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Monetary Policy Modelling: New Directions “Practice is ahead of theory, theory is ahead of modelling ...” Erdem Başcı Mehmet Yörükoğlu Deputy Governor 2013 Central Bank Macroeconomic Modelling Workshop November 7-8 2013, Istanbul Contents I. The changing role of monetary policy in the pre and post-crisis period II. Changes in monetary policy modelling approach III. Turkish experience 2 The redesign of monetary policy strategy Challenging questions: How will monetary policy objectives and policy tools evolve? How will financial stability considerations be integrated into the policy process? What changes to the policy framework will be adopted? 3 Pre-crisis consensus Commitment to a strong nominal anchor Inflation targeting Main objective: price stability Single instrument: interest rate Subsidiary role for the financial system 4 Need for a new monetary policy framework Why a new policy framework? New role for central banks: avoid development of financial imbalances The post-crisis economic environment is different Unconventional policy instruments 5 Decoupling The traditional monetary policy framework was embraced by both emerging and developed countries The crisis created a decoupling Problems and policy responses differed among developed and emerging economies. 6 Crisis experience: Developed countries Problems sharp decline in growth, deflationary pressures, liquidity problems. Measures large-scale balance sheet policies, provision of ample liquidity, buying risky assets, forward guidance... 7 Crisis experience: Emerging economies Problems volatile cross-border capital flows, exchange rate appreciation, rapid credit growth. Measures increasing bank reserve requirements, restrictions on credit market, taxing capital flows... 8 Capital flows Financial Instability Cycle for an Emerging Market Economy Improvement in Risk Perceptions Capital Inflows Currency appreciation Easier external finance External Borrowing Balance sheet effects and easing credit standards Capital flows affect economy significantly mainly through credit and exchange rate channels. 9 Turkish Experience 10 Financial Stability Concerns: Credit Growth Total Loan Growth Rates (13 Weeks Moving Average, Annualized, FX Adjusted, Percent) 60 45 30 15 0 -15 0111 1110 0910 0710 0510 0310 0110 1109 0909 0709 0509 0309 0109 1108 -30 Source: CBRT. Fast credit growth... 11 Financial Stability Concerns: Current Account Current Account Balance Main Sources of Current Account Deficit Finance* (Seasonally Adjusted, Quarterly Average, Billion USD ) (12-months Cumulative, Billion USD) 2 80 1 70 Portfolio and Short-Term* FDI and Long-Term** Current Account Deficit 60 0 50 -1 40 -2 30 -3 20 -4 10 CAB -5 0 -6 CAB (excluding energy) -10 -7 4 1 2 3 4 1 2008 Source: TURKSTAT, CBRT. 2 3 2009 4 1 2 3 2010 4 1 2011 2007:09 2007:11 2008:01 2008:03 2008:05 2008:07 2008:09 2008:11 2009:01 2009:03 2009:05 2009:07 2009:09 2009:11 2010:01 2010:03 2010:05 2010:07 2010:09 2010:11 2011:01 -20 -8 *Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Source: CBRT. Current account deficit widened significantly Most of CA deficit was financed by short-term capital flows 12 Financial Stability Concerns: Exchange Rates TL and Other EM Currencies Against USD Real Exchange Rates (ReR) in Turkey (9 March 2009=1) (2003=100, Logarithmic scale, Reverse order) 4.68 1.1 20% - 80 % Interval of EM 4.73 EM Average 1 Turkey 4.78 0.9 CPI Based ReR 4.83 Long-term Linear Trend 0.8 4.88 Oct-10 Aug-10 Jun-10 Apr-10 Feb-10 Dec-09 Oct-09 Aug-09 Jun-09 Apr-09 Feb-09 Dec-08 Oct-08 7-Sep-10 27-Jul-10 15-Jun-10 4-May-10 23-Mar-10 9-Feb-10 28-Dec-09 16-Nov-09 5-Oct-09 24-Aug-09 13-Jul-09 1-Jun-09 20-Apr-09 9-Mar-09 0.7 EM countries are Brazil, Chile, Colombia, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, South Korea, Taiwan and Thailand. Source: Bloomberg, CBRT. Nominal currency appreciated around 20 percent, moving together with other EM currencies Real exchange rates appreciated significantly compared to its long-term trend 13 Modification of inflation targeting regime Adopting financial stability as a supplementary objective. Enriching the set of policy instruments: wide assymmetric interest rate corridor, reserve option mechanism. 14 Interest Rate Corridor 15 30/09/11 28/10/11 25/11/11 23/12/11 20/01/12 17/02/12 16/03/12 13/04/12 11/05/12 08/06/12 06/07/12 03/08/12 31/08/12 28/09/12 26/10/12 23/11/12 21/12/12 18/01/13 15/02/13 15/03/13 12/04/13 10/05/13 07/06/13 05/07/13 Reserve Option Mechanism Reserve Option Coefficients Use of the ROM Upper Bound of FX for ROM Use of ROM 60 60 50 50 40 40 30 30 20 20 10 10 0 0 Source: CBRT. 16 Results: Credit growth Total Credit Growth (%) Commercial Loans Total Loans Consumer Loans 0913 0713 0513 10 0313 10 0113 15 1112 15 0912 20 0712 20 0512 25 0312 25 0112 30 1111 30 0911 35 0711 35 0511 40 0311 40 0111 45 1110 45 Credit growth is contained. 17 Results: Current Account Current Account Balance Main Sources of Current Account Deficit Finance* (12-month Cumulative, Billion USD ) (12-months Cumulative, Billion USD) CAB CAB (excluding energy and gold) CAB (excluding gold) 30 30 Source: TURKSTAT, CBRT. 0913 0513 0113 0912 0512 -90 0112 -90 0911 -70 0511 -70 0111 -50 0910 -50 0510 -30 0110 -30 0909 -10 0509 -10 0109 10 0908 10 Source: TURKSTAT, CBRT. *Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Longterm capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Significant improvement both in the level and financing of the current account deficit. 18 Results: Exchange Rate TL and Other EM Currencies Against USD (1 November 2010=1) EM Currencies (with 20%-80% band around the mean) Implied FX Volatility (1-month) Turkey Correction of the initial overvaluation in the currency. Low volatility of currency relative to peer emerging countries. 19 Overview Practice is ahead of theory; theory is ahead of modelling ... Incorporating financial stability along with the price stability, and a better management of global spill-overs The crisis stimulated research on incorpotating the interactions between financial market imperfections and the real economy in policy models. To understand the transmission of unconventional policies empirically, future research should continue to exploit the experience of central banks in the last five years. 20 Thank You. Mehmet Yörükoğlu Deputy Governor 2013 Central Bank Macroeconomic Modelling Workshop November 8, 2013, Istanbul