Evolving MP Frameworks in LIC and developing countries - Banking Academy Dec 2017

Price stability Role of Price Stability and Other Objectives principle 2  Price stability should be primary objective of MP..  When determining magnitude and pace of policy adjustmen

Evolving Monetary Policy

Frameworks in Low-Income and

other Developing Countries

December 15, 2017 IMF Vietnam

Snapshot of current landscape in LLMICs

 Many LLMICs have made substantial progress in achieving price and

macroeconomic stability

 Yet monetary policy frameworks suffer from a number of drawbacks:

 Opacity regarding policy objectives and decision processes

 Weak analytical capacity

 Incoherent operational frameworks

 Poor communication strategies

 Lack of a well-articulated forward-looking framework to assess how policy

should respond to shocks

Principles of Effective Monetary Policy

VII

Effective communications

VI

Forward looking strategy that maps objectives to operations

Principles: Path to Modernization

Other objectives

Operation

al framewor

k

Communicati

on

Policy Formulatio

n and strategy

Independence

&

Accountability

Mandate, Independence & Accountability (principle I)

 CBs should have a clear mandate in terms of CBs MP goals + jure and

de-facto operational independence to pursue them

 A catalytic step in the modernization process De facto progress often comes

first

 Given independence and mandate, CBs should be accountable

 CB independence and monetary and fiscal interactions:

 Independence sometimes hampered by fiscal dominance

 Even if no fiscal dominance per se, CBs likely to face fiscal pressures—makes task of monetary policy difficult but not impossible

 Changes to the legal framework may be needed, but political commitment is

critical for long term success

Price stability

Role of Price Stability and Other

Objectives

(principle 2)

 Price stability should be primary objective of MP.

 CBs should consider effects of policy on macro/financial stability, but not at the cost of eroding policy credibility.

 When determining magnitude and pace of policy adjustments warranted by the inflation objective, CB should consider impact on other objectives.

 Credibly establishing primacy of price stability gives CBs more room to take other objectives into account.

 Primacy of price stability not clear in many LLMICs.

 Multiple objectives lead to incoherent frameworks.

 Output, employment, competiveness/exchange rate, interest rates, credit growth objectives often given importance along with price stability

 Which objective will prevail if they come in conflict?

 For which objective will the CB be held accountable ?

 Some commitment to price stability is essential for modernizing monetary policy frameworks.

 But inflation can be expected to stabilize around objective if MP is appropriate.

 Many LLMICs do not have a clear inflation objective

 Confusion between forecast and objective Need to distinguish between

forecast and objective

Adopting a Medium-Term Inflation

Objective (1)

(principle III)

Price stability

& other objectives

Adopting a Medium-Term Inflation Objective (2)

Price stability

Other Objective—Output and Financial Stability

(principles IV)

 Supply shocks and the difficult tradeoffs between inflation and output

stability CBs have flexibility regarding the magnitude and pace of policy

adjustments warranted by the inflation objective to consider impact on

output and market volatility:

Allow “first-round” effects but respond to “second-round” effects.

If credibility is limited, may put more weight on price stability.

Coherent framework, clear communications and strong analytical

capacity can help handle tradeoffs.

 Financial stability concerns and the role of monetary policy:

The costs of leaning against the wind likely to exceed benefits.

Macro-prudential policies should act as first line of defense.

Price stability

& other objectives

What About the Role of the Exchange Rate?

 Many LLMICs with de jure flexibility assign a central role to the exchange rate, which

is problematic.

 Most transitions will involve a move toward more exchange rate flexibility.

 Experience of EMs suggest that some degree of exchange rate management may

endure There are good reasons for this But there are important risks and drawbacks.

 Finding the right role for the exchange rate is likely to be an unsettled, evolving,

country-specific challenge.

 Intermediate target or information variable?

 Can provide timely information about the state of the economy and

inflation pressures

 Role of money will diminish as velocity becomes unpredictable

 Also, focus on single variable can cause policy mistakes

 Cross checking devise and tripwire?

 It depends!

 Fiscal dominance and pressure to keep rates too low

 Information content of money and availability of other data

Operational Framework

The Operational Framework (principle V)

 Reserve money targeting still prevalent among LLMICs This operating target only warranted in case of severe fiscal dominance and lack of operational

independence

 Opaque framework with frequent target misses

 Volatile interest rates that hampers transmission

 Can confuse policy-making and operations

 Operations should align market conditions to policy stance

 Should ensure that banks can place surplus liquidity with, and obtain term funding from, each other or the central bank at rates that are

short-reasonably stable

 Short-term interest rates should be the operating target

 Operations to align interbank market rates with policy rate

Incoherent operational frameworks a major

issue

Interest Rate Spreads between Policy Rate and Interbank Rates

(selected countries, January 2002–December 2014)

-6 -4 -2 0 2 4 6 8 10

2011 2012 2013 2014

Kenya

-6 -4 -2 0 2 4 6 8 10

2007 2008 2009 2010 2011 2012 2013

Nigeria

-6 -4 -2 0 2 4 6 8 10

2004 2006 2008 2010 2012 2014

Ghana

-6 -4 -2 0 2 4 6 8 10

2007 2008 2009 2010 2011 2012 2013

Indonesia

-6 -4 -2 0 2 4 6 8 10

2011 2012 2013 2014

Uganda

-6 -4 -2 0 2 4 6 8 10

Forward Looking Policy Formulation and Strategy

Policy Formulation and Strategy

CBs should have a forward-looking strategy (Principle VI)

 Full assessment of the economic outlook and monetary transmission mechanism.

 Path of policy consistent with consistent with objective.

 Evaluation of risks and contingency plans.

 It:

 Maps objectives to operations.

 Support and anchor communications.

 Draws on and supports better analytical capacity and data.

 Multiple approaches and tools needed.

 Changing role of exchange rate and monetary aggregates as capacity develops and understanding of transmission deepen:

 From intermediate targets to information variables

 CBs should have clear and effective communications that explain past performance and policy actions (Principle VII)

Explain past outcomes and deviations from target

Explain actions necessary to bring expected inflation inline with objective

Emphasize the variables that matter for private sector behavior

Target a wide range of stakeholders

outcomes.

 No single or standard sequencing of reforms.

 Countries should move on as many fronts as possible.

Progress is self-reinforcing, synergies between principles.

Some degree of operational independence and primacy of price stability is essential for making progress

Establishing the primacy of price stability a catalytic step

 Central Bank should work towards ensuring that all stakeholders share a common view of the way forward.

Priorities and Synergies

Key principles and key stakeholders

Role of the Fund

strengthen MP frameworks in LLMICs This includes:

guidance in their dialogue with authorities.

TA/training

Fund to exploit synergies between training and TA.

statistics.

Thank you for your attention!!!https://www.imf.org/external/np/pp/eng/2015/102315.pdf

Flexible exchange rate

Intervention strategy aimed

at supporting market functioning

Increase exchange rate flexibility

Develop FX markets

Coherent intervention strategy

Alternative intermediate target

Enhance Policy Transmission

Develop financial markets

Establish a coherent interest

Combine Monetary and Economic Analysis

Inflation forecast Cross checking role of monetary

Develop analytical tools for policy making

Multiple and inconsistent objectives

Single objective Price Stability

A Stylized Reform Agenda