Global Imbalances and the New Central Banking

Dr. Ahmet Faruk Aysan Member of the Board and Monetary Policy Committee

Central Bank of the Republic of Turkey

August 2012 São Paulo

Outline

I. Global Outlook

II. Current Issues facing Central Banks

III. Mainstream suggestions on the future of Central Banks

IV. CBRT Policy Mix

2

Outline

I. Global Outlook

II. Current Issues facing Central Banks

III. Mainstream suggestions on the future of Central Banks

IV. CBRT Policy Mix

3

-0,10%

-0,05%

0,00%

0,05%

0,10%

-0,25% -0,20% -0,15% -0,10% -0,05% 0,00% 0,05% 0,10% 0,15% 0,20% 0,25%

Acc

eler

atio

n

Change

World Economy

05/2012

08/2011

Forecast

Global Outlook

4

Slow Down

Growth

Recession

Recovery

11/2010

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

2007 2008 2009 2010 2011 2012 2013

Euro Zone Germany France Italy Spain Portugal Greece

2012 will be a difficult year for Europe.

Growth Rates (annual, %)

Source: IMF, July 2012

2012 2013

IMF CE IMF CE

Eurozone -0.3 -0.5 0.7 0.5

Germany 1.0 0.9 1.4 1.3

France 0.3 0.2 0.8 0.7

Italy -1.9 -2.0 -0.3 -0.3

Spain -1.5 -1.7 -0.6 -0.9

Portugal -3.0 -3.4 0.2 -2.2

Greece -4.3 -6.8 0.2 -2.6

Growth Forecasts (annual, %)

IMF: WEO Update, July 2012 CE: Consensus Economics, July 2012

7

8

Unemployment (Percent)

Unemployment stays at its historically high levels since 2008

0

4

8

12

16

20

24

2002 2004 2006 2008 2010 2012

Greece Portugal Ireland Spain Italy

Source: Bloomberg, CBRT.

9

Source: CBRT, Bloomberg.

Policy Rates in Advanced Economies and Emerging Markets (Percent)

Not Much Policy Space Left for Interest rate policy

0,00

2,00

4,00

6,00

8,00

10,00

12,00

Emerging Markets

Advanced Countries

10

Source: FED, CBRT.

Excess Reserves (FED)

Likely to Monetary Expansion (US)

0

200

400

600

800

1000

1200

1400

1600

1800

01/0

8

03/0

8

05/0

8

07/0

8

09/0

8

11/0

8

01/0

9

03/0

9

05/0

9

07/0

9

09/0

9

11/0

9

01/1

0

03/1

0

05/1

0

07/1

0

09/1

0

11/1

0

01/1

1

03/1

1

05/1

1

07/1

1

09/1

1

11/1

1

01/1

2

03/1

2

05/1

2

07/1

2

(Billion USD)

11

Source: ECB, CBRT.

*Excess Reserves=ECB Balance Sheet Deposit Facility + Fixed Term Deposits

Excess Reserves* (ECB)

Likely to Monetary Expansion (Eurozone)

(Billion Euro)

0

200

400

600

800

1000

1200

01/0

8

03/0

8

05/0

8

07/0

8

09/0

8

11/0

8

01/0

9

03/0

9

05/0

9

07/0

9

09/0

9

11/0

9

01/1

0

03/1

0

05/1

0

07/1

0

09/1

0

11/1

0

01/1

1

03/1

1

05/1

1

07/1

1

09/1

1

11/1

1

01/1

2

03/1

2

05/1

2

07/1

2

No guarantee for the monetary expansion to work

12

Credit Growth (US)

Credit Growth (Eurozone)

Source: Bloomberg, , CBRT. Source: Bloomberg, CBRT.

-15

-10

-5

0

5

10

15

-2

0

2

4

6

8

10

12

14

13

There is no space for fiscal expansion either.

Public debt (as % of GDP)

25

50

75

100

125

150

175

200

225

00 01 02 03 04 05 06 07 08 09 10 1125

50

75

100

125

150

175

200

225 Euro zone United States United Kingdom Japan

Sources: Datastream, Natixis

Sovereign Debt problem is even worse for Europe

Source: IMF, April 2012

General Government Budget Balances (% of GDP)

Public Debt (% of GDP)

Source: IMF, April 2012

14

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

2007 2008 2009 2010 2011 2012 2013 2014

Germany

France

Italy

Spain

Portugal

Greece

30

40

50

60

70

80

90

100

110

120

130

140

150

160

170

2007 2008 2009 2010 2011 2012 2013 2014

Germany

France

Italy

Spain

Portugal

Greece

3

4

5

6

7

8

9

10

11

12

13

14

15

16

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

5,0

5,5

6,0

6,5

7,0

7,5

Jan-

10

Feb-

10

Mar

-10

Apr

-10

Jun-

10

Jul-1

0

Aug

-10

Sep-

10

Nov

-10

Dec

-10

Jan-

11

Feb-

11

Apr

-11

May

-11

Jun-

11

Jul-1

1

Sep-

11

Oct

-11

Nov

-11

Dec

-11

Feb-

12

Mar

-12

Apr

-12

May

-12

Jul-1

2

Aug

-12

Italy Spain Germany France Portugal-right axis

Divergence among government bonds of Eurozone countries...

10 year Government Bond Yields (%)

Source: Bloomberg

15

Also fragmentation in financial sectors of Eurozone countries.

16

Dispersion of euro area deposit rates (units and percentages)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Mar-12

Sep-11

Mar-11

Sep-10

Mar-10

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

Sep-05

Mar-05

Sep-04

Mar-04

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Min Max Standard deviation (left scale)

Dispersion of euro area loan rates(units and percentages)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Mar-12

Sep-11

Mar-11

Sep-10

Mar-10

Sep-09

Mar-09

Sep-08

Mar-08

Sep-07

Mar-07

Sep-06

Mar-06

Sep-05

Mar-05

Sep-04

Mar-04

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

Min Max Standard deviation (left scale)

0

10

20

30

40

50

60

70

80

90

17

Source: CBRT, Bloomberg.

VIX

Volatility Continues.

0

50

100

150

200

250

300

350

400

18

Source: CBRT, Bloomberg.

ITRAXX Senior Financials

Volatility Continues.

Outline

I. Global Outlook

II. Central Banking is rewritten

III. Mainstream suggestions on the future of Central Banks

IV. CBRT Policy Mix

19

Critics on Conventional Central Banking

The conventional approach fails to account adequately for financial-sector

risk and is therefore too narrowly focused.

The conventional framework assumes limited or nonexistent cross-border

spillovers of monetary policies

The incompatibility of national monetary policies in the face of spillovers is

heightened when countries follow different monetary policy regimes

The period in which the IT regime was tested was exceptionally benign,

leaving question marks for the period ahead

High levels of government debt in advanced countries and the slowing

growth of traditional export markets for developing countries create

pressure on central bank independence

20

Challenges Ahead : The Need for IT++

Uneasy coexistence: floaters and fixers

Controlling inflation in the age of volatility

Destabilizing channels of financial transmission

A journey to uncharted territories in monetary policy

21

Financial Stability and Central Banks

From Micro-to-Macroprudential tools in financial regulation

The «lean vs. clean» debate, when should CBs act?

A joint optimization problem: Using monetary and regulatory

policies in concert to pursue price and financial stability

Should Central Banks be primary institution responsible for

financial stability?

• Coordinated approach

• Unified approach

22

Macroprudential Toolkit

Contercyclical capital buffers

Systemic levy for leveraged financial institutions

Limits to the loan-to-value and service-to-income ratios on bank

lending

Better resolution regimes for Systemically Important Financial

Institutions (SIFIs)

Surcharges on capital requirements for «too big to fail»

institutions

23

Two Approaches

Approach 1: Use capital flow measures to restrict inflows

while tightening via interest rates (Brazil, South Korea)

Approach 2: Use macro-prudential measures to restrict domestic credit and domestic demand while keeping the short term interest rate differentials as low as possible (Turkey)

24

Outline

I. Global Outlook

II. Current Issues facing Central Banks

III. Mainstream suggestions on the future of Central Banks

IV. CBRT Policy Mix

25

Need for Rebalancing

26

Current Account Balance (Seasonally Adjusted, Monthly Average, Million USD )

Capital Flows and Credit Growth (percent)

Source: TURKSTAT, CBRT.

*July and August figures are realization, September and Q4 figures are forecast. Source:TurkStat, CBRT .

-7000

-6000

-5000

-4000

-3000

-2000

-1000

0

1000

2000

3000

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

2007 2008 2009 2010

Current Account

Current Account (Excluding Energy)

0

2

4

6

8

10

12

14

16

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

2007 2008 2009 2010

Change in Credit/GDP

Net Capital Flows/GDP

Need for Rebalancing

27

Monthly Imports and Exports (Seasonally Adjusted, Million USD)

Main Sources of Current Account Deficit Finance (12-months Cumulative, Billion USD)

Source: TurkStat, CBRT. Source: CBRT. *Short-term capital movements are sum of banking and real sectors' short term net credits and deposits in banks.

6000

8000

10000

12000

14000

16000

18000

20000 Exports (excluding gold)

Imports

-20

-10

0

10

20

30

40

50

60

70

Portfolio and Short-Term* FDI and Long Term Current Account Deficit

The New Policy Mix

A lower policy rate, a wider interest rate corridor and higher reserve requirements

The framework we adopt in spirit is not significantly different from the

conventional inflation targeting framework.

The only difference is that, previously our policy instrument was the one week repo rate, but now our instrument is a “policy mix”

We seek to use these instruments in the right combination in order to cope with both inflation and macro-financial risks.

The monetary policy stance in this framework is determined not by policy rates alone, but as a combination of all the policy instruments.

28

Multiple Instruments, Multiple Objectives

29

Credit Policy

Reserve Requirements

Macro-

prudential Tools

Weekly Repo

Interest Rate

Policy

Liquidity Policy

Interest Rate Corridor

Funding Strategy

KEY INDICATORS

Financial Stability

Price Stability

OBJECTIVES INSTRUMENTS

Expectations

Credit Growth

Exchange Rate

Policies Against Short Term Capital Flows

30

Strong Inflows

FX Purchases

Decreasing the lower bound of the interest rate corridor

RRR hikes

Outflows/Weak Inflows

FX Sales

Increasing the upper bound of the interest rate corridor

RRR cuts

Measures Against Excessive Credit Growth

31

Predominant Policy

Before August 2011 Macroprudential Tightening

After October 2011 Monetary Tightening

0

2

4

6

8

10

12

14 O/N Lending - Borrowing Interest Rate Corridor 1-week Repo Rate

Average Cost of Central Bank Funding

CBRT started to implement monetary tightening.

32

CBRT Policy Rates (Percent)

TL Required Reserve Ratios (Percent)

Source: CBRT.

Latest Observations: August 3, 2012. Source: CBRT.

Latest Observations: August 3, 2012.

0

2

4

6

8

10

12

14

16

18 The range of RRR Weighted average RRR

33

Source: ISE, CBRT.

ISE O/N Repo Rates (Percent, Daily)

O/N rates fluctuate close to the upper bound of the interest rate corridor.

Latest Observation: August 3, 2012.

0

2

4

6

8

10

12

14 CBRT Interest Rate Corridor ISE O/N Repo Rates

CBRT Policy Rate (1-week Repo Rate)

13,64

0

5

10

15

20

25

30

35

40

45

50

34

Source: CBRT.

Consumer Loan Growth Rates (Annual, Percent)

Consumer loan growth decreased.

Latest Observation: July 20, 2012

Macroprudential Tightening

35

Source: TurkStat, CBRT.

Current Account Balance (CAB) (Seasonally Adjusted, Quarterly Average, Million USD)

Rebalancing is on the way

*Latest observations are as of May.

-8000

-7000

-6000

-5000

-4000

-3000

-2000

-1000

0

1000

2000

3000

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2*

2007 2008 2009 2010 2011 2012

CAB CAB (excluding energy)

36

Source: CBRT.

*Portfolio and Short-Term: Equities, Domestic government bonds, short-term credits of banks and non-banks and deposits held in banks.

**FDI and Long-Term: FDI, bonds issuance of banks and goverment and long-term credits of banks and non-banks.

Composition of Capital Flows (12-Month Rolling Sum, Billion USD)

Improved Financing Quality

Latest Observations: May 2012

-20

-10

0

10

20

30

40

50

60

70

80 Portfolio and Short-Term*

FDI and Long-Term**

Current Account Deficit

37

Source: TurkStat, CBRT.

100

120

140

160

180

200

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1

2005 2006 2007 2008 2009 2010 2011 2012

Real Exports Real Imports

Real Exports and Imports (2003=100, Seasonally Adjusted)

Rebalancing is taking place.

Latest Observations: 2012 Q1

38

Source: Bloomberg, CBRT.

0,00

5,00

10,00

15,00

20,00

25,00

30,00

35,00

40,00

Emerging Markets* Turkey

Implied Volatility: Emerging Markets vs. Turkey (12-Month, Percent)

Relatively benign volatility of TL

*Emerging markets include Brazil, Chile, Czech Republic, Hungary, Mexico, Poland, South Africa, Indonesia, Korea and Colombia.

Latest Observations: August 3, 2012

39

FX

Automatic Stabilizer

Upper limit for FX reserves that might be held to maintain Turkish lira reserve requirements (Percent)

Additional Coefficient

40

1

45

1,4

1,7

50

1,9

55

40

Gold

Automatic Stabilizer

Upper limit for gold reserves that might be held to maintain Turkish lira reserve requirements (Percent)

Additional Coefficient

20

1

25

1,5

The policy actions required to take in these “interesting times” depend on country specific conditions.

Policies should be flexible and able to adapt to the fast pace of the global economic conditions and volatile risk appetite.

Ultimate goal of the policies used should be achieving sustainable growth coupled with price and financial stability.

In order to reach this goal all policy makers should cooperate in tackling the imbalances and structural deficiencies in the economy.

41

Summary

Dr. Ahmet Faruk Aysan Member of the Board and Monetary Policy Committee

Central Bank of the Republic of Turkey

August 2012 São Paulo

43

Source: CBRT.

6,78

6,33

5

2

3

4

5

6

7

8

9

10

11

12 12 month 24 month Inflation target

Inflation Expectations

Inflation expectations are well anchored.

44

Source: CBRT.

Inflation

* Shaded region indicates the 70 percent confidence interval for the forecast.

9.1

-4

-2

0

2

4

6

8

10

12

(Percent) Forecast Range* Uncertainty Band Output Gap Realizations Year-End Inflation Targets

Control Horizon

45

Source: CBRT.

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

Reserves of the CBRT (FX and Gold, Million USD)

CBRT reserve level remain solid