Turkish Experience with Inflation Targeting Hakan Kara Central Bank of Turkey International Financial Congress July 12 14, 2017 St. Petersburg
Outline 1. Performance under inflation targeting 2. Operational framework for inflation targets 3. Fiscal-Monetary coordination 4. Capital flows and inflation targeting 2
The evolution of Inflation Targeting regime in Turkey 2001-2005: Implicit Inflation Targeting (IT) 2006-20: Full-fledged IT 2011-2015: Integrating financial stability into IT 2016 to date: Stronger focus on structural factors 3
2001 2002 2003 2004 2005 2006 2007 2008 2009 20 2011 2012 2013 2014 2015 2016 2017 Inflation and Targets: 2001-2017 CPI Inflation (y-o-y) (Percent) Strengthened emphasis on structural factors 80 70 60 Implicit Inflation Targeting (IT) Conventional IT Integrating Financial Stability into IT 50 40 30 Targets 20 Inflation 0 4
2006 2007 2008 2009 20 2011 2012 2013 2014 2015 2016 2017 Inflation and Targets: 2006-2017 16 14 12 8 6 4 2 Conventional Inflation Targeting (IT) CPI Inflation (y-o-y) (Percent) Integrating Financial Stability into IT framework Inflation Targets 0 5
01/02 01/03 01/04 01/05 01/06 Inflation Targets and Expectations (2002-2006) 70 Max Target Expectations Range 60 50 40 30 20 Min 0 6
01/07 01/08 01/09 01/ 01/11 01/12 01/13 01/14 01/15 01/16 01/17 Inflation Targets and Expectations (2007-2017) 14 12 8 Max Target Expectations Range 6 4 2 Min 0 7
Operational Framework for Inflation Targeting 8
Main parameters of the operational framework Target level: 5 percent Target variable: end year CPI inflation Uncertainty band ± 2 percent Accountability: open letter to the government Target horizon: 3 years Forecast horizon: 3 years 9
Why 5 percent? Convergence of prices to EU levels Structural factors Demographic factors, external balances Substitution effect Quality improvement and new product bias
06/05 03/06 12/06 09/07 06/08 03/09 12/09 09/ 06/11 03/12 12/12 09/13 06/14 03/15 12/15 09/16 06/17 Romania Russia Peru Turkey Chile South Africa Indonesia Thailand Poland South Korea Mexico Malaysia Why ±2 percent tolerance band? Volatility of unprocessed food prices High exchange rate pass-through Contribution of fresh fruit and vegetables to inflation (Percentage points) 3.0 2.5 2.0 1.5 1.0 Pass-through from FX to Inflation in Emerging Countries (At the end of 12-month period, percent) 25 20 15 0.5 0.0-0.5 5 0-1.0-1.5 11
03/16 06/16 09/16 12/16 03/17 06/17 09/17 12/17 03/18 06/18 09/18 12/18 03/19 06/19 09/19 12/19 03/20 Percent Presentation of Inflation Forecast Forecast Range Uncertainty Band Year-End Inflation Targets Output Gap 13 11 Control Horizon 13 11 9 9 7 7 5 5 3 3 1 1-1 -1-3 -3 12
Monetary-Fiscal Policy Coordination Ownership/enforcement of the government in achieving targets. Involvement of the government in setting the target Goverment s willingness to attain price stability Fiscal-monetary coordination is crucial for long-lasting price stability. Also key for managing expectations, easing trade-offs. Inflation target should be incorporated as a «hard parameter» in government s medium term budget plans. Consistency of tax/administered prices and wage setting with the inflation targets. 13
Some Lessons from Turkey s IT Experience Building credibility (convergence of expectations to target) takes time. «Just do it» Prove that it is not good luck Having a convincing track record is a prerequisite to anchor expectations. Is it possible to speed up the convergence of expectations to the target? Simple, transparent, and consistent communication Inflation forecast credibility (betting against the market and being vindicated) Government s endorsement (fiscal-monetary policy coordination) 17
2012 2013 2014 2015 2016 2017 20 18 16 14 12 8 6 4 2 How much weight should the CB attach to inflation expectations? Professionals Market Based Households 12-Month ahead inflation expectations (Percent) 20 18 16 14 12 8 6 4 2 0 0 Source: CBRT, TURKSTAT. Last Observation: June, 2017. May, 2017 for Households. 18
Capital Flows and Inflation Targeting
The Role of Capital Flows in Amplifying Financial Cycles Global Liquidity Capital Inflows Improved risk perceptions Currency Appreciation Rapid Credit Growth Balance sheet and collateral effects, further credit growth 20
IT and reaction to capital flows Global Liquidity Flexible Interest Rate Corridor Capital Inflows Reserve Requirements Improved risk perceptions Currency Appreciation Rapid Credit Growth Balance sheet and collateral effects, further credit growth 21
Jun- Aug- Oct- Dec- Feb-11 Apr-11 Jun-11 Jun- Jun- Jun- Jul- Jul- Aug Aug Sep- Sep- Oct- Oct- Nov Nov Nov Dec- Dec- Jan- Jan- Feb- Feb- Mar Mar Apr- Apr- May May May Jun- Jun- IT and reaction to capital flows: An example 9 8 7 6 5 4 3 2 1 140 Overnight Rate (%,5-day MA) One-Week Repo Rate (%) Interest Rate Corridor 9 8 7 6 5 4 3 2 1 14 0 12 8 6 4 2 Reserve Requirement ratio (RRR) Effective RRR 12 8 6 4 2 0 0 22
2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 20Q1 20Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 2016Q3 2017Q2 The interaction between capital flows, exchange rate and bank loans has been dampened in recent years. 2 1.5 1 Capital flows, exchange rate, and credit cycles (HP filtered, standardized) Loans (t) REER (t+3) Inflows (t+3) 0.5 20 0-0.5-1 -1.5-2 Policy Response Source: Kara, Özlü and Ünalmış (2015) 23
Challenges and Lessons Complex transmission mechanism of multiple tools Difficulty of linking each tool to objectives (unlike pure IT) Overall, it might be wiser to preserve the credibility of monetary policy by avoiding the burden of multiple objectives. Keep close coordination with macroprudential and fiscal policy Address the origin of the problem through deep-seated policies. 24
Turkish Experience with Inflation Targeting Hakan Kara Central Bank of Turkey International Financial Congress July 12 14, 2017 St. Petersburg