of Foreign Currency SINEDI [For is acronym in Spanish]-, mechanism ha was adoped o ease he exchange rae would esablish marke condiions. In 1997, a goal of 8% and 10% and began giving emphasis o he use of open marke operaions as a moneary conrol insrumen. In 1998 a new range of inflaion was esablished, which was defined beween 6% and 8% and advanced in eh use of open marke operaions as he main insrumen in order o regulae he liquidiy in he economy. In1999 and 2000 an inflaion range beween 5% and 7% for boh years was announced, bu beween 2001 and 2005, he inflaion goal range was esablished beween 4% and 6%. On he oher hand, in 2006 he goal was fixed a 6% +/- 1 percenage poin. Following is a graph ha summarizes he inflaion goals referenced o above, as well as he deviaion of he inflaionary rhyhm observed regarding he same, for he period. METAS DE INFLACIÓN Y RITMO INFLACIONARIO Período: Años Puno fijo Mea de inflación Rango de la mea Mínimo Máximo Rimo inflacionario Desviación en punos porcenuales * */ A ocubre 11

12 In he described conex, as is observed in he above graph, under he scheme of moneary goals, in 1991 he deviaion of he inflaionary rhyhm was significanly lower regarding he esablished goal for ha year. On he oher hand, in he period, said deviaion was higher han he goal. In 1995, he inflaionary rhyhm was locaed wihin he range-goal esablished. For 1996, a sligh deviaion was observed of he esablished range for his year; whereas in 1997 he inflaionary rhyhm was locaed under he inferior limi of he goal-range. In 1998, he acions in moneary maers allowed he new inflaionary rhyhm o December of ha year so no deviaion was observed. Finally, wihin he referred scheme of moneary goals, in 1999, he inflaionary rhyhm was slighly below he lower limi of he esablished goal-range for said year. I is worh poining ou ha as of 2000 here were imporan changes in he manner in which he Moneary Board deermined he Moneary, Foreign Exchange Rae and Credi Policy, since he following indicaive variables were issued: moneary issue, ineres raes, banking credi o he privae secor, real exchange rae, subjacen inflaion, moneary condiions index and a parameer rae, ha reflecs a similar crieria o he Taylor Rule. The referred variables were adoped o orien he decision in moneary policy maer due, among oher facors, o he fac ha he moneary aggregae (due o financial innovaion, especially) had los a lo of is informaive and predicive value. On he oher hand, i is worh indicaing ha wih he enforcing of Decree Number he Congress of he Republic, Organic Law of he Banco de Guaemala, he Moneary Board decided he necessary legal framework for he adopion of a scheme of explici inflaion goals, giving prioriy o he esablished in he general level of prices; srenghening is formal, operaive and financial auonomy (parimonial resoraion); delimiing is role of las insance lender; assigning imporance o is responsibiliy of waching he paymen sysem; obligaing i o increase is ransparency as o spreading he repors on he resuls in inflaion maers; obligaing i o render accouns hrough he appearing of he Presiden of he Cenral Bank before he Congress of he 12

13 Republic wice a year (January and July) o render he corresponding repors; and, privileging he use of indirec insrumens of he moneary policy, paricularly, of he moneary sabilizaion operaions a marke ineres raes. On he above, a fundamenal change in he operaive auonomy of he Cenral Bank was he esablishmen of an Execuion Commiee, hrough which he Banco de Guaemala execues he moneary, foreign exchange rae and credi policy deermined by he Moneary Board. The Execuion Commiee has he following aribuions: Use he insrumens of moneary policy in he manner of approval by he Moneary Board; Inform in he nex Moneary Board meeing, hrough is coordinaor, regarding he execuion of he moneary, exchange and credi policy adoped by hem; and, Exercise he oher aribuions ha he Moneary Board assigns for execuing he moneary, foreign exchange rae and credi policy. In he conex of aribuions of he Execuion Commiee, i is worh menioning ha in 2005 hey approved he inroducion of modificaions o operaions of moneary sabilizaion wih he purpose of increasing he efficiency of he moneary policy; among hese we can menion: i) fixing he leading shor erm ineres rae (LTDs in 7 day erms); ii) seing a calendar for decisions regarding changes in he leading ineres rae; iii) reducion of he number of biddings; and iv) fixaion of quoas for he fund-raising of LTDs ha are placed hrough he bidding mechanism. On he oher hand, in 2005 and in 2006 he Banco de Guaemala paricipaed in he exchange marke hrough an explici paricipaion rule, ha is oriened oward eliminaing he discreion in he paricipaion of he Cenral Bank in said marke and whose objecive consiss of moderaing he volailiy of he exchange rae, wihou affecing is endency. Also, concerning he projecions of macroeconomic variables for a beer conducion of he moneary policy, in 2006 was implemened as an analysis ool 13

14 of he Semi-srucural Macroeconomic Model- MMS - 7, whose purpose is o help he Cenral Bank in he inerpreaion of he sae of he economy and in he policy decision-making ha conribues o he achievemen of is fundamenal objecive. The MMS consiss of a sysem of equaions ha allow quanifying he direcion and magniude of he relaions beween he main macroeconomic variables, as well as he foreseeable evoluion of he same, aking ino accoun he reacion of economic agens before he decisions of he moneary policy of he Cenral Bank. In his manner, he MMS has been designed as an analyical framework ha allows discussing he more precise and orderly manner of he implemenaion of policy acions o moderae he inflaion expecaions. The MMS generaes forecass ha are condiioned o he cenral bank fulfilling a moneary policy ha leads inflaion oward is balance values in he mid and long erms 8. On he oher hand, in maers of explici inflaion goals, ransparency and accoun rendering consiues key facors for he design, implemenaion and effeciveness of he moneary policy. Therefore, he decisions of he moneary policy are periodically spread hrough he following repors: Publicaion of moneary policy repors According o he esablished in he organic law, he Banco de Guaemala publishes a moneary policy repor wice a year ha conains an explanaion of he operaions made o reach he fundamenal objecive. Repor o he Congress of he Republic of Guaemala In he monh of January eve ry year, he Presiden of he Banco de Guaemala mus appear o render a repor before he Congress of he Republic, ha conains he deeds and policies of he Cenral Bank in he previous year and explain he objecives and policies forecas for 7 I is imporan o poin ou ha his model has been buil wih he echnical assisance of he Inernaional Moneary Fund in he maers of adoping a scheme of explici inflaion goals. 8 The model is calibraed so ha, in he long erm, he inflaion converges a an annual rae of 3%. 14

15 he curren fiscal year. In he monh of July, a repor of he execuion of he moneary, foreign exchange rae and credi policy mus be given in he curren fiscal year. Presenaion of he deeds of he Execuion Commiee Weekly, he Banco de Guaemala on is Inerne page presens he deeds ha conain he discussions of he members of he Execuion Commiee regarding he guidelines for he execuion of he moneary policy wih a weeks delay. Presenaion of he deeds of he Moneary Board Monhly, he Banco de Guaemala publishes a summary of he argumens of he Moneary Board aking ino accoun heir decisions in maers of deermining he leading ineres rae of he moneary policy wih a monhs delay. Release of he informaion of he Banco de Guaemala According o he organic law, he Banco de Guaemala hrough he media presens is general balance, including noes of explanaion and an ouline of adminisraive expenses, monhly. Also, once a year, presen financial saemens in an analyical form, verified by an independen audior. The Banco de Guaemala also publishes a sudy ha conains he mos relevan aspecs of he naional economy annually; also, releasing he main macroeconomic saisics of moneary, foreign exchange rae and credi characer, of he paymen balance, he Aide de memoir of he Cenral Bank, he moneary program, he evaluaion of he moneary policy and oher relevan documens. 15

16 B. THE INTERNATIONAL EXPERIENCE IN MATTERS OF EXPLICIT INFLATION GOALS A low and sable inflaion rae is fundamenal o promoing susainable economic growh. In his conex, he scheme of explici inflaion goals consiues a reference framework so ha he moneary policy, hrough he use and combinaion of differen insrumens, efficienly ensures he sabiliy of he general level of prices. In he following we presen a general vision ha conains he concepual aspecs of he menioned scheme and he inernaional experience of he same. 1. The role of economic informaion in he design and follow-up of he scheme of explici inflaion goals The majoriy of moneary policy sraegies, like he growh goals of moneary aggregaes, make inense use of inermediae goals (for example, he balance of Money in a reduced sense or in an ample sense), ha can be reasonably conrolled by he moneary auhoriies, bu only have an indirec effec and an uncerain saisical relaion wih he objecive variable, inflaion in his case. Based on his, he cenral banks are suppored on more variables ha provide useful informaion on he economic siuaion, known as informaive variables or indicaive variables, which are chosen o projec, as good forecasers. However, i is worh indicaing ha hese variables mus be used wih cauion, since here is no guaranee ha he informaion ha hey conain will remain consan in he fuure. On he oher hand, he beer opion is o combine he use of informaion variables wih forecas models susained in he economeric mehods. 2. Discreion or esablished rules During he nineies many cenral banks susained he operaive procedures in moneary policy rules. These rules were desined o eliminaing he possible inflaionary bias as well as he srenghening of he credibiliy of he 16

17 moneary policy; however, he rigidiy of he menioned rules made he need o coun on a scheme for he moneary policy eviden ha simulaneously, could eliminae he possible inflaionary bias and posiively affec he expecaions of he economic agens. The moneary policy scheme ha fulfills he menioned requiremens should reach a soluion of fulfillmen among he models of esablished rules and hose of absolue discreion; in oher words, should incorporae he advanages of boh schemes and avoid, as possible, he probable disadvanages aribued o he same. Said soluion of fulfillmen came from he experience of several counries ha decided ha is cenral banks publicly announced inflaion goals ha com mied o reaching a deermined horizon. Also, ogeher wih he announcemen of inflaion goals (inflaion argeing) should make known operaive and analyical procedures o he economic agens ha he moneary auhoriy will implemen of reaching he announced goal. The implemenaion of he moneary policy in he menioned erms has he advanage of commiing he cenral bank in fulfilling he announced, which eliminaes any inflaionary or deflaionary bias ha could derive in a moneary policy dynamically inconsisen and also, posiively affec he expecaions of he economic agens, due o he fac ha hese coun on he relevan informaion on he possible evoluion of he moneary managemen. 3. The elecion of a nominal anchor: a crucial elemen In choosing he nominal anchor of he moneary policy, he managers of he same have hree basic choices: he nominal exchange rae, a moneary aggregae or he inflaion. In he counries wih a regimen of a flexible exchange rae, he nominal anchor can be a moneary aggregae (moneary base issue or ineres rae). According o his sysem, he cenral bank uses is insrumens, for example, he ineres raes, o conrol he moneary aggregaes ha are considered he main deermining facor of he long erm inflaion. In his way, he conrol of moneary aggregaes would be equivalen o sabilizing he inflaion rae as o he value 17

18 goal, which ensures no losing he nominal anchor in he economy. Evidenly, he possibiliy ha he moneary aggregaes ac effecively depend on he sabiliy of is empiric relaion wih he goal variable (he inflaion rae) and is relaion wih he moneary policy insrumens (generally he moneary sabilizaion operaions). Even hough he growing inegraion of world capial markes in he las weny years has aken place, and he growing lack of sabiliy of he capial curren from he European Moneary Sysem (SME, for is acronym in Spanish), in 1992, especially afer he mos recen financial crisis in Asia and Lain America, he condiions o mainain he fixed exchange rae sysem has become more complicaed. In effec, he developing and ransiion economies ha coninue keeping a fixed exchange rae as a nominal anchor of he moneary policy are he objec of growing pressure wheher i be more flexible mechanisms or on he oher end of he specrum, privileging he conversion ill mechanisms or he dollarizaion. Of his accoun, a measure ha he financial insiuions creae money subsiues, money demand is each ime more unsable, evidencing ha, alhough here is an imporan correlaion in he long erm beween money and inflaion, is shor erm correlaion is difficul o poin ou. Therefore, from he beginning of he nineies he number of counries ha have adoped a scheme of explici inflaion goals as a sraegy for conducing he moneary policy has increased. 4. Operaive aspecs of explici inflaion goals sraegies The adopion of a scheme of explici inflaion goals commis he cenral banks o sabilize he inflaion rae. The process habiually begins wih a public announcemen of he cenral bank of an explici quaniaive goal ha mus reach a deermined horizon (for example, a 5% annual rae in a wo year period). Afer, he cenral bank, ha mus have he freedom o decide how o use heir moneary insrumens (insrumenal independence), has he responsibiliy of reaching ha foal and mus periodically inform he public on is moneary policy sraegy. This ransparency obligaion conribues o reducing he uncerainy regarding he fuure direcion of he moneary policy and 18

19 promoing he credibiliy of he cenral bank and he accoun rendering on is behalf. Normally, he cenral banks ha adop his sraegy adjus is insrumens (for example, he moneary sabilizaion operaions) a a level ha will ake he inflaion rae previsions for one or wo years ahead. The previsions ac like an inermediae goal; he discrepancy beween he forecas and he fixed goal moivae moneary policy decisions ha allow closing he gap. In pracice, he cenral bank habiually decides he fuure course of he moneary policy hrough an evaluaion of he informaion coming from a series of indicaors or indicaive variables, like he inflaionary forecas of he srucural and semi srucural macroeconomic models, he previsions generaed wih more mechanical crieria (like he models of auoregressive vecor models or ime series) and he surveys of he inflaionary expecaions of he marke. The moneary auhoriies also sudy he evoluion of he fundamenal moneary and financial variables, like money and credi, he srucure of ineres rae erms, he price of asses and he labor marke condiions. In he measure in which more han one of hese indicaors suggess ha he fuure inflaion could overcome he goal, making he need o acivae he insrumens ha allow resricing he moneary condiions more eviden. 5. Imporance of ransparency The moneary policy is more efficien if he markes of goods and services, money; lending and exchange funds make up he objecives of he policy and he links beween he moneary policy measures and is objecives. Also, ransparency ransmis he idea ha he cenral bank is responsible for he resuls o he marke agens, which a he same ime, could influence in he design and implemenaion of he policy. I is worh indicaing ha he cenral banks will inspire greaer rus if hey have had a good rajecory in he achievemen of he announced inflaion goals. In ha conex, all cenral banks ha apply a sraegy of explici inflaion goals publish periodic repors of he moneary policy or repors on inflaion, in which hey indicae he direcion of he moneary policy and explain he discrepancies 19

20 beween he observed and he fixed inflaion rae as a goal. To faciliae he comprehension of he sraegy of he cenral bank, also include inflaion forecas of inflaion and a descripion of coningen policies. This anicipaed announcemen reduces he probabiliy ha he reacion of he bank before said coningencies be misinerpreed. 6. Oher aspecs of he implemenaion The implemenaion of a sraegy of explici inflaion goals demands ha he auhoriies adop various key decisions. Firs, hey have o esablish he measure of inflaion o be used. The wo naural opions are he Consumer Price Index (CPI) and he implied deflecor of he gross domesic produc. Alhough he laer is he mos aracive, given ha i direcly reflecs he inernal inflaion concep, he CPI offers eviden operaive advanages: his is he mos familiar index for he public; i is habiually available monhly and puncually (which allows periodic conrol) and is occasionally reviewed. The second aspec is o decide he inflaion goal. There is consensus in ha i is no convenien o have a zero inflaionary goal, since he presence of rigidiy oward he decline of nominal salaries and prices requires a posiive inflaion rae o give margin o he necessary variaions of real salaries and oher relaive prices of he economy. A zero inflaion goal would no leave margin eiher so ha, if necessary, he real ineres raes would acquire a negaive sign in some phase of he economic cycle. Cerainly, one of he advanages of he sraegies based on he explici inflaion goals is ha hey can avoid deflaion, compensaing he effec of negaive sysemaic perurbaions in he aggregae demand. A hird aspec is o decide if a puncual goal is adoped or an inerval inflaion goal. Usually, he cenral banks ha apply a sraegy of explici inflaion goals have chosen a goal wih a lower limi and an upper predeermined olerance limi. I is his way because of he difficulies of predicing inflaion and he uncerainy in he precise emporary conex of he naural de-phasing of he moneary ransmission mechanisms, migh no reach he announced puncual goal, which would cause loss of credibiliy. The puncual goal could demand a 20

21 very firm moneary policy o minimize he probabiliy of lack of fulfillmen. The inerval goal, on he oher hand, requires a decision on he wide band. A narrow band in some measure presens he same problem ha he puncual goal. Whereas a band ha is oo wide, alhough i increases he probabiliy of fulfilling he goal, could be an inefficien guide for he expecaions. The fourh aspec is he elecion of a emporary horizon of he moneary policy; in oher words, which should be he speed of he rajecory oward he lowes inflaion goal. Maybe iniially gradual deflaion crieria may be preferable before he long erm conracs and an adjusmen of he inflaion expecaions. A he same ime, he need o overcome he ineria in he inflaion expecaions and promoe he credibiliy, would poin oward a more acceleraed deflaion. A las aspec is he regimen of he exchange rae. The regimen ha is compaible wih he sraegy of he explici inflaion goals is he flexible exchange rae, which allows an immediae and permanen adjusmen of he exernal secor. An advanage of he exchange floaion is ha i reduces he vulnerabiliy of he counries before sudden speculaive crisis. However, a common problem, especially for he counries wih a hisory of high inflaion raes, is he fear ha he greaer variabiliy of he nominal exchange rae will be ransferred direcly o he prices (ransfer effec). I is worh indicaing ha he nominal exchange rae is an imporan channel of he ransmission mechanism of he moneary policy. The depreciaions of grea magniude, for example, produced perurbaions of he relaion of exchange erms or due o capial currens, could be quickly ranslaed ino an increase in inernal prices. 7. Degree of flexibiliy ha is offered by he explici inflaion goals sraegy One of he quesions presened by he sraegy of explici inflaion goals is if i provides flexibiliy o implemen he moneary policy or if he cenral banks ineviably adop a sric focus, according o which he achievemen of he inflaion goal is he only objecive of he moneary policy. I is eviden ha he cenral banks have no only ried o reduce he minimum gap beween effecive inflaion and he fixed goal, as well as he inflaion variabiliy, bu have been 21

22 worried by he variabiliy of inernal producion around he poenial level. However, he preoccupaion regarding he sabiliy of he inernal producion mus never se he viabiliy of he mid-erm inflaion goal a risk. In he described conex, i is imporan o presen ha here is an inverse relaion beween flexibiliy and credibiliy. If he regimen is oo flexible, he objecives of he policy are no credible. On he conrary, if he regimen is excessively rigid, he variabiliy of inernal inflaion can be greaer han he desired. Definiely, cauion is necessary. If he credibiliy is solid from he beginning, his inverse relaion will coninue o lose srengh and increase he flexibiliy in he mid-erm. The perseverance of he auhoriies in his environmen sends he money and exchange markes he signal ha he cenral bank enjoys rue independence and credibiliy. C. INTERNATIONAL EVIDENCE The resuls obained o dae by he cenral banks ha apply a sraegy of explici inflaion goals in indusrialized counries are saisfacory. The concenraion in he sabiliy of prices has conribued o a noable convergence of inflaion raes of hese counries. I is worh saing ha he benign economic inernaional environmen in he las few years and he inernaional inegraion process have conribued in par o his convergence, herefore some specialiss poin ou ha he sraegy of explici inflaion goals has sill no passed he rial of a complee economic cycle. However, he auhoriies ha have applied hese sraegies have had o face a series of perurbaions ha have been regisered in he crisis of Mexico, Asia, Russia, Brazil and Argenina. 1. Aspecs ha affec developing counries The promising experience of he pioneers in he applicaion of sraegies based on explici inflaion goals and a series of failed experiences wih exchange anchors in Asia and Lain America have persuaded several developing counries of he convenience of adoping a similar sraegy o conain inflaion, promoe he credibiliy and anchor he expecaions. In Lain America: Brazil, Chile, Colombia, Mexico and Peru have abandoned he 22

23 exchange bands and have gone o regimens of floaing exchange raes. These counries, like oher emerging economies, like Poland, he Czech Republic, Souh Africa and mos recenly, Thailand, Philippines and Korea conduc heir moneary policy hrough a more or less formal process of explici inflaion goals. Alhough he majoriy of hese counries have applied his sraegy for only a shor ime, he experience o now has been inspiring. For example, Chile and Israel had similar experiences; boh counries adoped a conex of explici inflaion goals a he beginning of he nineies, when hey regisered annual inflaion raes close o 20%. The sraegy was gradually implemened and flexible in boh counries, and since 2003, reduc ed he inflaion o inernaional levels wihou originaing subsanial coss in maers of economic growh. The fixaion of explici inflaion goals can benefi in developing counries in many ways, esablishing a coordinaion insrumen of inflaionary expecaions and a measure ha allows judging he fulfillmen of he commimen of he cenral banks. Bu he developing counries have specific problems ha can make i more difficul han for indusrial counries o implemen he sraegies based on explici inflaion goals. Firs, many developing counries sill regiser relaively high inflaion raes, so i is difficul o precisely foresee, fuure inflaion. Therefore, he probabiliies of no fulfilling he inflaion goal are greaer han in developed counries. Second, he degree of impac of he exchange variaions on he prices (ha end o be greaer in developing counries) and he generalizaion of explici indexaion and even implied mechanisms, give way o considerable inflaionary ineria. Third, one of he prior requiremens for he fixaion of explici inflaion goals is ha here is no commimen regarding anoher nominal goal (for example, he nominal exchange rae). Given ha in many developing counries here is a grea proporion of asses and liabiliies denominaed in foreign currency, a significan exchange variaion could adversely affec he inflaion and he degree of financial and real dollarizaion of he economy. Fourh, in many developing counries, he independence of he cenral bank is more heoreical han real, since is decisions coninue o basically be regulaed by he need o finance he fiscal defici, so here is cerain fiscal predominaion. 23

24 In general, many developing counries have subsanially reduced he cenral governmen s defici, bu some sill have coningen liabiliies ha cover municipal obligaions, public business and he cenral bank iself ha hreaen he consolidaed fiscal siuaion of he public secor. In said circumsances, he cenral banks could doub, for fiscal reasons, before he possibiliy of having o raise he ineres raes o conain inflaion. Las, some developing counries could find difficulies in fulfilling he complex informaion requiremens and of formulaion of inflaion forecas(for example, repors on he main indicaors and rusworhy economeric models). Nowihsanding hese problems, he sraegies based on explici inflaion goals seem promising for he developing counries, since hey offer a series of operaive advanages and obligae hose in charge of policy formulaion of deepening reforms and increasing he ransparency and improving he fiscal orienaion. IV. THE ROLE OF THE MONETARY POLICY AND STABILITY The empiric evidence, in developing counries, has shown ha he main conribuion ha a cenral bank can make on economic developmen is o ensure he acquiring power of he currency is kep and ha he only way o achieve i is hrough he sabiliy in he general level of prices. In ha order of ideas, he Organic Law of he Banco de Guaemala incorporaes he modern focus of assigning he Cenral Bank he fundamenal objecive of promoing he sabiliy in he general level of prices. Said focus emphas izes he search of he efficiency in he acions of he Cenral Bank and subsiues he focus of he search of muliple objecives ha prevail in he previous organic law. The fixaion of a fundamenal objecive in erms of he search and mainenance of sabiliy in he general level of prices, allows he Banco de Guaemala o concenrae is effors in he consecuion of his goal, in his way, maximizing he beer conribuion ha could be offered in he achievemen of he economic developmen of he counry 9. 9 The sabiliy of prices has become a sine qua non condiion o exrac he maximum benefis ha he globalizaion process can offer. This process has creaed an economic and financial environmen ha is exremely dynamic; which generaes he need o coun on efficien and versaile cenral banks o fulfill heir sabilizing ask. 24

25 As for he need o generally keep he sabiliy in he general level of prices, and in paricular, a low and sable inflaion rae, he empiric evidence has made clear ha said sabiliy is a necessary condiion o promoe economic growh. An elevaed inflaion is harmful o growh and economic developmen due, among oher reasons, o he fac ha i promoes a deficien assignmen of economic recourses, which reduces he possibiliy of economic growh; also in he measure in which he volailiy generaes uncerainy and affecing he financial secor of he economy, reduce savings in real erms, negaively redisribues he income, due o he fac ha salaries do no adjus a he same rhyhm ha prices do and promoes a high variabiliy in he money demand, which makes he esimaion of he same difficul and, herefore, makes he conducion of he moneary policy difficul. In he described conex, i is necessary ha for 2007 and 2008 he Banco de Guaemala coninue concenraing is effors in he consecuion of is fundamenal objecive, which is o promoe he sabiliy in he general level of prices. V. SYSTEMS OF MONETAR Y POLICY FORECASTAND ANAYLISIS In a regimen of explici inflaion goals, he Forecas and Analysis Sysem of he Moneary Policy (SPAPM, for is acronym in Spanish), consiss of a se of echnical ools (economeric models, informaion relevan coming from exper analyss, economic indicaors, daa bases and ohers) used o make relevan economic variables forecas for he Cenral Bank, mainly forecas of inflaion and of economic growh, as well as in he aciviy group who make moneary policy decisions in he analysis of said forecas and fuure macroeconomic scenarios derived of he possible policy acions. The SPAPM makes up par of operaive reforms ha he Banco de Guaemala has been making in he moneary policy ransiion period oward a scheme of explici inflaion goals. The design of said sysem began in March 2005, wih he advice of he Inernaional Moneary Fund, and is applicaion began in January During his las year, four forecas exercises were 25