Inflation Targeting in Hungary Lessons and Challenges. Agnes Csermely Economics Department. March 30, 2005

Transcription

1 Inflation Targeting in Hungary Lessons and Challenges Agnes Csermely Economics Department March 30, 2005

2 Overview Peculiarities of IT Performance in Major shocks and policy reactions Challenges and lessons

3 Evolution of the regime : crawling peg Whytoexit: Inflationary inertia (oil prices, food prices) Clear need for monetary contraction 2001, May: Widening of the exchange rate band: In 2001 it was considered as a quasi-floating regime, but ERM II compatible at the same time Lost nominal anchor 2001, Aug.: Inflation targeting

4 Inflation history 35 % % Introduction of crawling peg regime Introduction of inflation targeting

5 Exchange rate developments Introduction of crawling peg regime Widening of the fluctuation band

6 New central bank law, 2001 Primary goal: price stability Without jeopardising the primary goal, the MNB supports the economic policy of the Government Declared independence from the Government But: The Government, in agreement with the MNB, shall determine the exchange rate regime

7 Consequences of dual objectives Inflation targeting within ER band limited instrument independence subordinated to ER management at the edges of the band limited goal independence? policy coordination required inflation targets: in agreement with the government speed of disinflation depends on: actual room for maneuver of monetary policy fiscal stance in line with convergence program ( ?)

8 Performance Major tasks: break down inflation inertia: 10% 4% (price stability: 3%) smooth output fluctuations: not higher volatility

9 Most targets have been met at moderate costs CPI and the target band % 6 6 % Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05

10 Most targets have been met at moderate costs Output gap 7,0 6,0 output gap (right scale) GDP growth 1,5 1,0 5,0 0,5 4,0 0,0 3,0 2,0-0,5 1,0-1,0 0,0-1,5 1995Q1 1995Q3 1996Q1 1996Q3 1997Q1 1997Q3 1998Q1 1998Q3 1999Q1 1999Q3 2000Q1 2000Q3 2001Q1 2001Q3 2002Q1 2002Q3 2003Q1 2003Q3 2004Q1 2004Q3

11 Credibility of monetary policy Long term inflation expectations not yet anchored: Household expectations: still double digit Slow wage adjustment (RER appreciation) High risk premium But: Slower exchange rate pass-through Slower pass-through of oil prices Benign reaction to one-off tax increase High risk premium: twin deficits

12 Inflation expectations (Households) % % q202 q302 q402 q103 q203 q303 q403 q104 q204 q304 q404 q105 Perceived Ecpected Actual cpi (right scale)

13 Wage developments % q199 q299 q399 q499 q100 q200 q300 q400 q101 q201 q301 q401 q102 q202 q302 q402 q103 q203 q303 q403 q104 q204 q304 q404 q105 CPI Wages

14 Exchange rate pass-through q101 q201 q301 q401 q102 q202 q302 q402 q103 q203 q303 q403 q104 q204 q304 q404 % Tradables inflation (left scale)* Forint/euro exchange rate

15 3,5 3 2,5 2 1,5 1 0,5 0 Expectations are not well anchored (5Y and 10Y interest rate differentials) % y 10y

16 Major shocks, Demand: European business cycle Fiscal shocks Financial deepening: consumption + housing boom Supply shocks: Oil +USD/EUR Food Increasing competition (EU entry) Public wages/employment shock Regulated prices + taxes

17 Fiscal developments: promises and outcomes % PEP, Aug 2002 PEP, Aug 2003 CP May 2004 CP Dec 2004 Fact/Expected

18 Major shocks, Riskpremium/exchangerateshocks Shifts in convergence expectations Shifts in ERMII central parity expectations Global risk appetite Domestic fundamentals

19 Monetary stance, : tighter monetary conditions : maintaining tight conditions lots of fluctuations interest rates: smooth exchange rate fluctuations 2005: first possibility to ease

20 Monetary conditions exchange rate and short term interest rates jan. ápr. júli. okt jan. ápr. júli. okt jan. ápr. júli. okt jan. ápr. júli. okt jan. ápr. júli. okt jan. HUF/EUR 2w deposit rate (right)

21 Challenges and lessons Price stability Disinflation path Forecasting capacities Communicating conditional forecasts A perfect nuisance: the exchange rate

22 Price stability Hungary: 3%, Poland: 2.5% ECB definition of price stability (< 2%) Maastricht criterion on inflation: moving target 1.8% 3.4%) In convergence economies: it can be higher: Balassa-Samuelson it will be higher after eurozone entry

23 Earn credibility: Optimal speed of disinflation Demonstrate determination Meet early targets despite shocks Euro convergence Government reveals preferences: PEP, CP Tight monetary policy can easily lead to overvalued ERM II central parity The sooner inflation convergence, the better: expectations should be well anchored Is ERM II compatible with IT?

24 Optimal speed of disinflation Is there a sustainability constraint? Nominalrigidities Capital inflows (growth potential + convergence speculation + tight monetary conditions) Nominal and/or real appreciation Potential vulnerabilities

25 Forecasting capacity Knowledge of transmission mechanism: some intuition, not much econometric evidence Pluralistic approach: expert view, time series techniques, single equation econometric models, leading indicators. Judgement : Model-based forecast: for consistency check + simulation only Transparency in methodological uncertainty: conditions and assumptions Detailed report of forecasting exercise story based report

26 Conditional forecast Methodological problems: How to define unchanged monetary conditions (fixed interest rate or fixed exchange rate) Interpretation problems of the forecasts: Not directly comparable to the analysts forecasts Guide for monetary decisions Influence expectations? unconditional forecast Bias arising from conditionality of fiscal forecasts

27 Exchange rate Strong pass-through inherited (+Exchange rate conditionality) ER major driver of the forecast MPC inclined to smooth ER How to communicate? MCI-type communication speculation or non-transparent or more costly (in the short run) Pitfalls: Volatile interest rates Exchange rate as a measure of commitment

28 Benefits of IT More forward-looking approach both central bankers and market participants Contained expectations: weakened pass-through lower exposure to external shocks Communication, transparency educating markets Public support

29 Thank you for your attention!