Download Inflation targeting in the Armenian context

Inflation targeting in
the Armenian context
King Banaian, David Kemme
and Grigor Sargsyan
AIPRG conference, 4/21/06
Inflation targeting is coming to
Armenia


Transition began in January.
Country has found problems with quantitative
targets.
 We

provide evidence that supports this view.
Opinions of inflation targeting for developing and
transition countries are changing.
 Poland,
Hungary and the Czech Republic were early
adopters; many others are joining in.
Aggregate targeting has had
problems
Velocity hasn’t been very stable
Suppose a very simple model


Simple IS curve, Phillips
curve and a policymaker
loss function.
Imagine first perfect
foresight.


 t   t 1   ( g t 1  g *g 1 )   t

Lt  Et   s t [(1   )( s   * ) 2   ( g s  g * ) 2 ]
s t
Minimize L.
Then imagine a Taylor
rule in both inflation and
output.

g t  g t*   (rt 1  r * )  t
Inflation targeting means σ2
= 0.
rt = r* + s1(t - *) - s2(gt - gt*)
Response to supply shocks
Inflation targeting response to supply shock
Perfect information response to supply shock
0.04
0.03
0.025
inflation
inflation
0.035
0.02
0.015
0.01
0.005
0.03
0.02
0.01
0
0
0
0.01
0.02
GDP grow th
0.03
0.04
0
0.01
0.02
GDP growth
0.03
0.04
Response to demand shocks
Perfect information response to demand shock
inflation
0.03
0.025
0.02
0.015
0.01
0.005
0
0
0.01
0.02
0.03
GDP grow th
0.04
0.05
GMM estimates
rt *  rt 1  (1   ){ [ E ( t  k |  t )   *]   [ E ( y t  k |  t )]   [ E (et  k |  t )]}   t
Parameter Coefficient value
α
0.382
β
0.289
γ
0.460
δ
1.015
constant
-38.59
t-statistic
6.70
6.44
12.6
22.4
9.01
(2)
The path of interest rates if
Armenia had used a Taylor rule
Alternative interest rate projections, Armenia 1998-2004
50.00
40.00
30.00
20.00
10.00
Actual
Predicted
Taylor (β, δ=1, γ = 0)
Mar-05
Sep-04
Mar-04
Sep-03
Mar-03
Sep-02
Mar-02
Sep-01
Mar-01
Sep-00
Mar-00
Sep-99
Mar-99
Sep-98
0.00
Mar-98
Lending rate, 90-day
60.00
Taylor (β = 1, γ,δ = 0)
SVAR estimation performed
ey =b11uy
ep=b22*up
er=ep + b33*ur +a34*eε
e=b31*ey+b32*ep+b33*eε+a34*uε
ey = 2.44*uy
ep= 2.175up
er = ep + 4.45*ur +*eε
ee = -0.336* ey + 0.553*ep - .008* er + 3.146*uε
SVAR impulse response analysis
Response of Inflation to Structural
One S.D. Innovations
Response of the GDP gap to Structural
One S.D. Innovations
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
-0.5
-1.0
-0.5
1
2
3
4
5
6
7
8
9
10
Response of the credit rate to Structural
One S.D. Innovations
1
2
3
4
5
6
7
8
9
10
Response of the real exchange rate to Structural
One S.D. Innovations
5
4
3
4
2
3
1
2
0
1
-1
0
-2
1
2
3
4
5
6
7
8
9
10
Price (supply) shock
Demand shock
1
2
3
4
Policy shock
Exchange rate shock
5
6
7
8
9
10
Conclusions

Inflation targeting set for 2008.
 Transition
period will need managing to gain
full benefits to reputation from transparency.

Taylor-rule modeling appears to fit the
Armenian case, particularly if augmented
by real exchange rate.
 What
are the implications of this for IFT? We
are testing that now.