Download Flexibility in Monetary Policy Hakan Kara

Flexibility in Monetary Policy
Hakan Kara
Central Bank of the Republic of Turkey
Presentation at ICOPEC Conference
Kocaeli University September 27, 2012
Outline
•
Monetary Policy Consensus Before 2008
•
How and Why have Policies Shifted Towards More Flexibility?
•
Implications for Monetary Policy in Turkey
•
New Policy Framework Designed by the Central Bank of Turkey
•
Implementation and outcomes
2
Consensus during the ‘great moderation’
•
Focusing price stability is the best CBs can do to contribute welfare
•
Monetary policy is too blunt to react to financial stability
•
Crisis prevention is costly, so it is better to mop-up afterwards
•
Financial intermediation costs should be avoided
3
Mindset during the ‘great moderation’
•
This time is different!
•
We know how the economy works
•
Agents are rational
•
Therefore, ‘good monetary policy should be boring’
•
Predictable,Transparent and Simple
4
Conventional Inflation Targeting Framework
•
Floating exchange rate regimes
•
Taylor rule-like reaction functions
•
•
Single objective (inflation)
•
Single instrument (short term interest rate)
New Keynesian models (w/o explicit macro-financial linkages)
5
Was this framework flexible?
•
At first sight seems so, since under a flexible ER regime the CB can
react freely to shocks by adjusting short term interest rates
•
However, reaction function did not allow much flexibility in practice,
because of rule based policy behavior and the scarcity of instruments
•
Moreover, it was too costly to deviate from the conventional behavior
in a financially integrated world
•
Alternative policy options that would surprise financial markets can
be risky to implement when consensus is strong
•
Paradoxically, monetary policy framework was too rigid while the
world was moving towards more flexibility
6
Shifting Towards More Flexibility
7
The crisis was a wake-up call
8
The crisis was a wake-up call
• It may be well worth to invest on crisis prevention
• Monetary policy should not disregard financial stability
aspects and asset price bubbles
• The assessment of financial risks has to be broadened
• The economy may not be as simple as previously thought
9
Re-emergence of Flexibility
• Financial stability mandate in itself calls for more flexibility
•
Flexibility in reaction function
•
Flexibility in using alternative instruments
• Thinking out of the box, contemplating richer view of
welfare assessment and transmission mechanism
• Search for an alternative policy framework
• Unconventional is the new conventional?
10
Reflections on the Turkish Monetary Policy
11
In search of a new policy framework
• Modify the existing inflation targeting regime to incorporate
financial stability as a supplementary objective
• But how? Implementation is not trivial.
•
Financial stability is a much broader concept than price stability
•
No past experience or role model
•
Lack of academic guidance
12
Main issues considered in the design of new policy-1
•
Observation 1: Historically, Turkey is prone to boom-bust episodes driven by
capital flows and excessive credit cycles
10
8
6
4
2
0
-2
-4
-6
Net Capital Flows/GDP
Growth of GDP
•
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
1988
-8
Implication 1: The new policy should aim at alleviating the adverse impact
of volatile capital flows and credit cycles on the domestic economy
13
Main issues considered in the design of new policy-2
•
Observation 2: The volatility in cross-border financial flows has been
excessively high in recent years (possibly due to QE and global uncertainty)
5300
Volatility of Stocks Flows to Emerging Countries
Volatility of Bond Flows to Emerging Countries (right axis)
1300
4800
1100
4300
3800
900
3300
2800
700
2300
500
1800
1300
300
800
100
0105
0405
0705
1005
0106
0406
0706
1006
0107
0407
0707
1007
0108
0408
0708
1008
0109
0409
0709
1009
0110
0410
0710
1010
0111
0411
0711
1011
0112
300
•
Implication 2: The new policy should be flexible enough to address volatile
capital flows and sudden reversals in global risk appetite
14
Flexible Policy Designed by the CBRT
15
Flexibility in the objectives and instruments
INSTRUMENTS
OBJECTIVES
OLD
FRAMEWORK
NEW
FRAMEWORK
Policy Rate
Liquidity Management
Interest Rate Corridor
Policy rate
Reserve Option Coefficients
Price Stability
Price Stability
Financial Stability
16
Flexibility in the reaction function
• Do not commit on a fixed interest rate for a predetermined period.
• Full commitment boosts credibility under normal times, but perhaps not
in these days and definitely not in an emerging economy.
• Uncertain global outlook may prompt frequent reversals in policy stance.
• It may be more credible not to promise on something you cannot deliver.
•
Credibility of ability
17
Flexibility in the reaction function: an example
Interest Rate Corridor
Overnight Repo Rates
14
12
10
8
6
4
2
0912
0712
0512
0312
0112
1111
0911
0711
0511
0311
0111
1110
0910
0710
0510
0310
0110
0
18
Implementation and Outcomes
19
Rapid credit growth and excessive currency
appreciation by the end of 2010
Total Loan Growth Rates
Real Exchange Rate
(2003=100)
(Annual Growth, Percent)
30%
140
25%
130
20%
120
15%
110
10%
100
5%
90
0%
CPI Developing Countries Based
CPI Developed Countries Based
0710
0110
0709
0109
0708
0108
0707
0107
0706
0106
0705
0105
0704
0104
0703
1110
1010
0910
0810
0710
0610
0510
0410
0310
0210
0110
1209
1109
1009
0909

0103
80
-5%
*Total credit is inclusive of all types of banks (deposit banks, participation banks, and
development/investment banks) and credit cards.
20
Current account balance by the end of 2010
(Seasonally Adjusted, Quarterly Average, Million USD )
3.000
2.000
1.000
0
-1.000
Excluding
Energy
-2.000
-3.000
Current
Account
-4.000
-5.000
-6.000
1
2
3
2008
4
1
2
3
2009
4
1
2
3
4
2010
21
The response of the CBRT
TL Reserve Requirement Ratios
(Percent)
CBT Policy Rates
(Percent)
14
O/N Lending - Borrowing Interest Rate Corridor
1-week Repo Rate
Average Cost of Central Bank Funding
Overnight Repo Rates
12
The range of RRR
Weighted average RRR
18
16
10
14
12
8
10
6
8
6
4
4
Adoption of
New Policy Mix
Oct-11
Aug-11
Jun-11
Apr-11
Feb-11
Dec-10
Oct-10
Aug-10
Jun-10
Sep-12
Jul-12
May-12
Mar-12
Jan-12
Nov-11
Sep-11
Jul-11
May-11
Mar-11
Jan-11
Nov-10
Sep-10
Jul-10
May-10
Mar-10
Jan-10
Apr-10
0
0
Aug-12
EU Debt
Problems
Jun-12
2
Apr-12
EU Debt
Problems
Feb-12
Adoption of
New Policy Mix
Dec-11
2
22
The outcome: credit growth and real exchange rate
Total Loan Growth Rates
(Annual Growth, Percent, FX Adjusted)
Real Exchange Rate
(Annual Growth, Percent)
150
45
Adoption of the new policy mix
Adoption of the new policy mix
40
140
35
130
30
120
25
110
20
100
15
90
Developing Countries Based Index
Developed Countries Based Index
80
0103
0603
1103
0404
0904
0205
0705
1205
0506
1006
0307
0807
0108
0608
1108
0409
0909
0210
0710
1210
0511
1011
0312
0812
0912
0712
0512
0312
0112
1111
0911
0711
0511
0311
0111
1110
0910
0710
0510
0310
0110
10
23
The outcome: current account and rebalancing
GDP and Final Domestic Demand
Current Account Balance
(Seasonally Adjusted, 2008Q1=100)
(Seasonally Adjusted, Quarterly Average, Million USD )
Current Account Balance
GDP
Current Account Balance (excluding energy)
4.000
Final Domestic Demand
115
2.000
110
0
105
-2.000
100
-4.000
95
-6.000
90
New Policy Mix
New policy mix
-8.000
85
-10.000
1
2
3
2008
4
1
2
3
2009
4
1
2
3
2010
4
1
2
3
2011
4
1
2 3*
2012
80
1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2
2005
2006
2007
2008
2009
2010
2011 2012
24
The outcome: inflation and expectations
14
Headline Inflation
24 Months Ahead Inflation Expectations
12
10
8
6
4
2
0712
0412
0112
1011
0711
0411
0111
1010
0710
0410
0110
1009
0709
0409
0109
1008
0708
0408
0108
1007
0707
0407
0107
1006
0706
0406
0
25
Concluding Remarks
• The global crisis has dramatically shaked the consensus view in
economics in many aspects.
• Monetary policy across the globe has moved towards more flexibility.
• The Central Bank of Turkey has formulated and implemented a more
flexible strategy to address challenges posed by heightened global
uncertainty and the ensuing volatility in cross border capital flows.
• So far, the new policy mix has been successful in rebalancing the
economy without hampering price stability objective.
26
Flexibility in Monetary Policy
Hakan Kara
Central Bank of the Republic of Turkey
Presentation at ICOPEC Conference
Kocaeli University September 27, 2012