Download Inflation Targeting: Five Years From The Inside

Inflation Targeting: Five Years From The Inside
Peter Duronelly, CFA
chief investment officer
Budapest Alapkezelő Zrt.
Five Years Of IT
 June, 2001: inflation targeting
 Purpose: meeting Maastricht to introduce the euro by January, 2007
 Result: complete failure; no euro in sight, but not for monetary policy
mistakes
 Despite the failure to introduce the euro inflation targeting is successful
 Magyar Nemzeti Bank’s credibilty has increased (from already high
levels)
 overspill effect of price shocks are controlled
 governments acknowledge the central bank’s mission
 by predicting the central bank’s behaviour financial markets send
signals on the potential future path of monetary policy
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Extrenal Factors To Inflation Targeting
 ‘The Great Moderation’: decreased volatility of global output and inflation
 Reasons: global division of labor, technological advances, higher energy
efficiency AND better monetary policy.
 Many central banks either operate in an IT framework or behave as they had
formal inflation targets.
 Central bank credibility can be monetized on by saving interest expenditures
due to lower risk premia on government debt.
 Low volatility of inflation  low inflation
 Even small open economies can go for inflation targeting.
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Life In „Bretton-Woods II”
 An export-led strategy of peripheral countries with undervalued and quasifixed exhange rates.
 Through rapid improvement in total factor productivity and pool of available
labor inflation is low despite fast economic growth. The center country acts
as an open economy converting its internal inflationary pressures into a
current account deficit.
 Official outflows of the peripheral countries help keep international interest
rates low, lower then inflation would imply.
 Hungary has been able to free-ride the easy liquidity and has converted
excess demand into a current account deficit at minimal cost. Financial
markets have failed to punish lax economic policies, leading to the
postponement of Eurozone accession.
 Hungary has survived by being the „country of unfinished crises”.
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What Is The Equilibrium Level Of Interest Rates?
real economy
financial markets
rde  MPK
1  rde  1  rfe  EREER  1   


 Countries of lower level of capital stock may have dual equilibium of real
interest rates.
 Real economy: marginal product of capital
 Financial markets: uncovered interest rate parity condition
 The existence of multiple equilibria can generate volatile monetary policy
actions in case of swinging risk premiums
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A Simple Visualisation Of Multiple Equilibria In EURHUF
 The currency has stable and unstable equilibrium levels.
 If we sell off from a stable equilibrium, we may not
swing back to normal but roll over.
 MNB can do to things to be sure to get back to normal
 pray
 hike agressively
275,00?
285,00?
245,00 – 255,00
???
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Inflation Targeting: An Istitution Of Democratic Control
 Politicians and policy makers act in ways which may conflict long term
interest of the public.
 Buying votes of particular groups by spreading the costs in the form of higher
inflation is always a compelling way to perform well on the elections.
 An inflation targeting central bank has the right, the means, and even the
obligation to keep inflation where it is supposed to be not regarding volatility
of economic output.
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Outlook For Inflation Targeting
 The grace period in the global economy and on the financial markets will not
last for ever.
 At least the volatility of global inflation will ultimately go up.
 The growing complexity of financial markets is also to be monitored.
 Meeting Maastricht is still project — even after five years of inflation
targeting.
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Thank you for your attention!
01 / 08
10
09 / 07
MNB inflation targets
05 / 07
01 / 07
09 / 06
05 / 06
01 / 06
09 / 05
05 / 05
01 / 05
09 / 04
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09 / 03
05 / 03
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09 / 02
05 / 02
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09 / 01
05 / 01
01 / 01
Inflation Goes Back To Target
After External Shocks
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Reuters
consensus for
Dec 2007
8
6
4
2
0
Source: KSH, MNB, Reuters
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11 / 06
08 / 06
05 / 06
02 / 06
11 / 05
12
08 / 05
14
05 / 05
02 / 05
11 / 04
08 / 04
05 / 04
02 / 04
11 / 03
08 / 03
05 / 03
02 / 03
11 / 02
08 / 02
05 / 02
02 / 02
11 / 01
08 / 01
05 / 01
Money Markets Have Properly Forecast Monetary Policy
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base rate
3X6 mm fwd
10
8
6
4
2
0
Source: Bloomberg, Budapest Alapkezelő
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Volatility Of G7 Growth And Inflation
3.0%
2.5%
GDP
inflation
2.0%
1.5%
1.0%
0.5%
Source: OECD, Budapest Alapkezelő
5-year rolling standard deviation of
quarterly yoy indices
2004
2001
1998
1996
1993
1990
1987
1985
1982
1979
1976
1974
1971
1968
1965
0.0%
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Inflation Under Bretton Woods
35
world cpi
30
25
Bretton
Woods
20
„Bretton
Woods II.”
15
10
5
2004
2002
2000
1998
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1974
1972
1970
1968
1966
1964
1962
1960
0
Source: Bloomberg, IMF
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Real Interest Rates:
Deviation From Long Term Averages
6%
EZ
US
JN
4%
2%
0%
-2%
-4%
-6%
Source: IMF
5-year rolling standard deviation of
quarterly yoy indices
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
-8%
14
base rate
2
risk premium over 12M
EUR
11 / 06
4
08 / 06
05 / 06
02 / 06
11 / 05
08 / 05
05 / 05
02 / 05
11 / 04
08 / 04
05 / 04
02 / 04
11 / 03
08 / 03
05 / 03
02 / 03
11 / 02
08 / 02
05 / 02
02 / 02
11 / 01
08 / 01
05 / 01
Swinging Premium Prompts
Agressive Monetary Policy Actions
14
12
12
10
10
8
8
6
4
6
2
0
-2
0
-4
Source: Bloomberg, Budapest Alapkezelő
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Oustanding OTC Derivatives
900%
800%
as % of world GDP
700%
600%
500%
400%
300%
200%
100%
2006
2005
2005
2004
2004
2003
2003
2002
2002
2001
2001
2000
2000
1999
1999
1998
1998
0%
Source: BIS, IMF, Budapest Alapkezelő
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