stan du plessis department of economics university of stellenbosch stan@sun.ac.za
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SAdP September 2002 1
Stan du PlessisDepartment of EconomicsUniversity of Stellenbosch
stan@sun.ac.za
Parliamentary Committee on Finance20 October, 2002
Perspectives on inflation targeting after a
difficult yearInflation rate
CPIX 10.80% Aug, 2002
CPI 11.60% Aug, 2002
SAdP September 2002 2
Issues coveredRecent concerns about domestic inflationThe present debate on inflation targeting Reasons for inflation targeting Evaluating inflation targetingSome suggestions for domestic policy
SAdP September 2002 3
Present problems: IModerate (but rising) domestic inflation undermines the credibility of the
framework for monetary policy SARB’s track record and hence credibility
harmed Government (having set the target) also
suffers credibility loss
SAdP September 2002 4
Recent international inflation experience
-5
0
5
10
15
20
25
30
35
40
CPI
infla
tion
Singapore
Peru
Malaysia
Czech R
ep
Chile
Korea
Poland
Israel
Philippines
Mexico
India
Hungary
Brazil
RS
A
Venezuela
Turkey
Emerging market inflation
Green indicates an inflation targeting country
SAdP September 2002 5
Present problems: IIInflation forecasts not credibly within the target range in years to come undermines the credibility of policy
making at the SARB…however, there are no expectations of runaway inflation
SAdP September 2002 6
Result: credibility deficit for monetary policy
Sector 2002 2003 2004Finance 9.2% 7.1% 6.2%Busines
s8.3% 7.9% 7.5%
Labour 7.9% 7.9% 7.3%Target Range
3-6% 3-6% 3-5%
BER survey of CPIX inflation expectations (in 3rd quarter of 2002)
SAdP September 2002 7
Issues coveredRecent concerns about domestic inflationThe present debate on inflation targeting Reasons for inflation targeting Evaluating inflation targetingSome suggestions for domestic policy
SAdP September 2002 8
Present debate on inflation targeting
Three broad camps Group A
Against inflation targets …arguing that government’s priorities are wrong
Group B Targets are good, but the present targets are not
… [some] arguing that the target should be higher in a developing country
Hence the SARB is (forced into) setting policy incorrectly Group C
The present targeting regime is good Hence the SARB’s decisions are sensible (Except that it may be time for the escape clause)
SAdP September 2002 9
Background to the debate on inflation targeting
3 observations about modern Central Banking Increasing adoption of explicit targets for
monetary policy Also in developing countries
Central Banks are gaining independence Associated with lower inflation
At no cost to growth Helping the poor (who cannot hedge against inflation)
Credibility increasingly recognised as crucial to the success of monetary policy
Inflation targeting incorporates all of the above in a disciplined framework for monetary policy
SAdP September 2002 10
Reasons for adopting inflation targeting as a framework
“Negative” reasons Lack knowledge for ‘fine tuning’ monetary policy Ensures consistent monetary policy over time Experience:
Capital flows cause problems for alternative anchors (for example, exchange rate targets)
“Positive” reasons Solves the “democratic deficit”
The problem of a (very) powerful, unelected, policymaking institution in a democratic country
Helps to build credibility Good track record internationally
SAdP September 2002 11
Inflation targeting is an increasingly popular tool for building credibility
Source: Mishkin and Schmidt-Hebbel, 2001
SAdP September 2002 12
Evaluating inflation targeting
Distinguish a number of different aspects of inflation targeting A. Ultimate objectives B. Transparency C. Final responsibility
(the institutional design, accountability and independence of the MPC does not concern this meeting directly)
(Government decisions have been underlined on the following slides)
SAdP September 2002 13
A. Ultimate objectives3-step procedure: Government defines clear goals for Central Bank
“goal dependence” e.g. an inflation target
Empower the SARB to pursue those goals “Instrument independence”
Hold the SARB accountable for the achieving the goals Reasonableness of the target affects the government’s
credibilityPresent situation SARB has instrument independence Treasury sets the inflation target
SAdP September 2002 14
B. TransparencyPublic must be able to monitor the goalsMajor problem - control lag in monetary policy implies separate evaluation of: The policy framework
evaluated with the track record (mainly on inflation) Policy stance, given the framework
forward looking evaluation using the inflation forecast
SARB’s credibility affected by both the framework and the stance of policy
SAdP September 2002 15
B. Transparency at SARBFair degree of “formal” transparencyBut some shortcomings: lack of openness
No published model, no information of conditioning variables
Policy signal of the fan chart cannot be monitored Hence, public cannot evaluate the stance of policy
The choice of a band as opposed to a point target …and narrowing of the range in 2004 by 33% “Hardening” of the range’s upper edge
does not reflect uncertainty of transmission mechanism undermines the evaluation of the policy framework and
the credibility of the SARB
SAdP September 2002 16
International experience with the design of inflation targets
Country Target Type Inception Escape clause
Mexico 4.5% Point Jan 1999 NoChile 3% Point Jan 1991 NoIsrael 1-3% Range Jan 1992 NoKorea 3% Point Jan 1998 NoNew Zealand
0-3% Range March 1990
Yes
UK 2.5% Point Oct 1992 NoRSA 3-6%
(2003)Range Oct 1992 Yes
SAdP September 2002 17
Further shortcomingsMPC implements a forecast target… specified as an average over a
calendar year this does not give a clear policy signal and makes timing difficult as monetary
policy is set continuously and not for periods matching the calendar year
Further, the average inflation rate over a calendar year is a ‘derived’ concept, and hard for the public to understand
SAdP September 2002 18
MPC’s target is tied to the calendar year would be preferable to have a rolling
horizon (say 2 years) for the forecast target This would reflect the duration of the
transmission mechanism more precisely than calendar year averages
Allows for adjusting the target when opportune as opposed to tying these adjustments to calendar
years
SAdP September 2002 19
Issues coveredRecent concerns about domestic inflationThe present debate on inflation targeting Reasons for inflation targeting Evaluating inflation targetingSome suggestions for domestic policy
SAdP September 2002 20
Recommendations:Clarify the target as point-target with tolerance range new target could be 6% at a rolling 2
year horizon … with 2% tolerance range on either
side(Presently, the SARB is aiming at the upper end of the 3-6% range)
SAdP September 2002 21
Benefits of this clarification: :Provides a clear policy signal to the MPC for setting the stance of monetary policy in contrast with the target as “calendar annual
averages”SARB target remains 6%But takes account of uncertainty in the realisation of inflation on both sides of the target allowing credibility to be built for monetary policy allowing scope for lowering the target at an
opportune timeRemoves the need for an escape clause Avoiding the associated credibility problem
SAdP September 2002 22
Credibility costs of these adjustments
Government: Effectively the forecast target remains
unchanged at 6% Government not seen to reverse policy in ‘hard times’ Avoid impression that goal posts have been shifted
SARB Cost in re-educating public about adjusted
framework for monetary policy Have to emphasise the forward and backward looking
aspects and 2 year rolling policy horizon But long term gain in credibility of improved
target design
SAdP September 2002 23
The end
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