One Year of Inflation Targeting in Brazil

Marvin GoodfriendFederal Reserve Bank of Richmond

Central Bank of BrazilRio de Janeiro

July 10-11, 2000

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Key Aspects of Inflation Targeting

• put price stability first

• announce numerical targets

• full information to set instrument

• transparency to support credibility

• accountability to discipline central bank

• challenges for Brazil

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Put Price Stability First

• communicate rationale: experience, theory

• mandate priority for inflation goal

• CB responsible for price stability

• CB independence: financial, instrument

• implicit support from other institutions and policies

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Announce Numerical Targets

• explicit commitment

• burden on CB to explain misses

• anchor expectations

• focus discussion of macroeconomic policies

• foundation for quantitative monetary policy analysis

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Full Information To Set Instrument

• use all information to forecast future inflation pressures and to position interest rate policy

• improve quantitative econometric modeling techniques

• recognize estimation, simulation complications due to short regime history, imperfect credibility

• rely on market sentiment, indicators of inflation expectations

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Transparency to Support Credibility

• use transparency to develop credibility• convey comprehensive assessment of inflation pressures --

relate fiscal, monetary, exchange rate developments• use Inflation Report to present coherent, unified view of short-

run policy situation• provide assessment of data• provide quantitative understanding of policy • speak out if fiscal, exchange rate, trade, banking policies

conflict with inflation target• central bank governor should act as go-between: enhance

communication between markets and policymakers

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Accountability to Discipline Central Bank

• disciplines CB

• reinforces CB responsibility for inflation

• gives CB opportunity to demand that fiscal, trade, credit policies conform to inflation target

• gives CB opportunity to point out costs of policies in conflict with inflation target

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Challenges for Inflation Targeting in Brazil

• CB has responsibility without full authority for price stability

• fiscal policy, exchange rate policy must be made to conform to inflation target

• inflation targeting procedures provide window of opportunity to change institutional behavior

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Challenges for Inflation Targeting in Brazil

• improve understanding of Brazilian laws, institutions, data, and fiscal, trade, banking policies to enhance credibility and reduce Brazil’s premium in capital markets

• fiscal dominance must be overcome for inflation targeting to succeed--provide a quantitative frame-work in the Inflation Report for understanding the relationship between fiscal policy, inflation targeting, interest rate policy, and economic growth

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Challenges for Inflation Targeting in Brazil

• transparency, credibility of inflation target enhanced by outspoken, independent CB governor openly critical of economic policies that jeopardize inflation target

• Market concern that exchange rate policy could conflict with price stability could hurt credibility for the inflation target. What is policy behind CB acquisition and sales of foreign reserves?

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Challenges for Inflation Targeting in Brazil

• create understanding of reasons for adjustment of flexible exchange rate (terms of trade shock, foreign growth, change of interest differential)

• bring down high bank reserve requirements and maintain strong supervision and regulation of banks

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Challenges for Inflation Targeting in Brazil

• lengthen the maturity of the public debt

• explain principles behind managed price policy

• although widely used around the world, inflation targeting framework not yet tested by generally rising inflation