Inflation Targeting at 20:Inflation Targeting at 20:Achievements and ChallengesAchievements and Challenges

By Scott RogerIMF

Prepared for the 6th Norges Bank Monetary Policy Conference

Oslo, 11-12 June 2009

OverviewOverview

Since start of IT in 1989, 29 countries adopting IT. Currently 26 IT countries of which 11 high income and 15 emerging market and developing countries

Topics:• IT frameworks• Macroeconomic performance under IT• Issues and challenges facing IT

Inflation Targeting FrameworksInflation Targeting Frameworks

Main elements: Policy mandates Policy accountability Inflation targets Policy formulation

Inflation Targeting FrameworksInflation Targeting Frameworks

Policy mandates Instrument autonomy, not goal autonomy Target specification usually set jointly or by central bank

Accountability Corollary of instrument autonomy, but also reinforces it Standard mechanisms for providing accountability Increasingly forward-looking approach—emphasis on

transparency of policy process and decision making

Inflation Targeting FrameworksInflation Targeting Frameworks

Target specifications CPI 12 month rate as target Range or point target with bands

• Centered on 2 to 3 percent

• Bands typically +/- 1 percentage point; ranges 2 percentage

points Target horizons 1 to 2 years Monitoring & reporting of a range of core inflation

measures: CPI ex; trimmed means; median

Inflation Targeting FrameworksInflation Targeting Frameworks

Policy formulation Flexible IT Forecast-based, but significant differences in capability;

Standard New Keynesian models Differences in treatment of exchange rate Differences in implementation/operational frameworks—

preference for market-based over rules-based instruments, but some countries actively using both.

Performance under IT Performance under IT

Focus on three aspects of performance: Performance in achieving inflation targets Macroeconomic performance compared with alternative

frameworks Resilience of framework in face of 2007-09 global

commodity price and financial shocks

1. Performance in achieving 1. Performance in achieving inflation targetsinflation targets

During disinflation:• For high income

countries, average outcome close to target, but target range missed 60% of time;

• For low income countries, average outcome 2.3% above target, target range missed 67% of time;

Inflation outcomes during disinflation

0.00

0.02

0.04

0.06

0.08

0.10

Deviation of inflation from target (%)

Freq

uenc

y

0.00

0.02

0.04

0.06

0.08

0.10

Low income

high income

1. Performance in achieving 1. Performance in achieving inflation targetsinflation targets

During stable inflation:• For high income

countries, average outcome a little above target above target; miss target range 47% of the time

• For low income countries, average outcome a little above target; miss target ranges 36% of time

Inflation outcomes during stable inflation

0.00

0.02

0.04

0.06

0.08

0.10

-5.0

-4.0

-3.0

-2.0

-1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0

Deviation of inflation from target (%)

Fre

qu

en

cy

0.00

0.02

0.04

0.06

0.08

0.10

Low income

high income

1. Performance in achieving 1. Performance in achieving inflation targetsinflation targets

Assessment: Misses of target ranges very common—may undermine

usefulness of ranges Harder to control inflation during disinflation Countries with weaker conditions may be too ambitious

on pace of disinflation Countries might use wider bands during disinflation (+/-

2 to 2.5), narrowing during stable IT (+/- 1.25 to 1.5) Supply shocks an important factor in misses by low

income countries

2. Performance of IT compared 2. Performance of IT compared to alternative frameworksto alternative frameworks

1991-00 vs. 2001-08 based on median adoption of IT in low income countries

Low income IT improvement greater than non-IT: growth gain of 0.7%; inflation down 5.8%

High income IT: inflation unchanged, small growth gain

Inflation and growth rates:

2001-08 vs. 1991-00

0

2

4

6

8

10

12

14

16

18

0 1 2 3 4 5 6

Real GDP growth (%)

CP

I inf

latio

n (%

)

0

2

4

6

8

10

12

14

16

18

Non-IT low income

IT low income

IT high income

2001-08

1991-00

1991-00

2. Performance of IT compared 2. Performance of IT compared to alternative frameworksto alternative frameworks

Low income IT experienced bigger declines in both inflation & growth than non-IT countries

High income IT experienced smaller reductions in both inflation & output volatility

Inflation and growth volatility

2001-08 vs. 1991-00

0

2

4

6

8

10

12

14

0 1 2 3 4

S.D . of GDP growth (%)

Infla

tion

vo

latil

ity (

%)

0

2

4

6

8

10

12

14

Non-IT low income

IT low incom e

IT high income

1991-00

2001-08

1. Performance in achieving 1. Performance in achieving inflation targetsinflation targets

During stable inflation:• For high income

countries, average outcome a little above target above target; miss target range 47% of the time

• For low income countries, average outcome a little above target; miss target ranges 36% of time

Inflation outcomes during stable inflation

0.00

0.02

0.04

0.06

0.08

0.10

-5.0

-4.0

-3.0

-2.0

-1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0

Deviation of inflation from target (%)

Fre

qu

en

cy

0.00

0.02

0.04

0.06

0.08

0.10

Low income

high income

2. Performance of IT compared 2. Performance of IT compared to alternative frameworksto alternative frameworks

Econometric analyses based on differences in differences, controlling for external factors:

IMF (2005), Mishkin & Schmidt-Hebbel (2005); Vega & Winkelried (2005)

Differences mainly in terms of selection of comparators Findings:

• IT associated with significant reduction in inflation and inflation volatility relative to non-IT, at least for non-industrial countries

• No trade-off of inflation or inflation volatility vs. output: shift of efficiency frontier, not a movement along it

3. Resilience to 2007-09 global 3. Resilience to 2007-09 global commodity price and financial shockscommodity price and financial shocks

Commodity price shock: Low income IT countries

experienced less increase in inflation than in non-IT countries (2.3% vs. 4.7), but only slightly bigger fall in growth (-1.6% vs. -1.3%)

High income IT have lower inflation rise (1.9%) but bigger growth decline (-2.8%)

Need to disentangle from financial crisis & other factors

Inflation and growth rates, 2006-08

0

2

4

6

8

10

12

0 1 2 3 4 5 6 7

Real GDP growth (%)

CP

I in

flatio

n (

%)

0

2

4

6

8

10

12Non-IT low income

IT low income

IT high income

2006

2008

2008

3. Resilience to 2007-09 global 3. Resilience to 2007-09 global commodity price and financial shockscommodity price and financial shocks

Financial shock: Several IT countries amongst

hardest hit by crisis (Iceland, CEE countries), but not clear that IT made economies more vulnerable, or effects worse

Deterioration in CDS spreads less for IT emerging markets, suggesting markets see less risk of crisis in these countries

CDS spreads, 2007-09

0

100

200

300

400

500

600

Jun-07

Sep-07

Dec-07

Mar-08

Jun-08

Sep-08

Dec-08

Mar-09

CD

S sp

read

s (b

asis

poi

nts)

0

100

200

300

400

500

600Non-IT low income

IT low income

IT high income

3. Resilience to 2007-09 global 3. Resilience to 2007-09 global commodity price and financial shockscommodity price and financial shocks

Consensus forecasts vs. 2001-08 averages:

Growth expected to fall less in low income IT countries than in non-IT (-3.7% vs. -4.8%), and inflation to fall by slightly more (-2% vs. -1.7%)

Growth in high income IT countries expected to fall by 3.4%, and inflation by 1%, relative relative to 2001-08 averages

Growth and inflation:

2009-10 forecasts

vs. 2001-08 performance

0

2

4

6

8

10

-2 -1 0 1 2 3 4 5 6

Real GDP growth (%)

CP

I in

flatio

n (

%)

0

2

4

6

8

10Non-IT low income

IT low income

IT high income

2001-08

2009-10

Issues & ChallengesIssues & Challenges

Conditions for IT Adapting IT to emerging market and developing

countries Role of the exchange rate in IT IT and financial stability Price path targeting

Issues & ChallengesIssues & Challenges

Conditions for IT & adapting IT to emerging markets & developing countries

Conditions fewer, but significant challenges:• Fiscal dominance• Weak credibility• Dollarization• Data weaknesses• Limited human capital• Limited financial market development• Communications issues• Cultural issues

Issues & ChallengesIssues & Challenges

Role of the exchange rate in IT Important issue in emerging markets & developing

countries Conventional wisdom: exchange rate should not be a

target in its own right because:• Exchange rate taken into account indirectly through effects on

inflation & output• Appropriate response to exchange rate movements depends on

cause, so policy should avoid automatic responses

Issues & ChallengesIssues & Challenges

More recent analysis more equivocal:• With high dollarization, limited access to international capital

markets, exchange rate can have perverse balance sheet effects which may justify leaning against the wind (Cespedes & others (2004), Moron & Winkelried (2005), Roger & others (2009))

• Policy rule including exchange rate may be more robust to incorrect specification of model of exchange rate determination (Wolmershauser (2006)

Issues & ChallengesIssues & Challenges

IT and financial stability Mixed views on benefits of reacting directly to financial

indicators: • Arguments analogous to including exchange rate in policy

reaction function—react indirectly to implications for output & inflation

• But most models do not adequately capture macro-financial interaction

Extending policy horizon: How good are forecasts? Overburdening monetary policy: Should we focus on

other policy instruments?

Takk!