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NationalNational BankBank of ofRomania Romania Near Term CPI and GDP Forecast National Bank of Romania Near Term CPI Forecast ¾ Two ARMAX models for the main components of the CPI using monthly data expressed both as annual growth rates (yoy) and monthly growth rates (mom): 9 Food items (excluding volatile items: vegetables, fruit and eggs) 9 Non-food items (excluding items with administered prices, fuel and tobacco) 9 Services (excluding services with administered tariffs) ¾ An expert forecast for CPI and its components National Bank of Romania Exogenous variables used in ARMAX models ¾ Exogenous variables: 9 9 9 9 9 9 9 9 RON/EUR exchange rate RON/USD exchange rate Total economy net wage HICP for euro area Volatile prices (vegetables, fruit, eggs) Administered prices Fuels prices Tobacco prices ¾ The ARMAX model with mom data allows us to catch possible asymmetries in the exchange rate or fuel pass-through National Bank of Romania Expert adjustments ¾ Expert adjustments can be done on model’s equations too ¾ Source data for expert adjustments includes: 9 Statements of regulatory authorities 9 Internal or external surveys National Bank of Romania Combining the forecasts ¾ In order to aggregate the forecasts obtained from ARMAX models (mom model and yoy model), we tested the following indicators: 9 RSS (52% mom, 48% yoy) 9 RSS/(N-k) (51% mom, 49% yoy) 9 Arithmetical mean We use this method due to small differences vs. the other 2 methods ¾ The final projection is obtained by averaging the aggregate forecast of the two models with the expert forecast. National Bank of Romania Near term GDP forecast ¾ ¾ Error correction models for GDP components (quarterly data) The structure of the model: 1. Equation for private consumption dynamics 2. Equation for gross capital formation dynamics 3. Equation for the export of goods and services 4. Equation for the import of goods and services 5. ARMA equation for inventories – residual in the GDP equation; 6. Assumption for public consumption 7. GDP = 1 + 2 +3 – 4 + 5 + 6 National Bank of Romania Private consumption ¾ Long term equilibrium equation: Consumption ↔ Disposable income (proxy: total economy net wage) ¾ Short term dynamics explained by: 9 Private consumption lag 9 Real wage growth 9 Real ROBOR12M 9 Dummy variables for the years with very high/low agricultural/farm output National Bank of Romania Gross capital formation ¾ Long term equilibrium equation: Gross capital formation ↔ GDP and Foreign Direct Investments ¾ Short term dynamics explained by: 9 Gross capital formation lag 9 Real ROBOR12M 9 FDI stock growth 9 Dummy variables which account for unusual fluctuations in 2001 Q1 and 2004 Q4 National Bank of Romania Exports ¾ Long term equilibrium equation : Exports ↔ Euro area GDP (proxy: for external demand) and RON/EUR real exchange rate ¾ Short term dynamics explained by: 9 Euro area GDP growth 9 RON/EUR real exchange rate growth National Bank of Romania Imports ¾ Long term equilibrium equation : Imports ↔ Private consumption, Gross capital formation and Exports ¾ Short term dynamics explained by: 9 Imports lag 9 Private consumption growth 9 Gross capital formation growth 9 Exports growth 9 RON/EUR real exchange rate growth National Bank of Romania The purpose of Near Term Forecasts ¾ NTF are discussed during the task-force meetings; 9 Can suffer another sequence of expert adjustments; ¾ NTF represent input data for MAPM – which is the main model for medium term analysis and projection; 9 Can be updated anytime during the forecasting cycle if required by new data; National Bank of Romania The forecasting framework at the NBR and the model for medium term analysis and projection (MAPM) National Bank of Romania Forecasting process ¾ Steps: 9 Near term CPI and GDP forecast 9 Initial position in the business cycle (initial conditions set) 9 Medium term projection ¾ Forecasting process: 9 Combining the model and the expert projection 9 Expert adjustments done in all 3 steps of the forecasting process National Bank of Romania Model based projections Combining projections from: ¾ Models for near term forecast – with almost all parameters estimated (statistical relevance enhanced) 9 Currently used for near term CPI and GDP components forecast ¾ Model for medium term analysis and projection – with almost all parameters calibrated (theoretical consistency enhanced) 9 Linear model with deterministic and unique solution 9 Starts from an estimated initial position (initial conditions set) 9 Use near term forecast National Bank of Romania Expert based projections Refers to: ¾ Some of the near term forecasts (financial variables, an expert projection for inflation) ¾ Exogenous events (ex. pre-announced tax changes, market liberalization steps, UE accession etc.) ¾ Scenarios for administered and volatile prices ¾ Other variables non-included in the model (ex. fiscal impulses) ¾ Other adjustments discussed in the task-force and the Monetary Policy Committee (MPC) National Bank of Romania Output of the forecasting process (1) ¾ One baseline scenario for inflation and other relevant macroeconomic indicators; ¾ This is the most likely scenario; ¾ Must be understood in correlation with certain risk factors; → more details in Risks and uncertainties surrounding the projection section in the Inflation Report National Bank of Romania Output of the forecasting process (2) Unique path for projected inflation and not a fan chart or a range because: ¾ Short history and size/ frequency of structural breaks makes harder to obtain a reliable statistical distribution for errors (ex. until 2004 fuel prices were administered, and liberalized after); ¾ For now, we prefer this method for its simplicity and for its contribution in anchoring inflation expectation; ¾ Major disadvantage concerns the disconnection between the presentation of the baseline scenario and the risks associated with it; National Bank of Romania Timetable of the forecasting process Time Event Detalii T-45 Task Force meeting Issue related to model specification, recalibration, future development – twice per year T-35 Task Force meeting Near term forecast for CPI, GDP, interest rate, exchange rates and exogenous scenarios for administered and volatile prices T-28 Task Force meeting Initial condition set (output gap, real exchange rate gap, real interest rate gap) and equilibrium trends (including their forecast for the projection horizon) T-22 MPC meeting Discussion of the initial conditions set and equilibrium trends T-16 Task Force meeting Projection scenarios T-10 MPC meeting Discussion of the baseline and risk scenarios Inflation Report Inflation Report sent for MPC discussion and approval T+3 MPC meeting Discussion of the Inflation Report T+10 NBR Board meeting Discussion of the Inflation Report, Monetary Policy Decision T ¾ Task Force = discussion forum under the supervision of Deputy Governor Cristian Popa. Includes directors and experts form Monetary Policy and Macroeconomic Modelling Department and Economic Studies Department. ¾ MPC = Monetary Policy Committee – main discussion forum for monetary policy decision proposals. Includes NBR executives, directors and other experts. National Bank of Romania Model for medium term analysis and projection (MAPM) (1) ¾ A stylized and simplified description of the transmission mechanism from monetary policy to relevant macroeconomic variables and inflation. ¾ Model’s role 9 Consistently integrates all relevant information; 9 Generates an inflation projection and an interest rate path which serve as a guideline for NBR Board decisions regarding monetary policy; 9 Allows comparison between different alternative scenarios; National Bank of Romania Model for medium term analysis and projection (MAPM) (2) ¾ Properties: 9 Relatively small number of behavioral equations; 9 Log-linear specification around an unique steady-state solution; 9 Semi-structural Neo-Keynesian core, but parameters are not necessarily structural; 9 Parameters are calibrated with respect to: Theoretical and empirical (from VAR models) moments matching; In sample forecast properties ; Expert judgment coming from NBR experts’ professional experience; Benchmark values found in the relevant econometric literature; 9 Mix of forward-looking and backward-looking variables in some equations (Phillips curve, interest rate parity, NBR reaction function). National Bank of Romania Transmission mechanism in the MAPM NBR interest rate Loans’ interest rate Deposits’ interest rate Consumption and investment Loans Consumption/ Saving Behavior Foreign interest rate Exchange Rate Net exports channel Balance sheet and wealth effect Fiscal policy Balassa-Samuelson Effect Output Gap Exchange Rate Pass-through Import price inflation CPI Inflation CORE2 Inflation Expectations National Bank of Romania Administered and Volatile price inflation Monetary policy transmission mechanism ¾ Interest rate channel: 9 Relatively slow and still inefficient; 9 Monetary policy impulses transmitted through commercial banks’ interest rates; 9 Net debtor position for NBR; 9 Financial markets still lack depth but quickly “catching-up” Æ could diluted monetary policy impulses also. ¾ Exchange rate channel: relatively fast, with a direct impact on import price inflation (including fuel price inflation) and also for some excises set in euro; and an indirect impact via output gap. ¾ Balance sheet and wealth effects: important because of the significant degree of currency substitution (euroisation/ dolarisation). ¾ Expectations channel: important for inflation projection; includes second round effects coming from any inflationary factors. National Bank of Romania Model’s equations (1) ¾ Inflation components: 9 CORE2 inflation Core2 inflation lag CPI expectations Output gap Import price inflation Balassa Samuelson effect 9 Administered prices inflation (exogenous scenario based on expert forecasts, based on discussions with the regulatory authorities) 9 Fuel price inflation Fuel price inflation lag International oil price (Brent) RON exchange rate (vs. EUR for taking into account the effects of excises , vs. USD for imports) CPI inflation expectations 9 Volatile prices inflation (exogenous scenario, expert forecast for the projection horizon) Lags and seasonal factors of volatile price inflation RON/EUR exchange rate Fuel price inflation National Bank of Romania Model’s equations (2) ¾ Output gap Output gap lag Lending and deposit interest rates (inter-temporal substitution) Real effective exchange rate (intra-temporal substitution, local vs. imported goods) A proxy for balance sheet and wealth effect: real EURIBOR and real exchange rate depreciation (opposite influence than the effect on net exports) 9 Fiscal impulse (exogenous, based on Government program + structural and cyclical decomposition) 9 9 9 9 ¾ Exchange rate 9 Interest rate differential vs. EURIBOR 9 backward and forward looking expectations 9 Risk premium ¾ NBR interest rate (adjusted to the NBR Board implied reaction function) 9 Expected deviation of CPI inflation from target 9 Output gap 9 Interest rate smoothing National Bank of Romania MAPM track changes (1) ¾ Initial MAPM structure was quite standard: CORE1 inflation equation (excluding administered prices), output gap equation (real NBR interest rate, real RON/EUR), uncovered interest rate parity, inflation expectations based on quarterly data, reaction function ¾ Changes: 9 Inflation expectations equation specified in annual terms – smoothing quarterly data 9 Splitting CORE1 inflation into: CORE2, fuel and volatile (LFO vegetables, fruit, eggs) 9 Appropriately specifying the real effective exchange rate by including the RON/USD exchange rate (USD/EUR forecast from Consensus Forecasts) 9 Including commercial banks’ sector with specific lending and deposits interest rate National Bank of Romania MAPM track changes (2) ¾ Including a synthetic variable = real EURIBOR + real effective exchange rate depreciation (in gap terms) for adequately capturing: 9 Changes in the cost of foreign currency denominated loans (including reserve requirements changes); 9 Balance sheet and wealth effects; ¾ Periodic recalibration of the parameters whenever new empirical evidence emerges: parameters for the behavioral equations (maximum once a year), others parameters (more often, depending on the relative size of the gap variables or on expert opinion regarding the speed of adjustment to long run equilibrium – ex.: GDP potential growth, real exchange rate, lending and deposits interest rate spreads vs. NBR interest rate etc.); ¾ Non-included in the MAPM: 9 Filtering the output gap by excluding the agricultural contribution to GDP - was not enough superior to the existing method; 9 Term structure of interest rates (not a good trade-off benefits vs. costs); National Bank of Romania The future of MAPM ¾ Explicitly modelling GDP components (in progress) and labor market – wage dynamics (in perspective); ¾ Refining the fiscal impulse (integrated as an exogenous variable to the output gap equation); ¾ Developing a new dynamic general equilibrium model (DGE): 9 Superior analitical and explanatory power; 9 Tehnical assistance received from the National Bank of Czech Republic/ IMF; National Bank of Romania