Workshop 1: Monetary policy framework assessment

Transcription

1 Workshop 1: Monetary policy framework assessment The goal of the first part of the workshop is to assess the monetary policy framework adopted by the State Bank of Vietnam. In the second part, we develop our understanding of the transmission mechanism of monetary policy. For Part 1, split in groups of three and work together for 40 minutes to answer questions 1 through 4. Then present your findings to the whole group. You can prepare a few slides to summarize them if you wish. For Part 2, you will stay in the groups but we will also work together in a plenary session. Files used in this workshop: W1_trilemma_indexes_update2018.xls (Raw data for Aizenman, Chinn and Ito methodology (trilemma measures) are accessible at W1_Vietnam_GDP_CPI.xls contains real GDP and CPI data for Viet Nam and other selected countries. The file is used in question 4. W1_MP_Transmission_mechanism.xls is a GUI for simulating basic macroeconomic scenarios and thinking about the monetary policy stance and policy transmission mechanism. The SBV is considering modernizing its monetary policy framework. You are the advisers to the Governors and you were asked to conduct an initial assessment and provide your expert opinion. Part 1: Understanding SBV s Monetary Framework Start your assessment with a stock take of the existing framework. Question 1: Use the template you were given to summarize the main characteristics of the SBV s framework. Follow the example for a similar classification of policy frameworks in Indonesia or Malaysia given in Annex. In particular, focus on answering the following

2 questions: does SBV have a clear policy mandate?, is price stability the primary objective of monetary policy?, what does the central bank law say?, how is monetary policy implemented?, what is the operational framework?, and what are the intermediate and operational targets? How monetary policy is implemented and what are the main financial/policy instruments? Question 2: Where does the SBV s framework stand in regards to the trilemma? Use the Aizenman, Chinn and Ito s methodology (see Annex). What are the measures the methodology uses? What are their values? What does it mean when they are valued at 0 or 1? The country data for financial integration, monetary independence and exchange rate stability indices are in the Excel file W1_trilemma_indexes_update2018. It is the original data set compiled by Aizenman et al. Find the indicators for Viet Nam. They will be in form of time series. For each of them compute the average for the five years available and visualize the measures by charting them in the trilemma diagram in Figure 1 below. Figure 1. Trilemma diagram Monetary independence Financial integration 1 Exchange rate stability Question 3: How does Viet Nam compare to its peers? Use the same data as in Question2. Select three peer countries of your preference and compute the five-year averages for each of the trilemma measures and plot them in the same diagram with the results for Viet Nam.

3 Question 4: In your expert opinion, is the existing framework fit for its purpose? One of the evaluation criteria is macroeconomic stability and performance. How does Viet Nam economic performance compare to its peers? Are there opportunities in terms of growth and inflation? Use the data of real GDP, headline and core CPI in the file W1_Vietnam_GDP_CPI.xls. First, compute annual growth rates. Second, calculate their averages for and Then calculate standard deviations for the growth rates over the same periods. Plot the averages in Figure 2 and compare the developments to ASEAN 5. Does Vietnam do better than ASEAN-5, non-it or IT emerging and developing countries?

4 Part 2: Transmission mechanism In this part, we are going to look into the transmission mechanism of monetary policy. For question 5 we are going to stay in groups, but question 6 (optional) will be done in a plenary session. Question 5: What policy stance would you recommend to the Governors to take in response to the following developments? Government announces a new housing programme to support young families. During the next three years the government is going to invest 3% of GDP in residential development. The spending will be front loaded with 2%of GDP being invested in 2019, and 1% invested over 2020 and Good economic prospects attract Vietnamese diaspora overseas to return back home. The government statistics expect 300,000 people to come back to Vietnam over the next two years, and join the labour force. Samsung s production lines have experienced outages. In the fourth quarter of 2018, the production output was half of its normal levels. As result exports are expected to fall by 3%. World trade war escalates. Global growth is expected to slow by 1 percentage point. The US economic conditions are improving more than expected. The US federal reserve announces it is going to increase the target for the federal funds rate by 0.25bps more than it was previously planned for Each group picks one situation. Use the Excel file W1_MP_transmission_mechanism.xls to quantify the scenario. The scenario is calibrated on the MAIN spreadsheet. The spreadsheet also shows a chart with a recommendation for monetary policy stance. Positive numbers indicate monetary policy stance tightening. Negative numbers indicate monetary policy stance loosening. Can you put together an economic story for the recommended monetary policy stance? What is the transmission mechanism that justifies the monetary policy stance? How does the monetary policy stance is going to deliver on the policy objective? Use the Charts spreadsheet to put the story together. It plots selected economic indicators and their development in response to your scenario. You can use a PowerPoint presentation to copy-paste the charts to tell your story. Question 6 (optional): What is the performance of Vietnamese economy under the current monetary policy regime? You can summarize the performance by looking at average business cycle and inflation volatility. Assess a counterfactual situation in which(i) the SBV moves to a more flexible Dong but maintains its control over money markets; (ii) the SBV moves to a more flexible Dong but loses control over domestic monetary policy; (iii) moves to a fully fixed exchange rate? We analyse these questions in a plenary session using a macroeconomic model.

5 Annex Template for monetary policy framework classification Mandate, Objective and Strategy 1. Central bank Achieve and mandate maintain the stable value of rupiah. 2. Primary monetary policy objective 3. Stated monetary policy framework 4. Medium-term inflation target 5. Intermediate monetary policy target Indonesia Malaysia Viet Nam Stable price of goods and services; and stable exchange rate. Inflation targeting (2005) Government approved inflation target : 4.0% ±1 percentage point (ppt) BI inflation forecast 2015: below midpoint of 4%. Promote monetary and financial stability conducive to the sustainable growth of the Malaysian economy. Price stability Implicit inflation targeting Comfort level of about 3% BNM inflation forecast 2015: 2 3% Independence 6. De jure operational independence 7. De jure operational (i.e., inflation targets) Policy Instruments 8. Central banks policy rate/stance 9. Reserve requirement Statutory reserve requirement ratio (RRR), with exceptional cases for lending to systemic important banks. Set by the government based on Central Bank recommendation BI policy rate, deposit and lending rates Primary RRR (7%) + secondary RRR on liquid assets (2.5%). BNM sets its own targets. BNM overnight policy rate 3.5%, commercial banks

6 10. Open market operations Issuance of BI certificates Repo and reverse repo transactions on government securities Outright sales/ purchase of government securities Foreign exchange buying/selling against the rupiah Uncollateralized direct borrowing Repo and reverse repo of government securities Issuance of BNM notes Outright sales/ purchase of government securities Foreign exchange swaps Transparency and Communications Explanation on: 12. Monetary Policy Objective 13. Monetary Policy Framework 14. Intermediate, inflation target target, short-term interest rate movements 15. Decision making process 16. Rationale/basis of monetary policy decisions/stance Timing of publication: 17. Inflation report Monthly Not available 18. Public release of Same day Same day monetary policy stance 19. Minutes/highlights of monetary policy meetings Accountability Report on monetary policy operation 21. Public document/ explanation in case of missed target, quarterly report to the Parliament/publ ic, report to the Parliament/publ ic Not available, regular reporting to the Minister of Finance on policies related to principal objectives.

7 Construction of trilemma measures, Aizenman et at (2013) 1 Monetary Independence (MI) The extent of monetary independence is measured as the reciprocal of the annual correlation of the monthly interest rates between the home country and the base country. 2 Money market rates are used. The index for the extent of monetary independence is defined as: where i refers to home countries and j to the base country. By construction, the maximum and minimum values are 1 and 0, respectively. Higher values of the index mean more monetary policy independence. 3,4 Here, the base country is defined as the country that a home country s monetary policy is most closely linked with as in Shambaugh (2004). The base countries are Australia, Belgium, France, Germany, India, Malaysia, South Africa, the U.K., and the U.S. For the countries and years for which Shambaugh s data are available, the base countries from his work are used, and for the others, the base countries are assigned based on the IMF s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) and the CIA Factbook. Exchange Rate Stability (ERS) To measure exchange rate stability, annual standard deviations of the monthly exchange rate between the home country and the base country are calculated and included in the following formula to normalize the index between zero and one: 1 Aizenman, Joshua, Menzie David Chinn, and Hiro Ito, 2013, "The Impossible Trinity' Hypothesis in an Era of Global Imbalances: Measurement and Testing, Review of International Economics, Vol. 21, Issue 3, pp The data are extracted from the IMF s International Financial Statistics (60B..ZF...). For the countries whose money market rates are unavailable or extremely limited, the money market data are supplemented by those from the Bloomberg terminal and also by the discount rates (60...ZF...) and the deposit rates (60L..ZF...) series from IFS. 3 The index is smoothed out by applying the three-year moving averages encompassing the preceding, concurrent, and following years (t 1, t, t+1) of observations. 4 We note one important caveat about this index. For some countries and some years, especially early in the sample, the interest rate used for the calculation of the MI index is often constant throughout a year, making the annual correlation of the interest rates between the home and base countries (corr(ii, ij) in the formula) undefined. Since we treat the undefined corr the same as zero, it makes the MI index value 0.5. One might think that the policy interest rate being constant (regardless of the base country's interest rate) is a sign of monetary independence. However, it could reflect the possibility that the home country uses other tools to implement monetary policy, rather than manipulating the interest rates (e.g., manipulation of required reserve ratios and providing window guidance; or financial repression). To complicate matters, some countries have used reserves manipulation and financial repression to gain monetary independence while others have used both while strictly following the base country's monetary policy. The bottom line is that it is impossible to fully account for these issues in the calculation of MI. Therefore, assigning an MI value of 0.5 for such a case appears to be a reasonable compromise. However, we also undertake robustness checks on the index.

8 Merely applying this formula can easily create a downward bias in the index, that is, it would exaggerate the flexibility of the exchange rate especially when the rate usually follows a narrow band, but is de- or revalued infrequently. 5 To avoid such downward bias, we also apply a threshold to the exchange rate movement as has been done in the literature. That is, if the rate of monthly change in the exchange rate stayed within +/-0.33 percent bands, we consider the exchange rate is fixed and assign the value of one for the ERS index. Furthermore, single year pegs are dropped because they are quite possibly not intentional ones. 6 Higher values of this index indicate more stable movement of the exchange rate against the currency of the base country. Financial Openness/Integration (KAOPEN) Without question, it is extremely difficult to measure the extent of capital account controls. Although many measures exist to describe the extent and intensity of capital account controls, it is generally agreed that such measures fail to capture fully the complexity of real-world capital controls. Nonetheless, for the measure of financial openness, we use the index of capital account openness, or KAOPEN, by Chinn and Ito (2006, 2008). KAOPEN is based on information regarding restrictions in the IMF s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). Specifically, KAOPEN is the first standardized principal component of the variables that indicate the presence of multiple exchange rates, restrictions on current account transactions, on capital account transactions, and the requirement of the surrender of export proceeds. Since KAOPEN is based upon reported restrictions, it is necessarily a de jure index of capital account openness (in contrast to de facto measures such as those in Lane and Milesi-Ferretti (2006)). The choice of a de jure measure of capital account openness is driven by the motivation to look into policy intentions of the countries; de facto measures are more susceptible to other macroeconomic effects than solely policy decisions with respect to capital controls. The Chinn-Ito index is normalized between zero and one. Higher values of this index indicate that a country is more open to cross-border capital transactions. The dataset covers 184 countries, but data availability is uneven among the three indexes. Both MI and ERS start in 1960 whereas KAOPEN in All three indexes end in The data set we examine does not include the United States, since we believe the U.S. is the Nth country which is not subject to the constraints of the trilemma. 5 In such a case, the average of the monthly change in the exchange rate would be so small that even small changes could make the standard deviation big and thereby the ERS value small. 6 The choice of the +/-0.33 percent bands is based on the +/-2% band based on the annual rate, that is often used in the literature. Also, to prevent breaks in the peg status due to one-time realignments, any exchange rate that had a percentage change of zero in eleven out of twelve months is considered fixed. When there are two re/devaluations in three months, then they are considered to be one re/devaluation event, and if the remaining 10 months experience no exchange rate movement, then that year is considered to be the year of fixed exchange rate. This way of defining the threshold for the exchange rate is in line with the one adopted by Shambaugh (2004).