Inflation Targeting in Romania: Experience and … · Inflation Targeting in Romania: Experience...

Inflation Targeting in Romania: Inflation Targeting in Romania: Experience and Future Experience and Future

DevelopmentsDevelopments

Cristian PopaCristian PopaDeputy GovernorDeputy Governor

National Bank of RomaniaNational Bank of Romania

Prague, April 2008Prague, April 2008

NATIONAL BANK OF ROMANIA

Initial ConditionsInitial Conditions•• In 1997In 1997--2004, Romania followed an eclectic monetary base targeting frame2004, Romania followed an eclectic monetary base targeting framework, work,

with increased reliance on interest rates + relatively frequent with increased reliance on interest rates + relatively frequent interventions within a interventions within a managed float regimemanaged float regime

•• High inflation rates, low financial depth/monetization, recourseHigh inflation rates, low financial depth/monetization, recourse to borrowing in fx, to borrowing in fx, fiscal dominance complicated choice of regime switch fiscal dominance complicated choice of regime switch

•• IT one of two choices envisaged in 2000 MT Economic Strategy (unIT one of two choices envisaged in 2000 MT Economic Strategy (underpinning EU derpinning EU accession effort) accession effort) –– other was a more predictable exchange rate arrangement, seen other was a more predictable exchange rate arrangement, seen risky in context of larger future capital inflows, likely shift risky in context of larger future capital inflows, likely shift in eq. real exchange ratein eq. real exchange rate

•• IT seen as constrained discretion, already successfully applied IT seen as constrained discretion, already successfully applied in EMs w. similar in EMs w. similar conditions (also in ECE), more likely to be robust to a variety conditions (also in ECE), more likely to be robust to a variety of shocks (incl. related of shocks (incl. related to rapid catchingto rapid catching--up, liberalization in context of upcoming accession), facilitateup, liberalization in context of upcoming accession), facilitateprogress towards euro adoption; possibly more favorable in termsprogress towards euro adoption; possibly more favorable in terms of sacrifice ratioof sacrifice ratio

•• IT viewed as least costly, most sustainable available means of sIT viewed as least costly, most sustainable available means of securing lasting ecuring lasting disinflation and conducing to eventual price stability: (i) statdisinflation and conducing to eventual price stability: (i) status quo not functional us quo not functional (breakdown of multiplier stability, eclecticism leading to incon(breakdown of multiplier stability, eclecticism leading to inconsistency); (ii) exchange sistency); (ii) exchange rate anchor risky in context of rapid credit growth, fast capitarate anchor risky in context of rapid credit growth, fast capital acct. liberalization w. l acct. liberalization w. high real rates, both on background of convergencehigh real rates, both on background of convergence--induced real appreciation trendinduced real appreciation trend


Source: National Institute of Statistics, National Bank of Romania

Inflation Rate

27 25 22 14 93.8

±1pp4

±1pp

5±1pp

7.5±1pp

3.5±1pp

30.3

17.8

14.1

9.3

4.84

22.5

34.5

6.569.0

11.9

15.3

45.7

6.574.87

8.6

40.7

0

5

10

15

20

25

30

35

40

45

50

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

target (Dec./Dec.)

actual (average)

actual (Dec./Dec.)

percent

February 2008 (yoy): 7.97% (Mar. 2007-Feb. 2008)/(Mar. 2006-Feb. 2007): 5.5%


Specifications & Preparatory WorkSpecifications & Preparatory Work•• IT framework defined in terms of:IT framework defined in terms of:

targeting 12M headline CPI (transparency/accountability, effectitargeting 12M headline CPI (transparency/accountability, effectiveness in veness in influencing expectations), despite limited capacity of monetary influencing expectations), despite limited capacity of monetary policy to influence policy to influence administered & volatile pricesadministered & volatile pricesdefining point central target w. narrow symmetrical variation bdefining point central target w. narrow symmetrical variation band (and (±±1 1 percentage points), again for effective anchoring of expectationpercentage points), again for effective anchoring of expectationsstwotwo--year overlapping targeting horizonyear overlapping targeting horizongradually declining annual targets, in line w. sustainability ofgradually declining annual targets, in line w. sustainability of disinflation (given disinflation (given substantial Bsubstantial B--S effect estimates, limited policy toolbox, improving but still S effect estimates, limited policy toolbox, improving but still constrained effectiveness of standard policy instrument, gradualconstrained effectiveness of standard policy instrument, gradual credibility gains)credibility gains)explanatory clauses, not used for copexplanatory clauses, not used for cop--outsoutsavoiding target revisions at all costsavoiding target revisions at all coststarget set by CB, announced jointly with governmenttarget set by CB, announced jointly with government

•• Valuable TA from IMF/CNB, 2003Valuable TA from IMF/CNB, 2003--4 and after: model 4 and after: model specification/calibration (full Board participation in final staspecification/calibration (full Board participation in final stages), further ges), further extensions, two quarterly cycles of dryextensions, two quarterly cycles of dry--run practice before going live (incl. run practice before going live (incl. fully fledged writing of QIR + attendant drafting of press releafully fledged writing of QIR + attendant drafting of press releases, etc.)ses, etc.)

•• Official introduction of IT in Romania: August 2005Official introduction of IT in Romania: August 2005


Initial Prerequisites & Challenges in Initial Prerequisites & Challenges in Implementing Inflation Targeting in RomaniaImplementing Inflation Targeting in Romania

•• Inflation at starting point already in single digitsInflation at starting point already in single digits•• Fiscal dominance no longer a threatFiscal dominance no longer a threat•• Increased effectiveness of interest rate instrumentIncreased effectiveness of interest rate instrument•• Soundness & stability of financial sector (w. low depth, howeverSoundness & stability of financial sector (w. low depth, however))•• Consolidation of CB full independence, transposition of EU acquiConsolidation of CB full independence, transposition of EU acquiss•• Increased forecasting capacity of CBIncreased forecasting capacity of CB•• Disinflation gains since 1999 improved credibility of monetary aDisinflation gains since 1999 improved credibility of monetary authorityuthority

•• Liberalisation of capital flows with large impact on forex markeLiberalisation of capital flows with large impact on forex market in the t in the context of significant interest rate differential & perspective context of significant interest rate differential & perspective of more of more appreciation (appreciation (ToToššovskovskýý dilemma)dilemma)

•• Significant level of currency substitution, net debtor position Significant level of currency substitution, net debtor position of the of the central bank hinder transmission of policy signalscentral bank hinder transmission of policy signals

•• Small open economy magnifies importance & visibility of exchangeSmall open economy magnifies importance & visibility of exchange raterate•• Persistently high current account deficitPersistently high current account deficit


Credit to Non-government*

61.5

23.0

58.2

20.8

49.3

37.6

16.4

76.0

112.0 113.8

31.7

94.4

71.7

0

20

40

60

80

100

120

140

CZ

(199

7)

PL (1

998)

HU

(200

1)

CL

(199

0)

BR (1

999)

MX

(199

9)

IS (1

992)

TH (2

000)

NZ

(199

0)

UK

(199

2)

SE (1

993)

ZA (2

000)

RO

(200

5)

percent of GDP

Source: EUROSTAT, NBR, NIS, IMF *) at the time of shifting to inflation targeting


Bank Assets*

56.069.1

53.9

127.2

104.4

229.0

92.5

45.2

138.0136.0

0

50

100

150

200

250

CZ

(199

7)

PL (1

998)

HU

(200

1)

BR (1

999)

IS (1

992)

TH (2

000)

NZ

(199

0)

UK

(199

2)

ZA (2

000)

RO

(200

5)

percent of GDP

Source: Websites of central banks and national statistics institutions *) at the time of shifting to inflation targeting


Fiscal Surplus/Deficit*

-4.4

-9.9

-2.2

-4.4

-6.4

-1.8

0.7

-2.2-1.1

-9.2

-11.4

-1.4-1.3

– 14

– 12

– 10

– 8

– 6

– 4

– 2

0

2 C

Z (1

997)

PL (1

998)

HU

(200

1)

CL

(199

0)

BR (1

999)

MX

(199

9)

IS (1

992)

TH (2

000)

NZ

(199

0)

UK

(199

2)

SE (1

993)

ZA (2

000)

RO

(200

5)

percent of GDP

Source: EIU, MPF, NIS *) at the time of shifting to inflation targeting


Increasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflationIncreasing role of policy rate in determining inflation

-8

-6

-4

-2

0

2

4

6

2 4 6 8 10 12 14 16

Response of Core2 inflation to a monetary policy induced shockSample: 1998:08 - 2001:12

0

20

40

60

80

100

2 4 6 8 10 12 14 16

real interest rate gapreal exchange rate gap

output gapCore2 inflation

Variance Decomposition of Core2 inflation

0

20

40

60

80

100

2 4 6 8 10 12 14 16

real interest rate gapreal exchange rate gap

output gapCore2 inflation

Variance Decomposition of Core2 inflation

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

2 4 6 8 10 12 14 16

Response of Core2 inflation to a monetary policy induced shockSample: 2002:01 - 2007:12

Months

Contributions of shocks

(% of total variance)

Months

Contributions of shocks

(% of total variance)


Characteristics of IT in RomaniaCharacteristics of IT in Romania•• Flexible interpretation of IT: NBR use of all available instrumeFlexible interpretation of IT: NBR use of all available instruments, incl. exchange rate & nts, incl. exchange rate &

““unorthodoxunorthodox””, i.e. administrative/prudential policy tools employed for both , i.e. administrative/prudential policy tools employed for both macroeconomic macroeconomic & prudential reasons (differentiated reserve requirements, limit& prudential reasons (differentiated reserve requirements, limits for bank lending to s for bank lending to unhedged borrowers, loanunhedged borrowers, loan--toto--income limits for households, broadening scope of income limits for households, broadening scope of regulations outside credit institution sphere, etc.), but with eregulations outside credit institution sphere, etc.), but with ex ante awareness of their x ante awareness of their limited effectiveness over time and potential side effectslimited effectiveness over time and potential side effects

•• Emphasis on mediumEmphasis on medium--term disinflation path, not only pointterm disinflation path, not only point--attainment of annual targetsattainment of annual targets

•• Emphasis on sustainability, esp. in terms of nominal appreciatioEmphasis on sustainability, esp. in terms of nominal appreciation arising from potentially n arising from potentially volatile capital flows, need to ensure complementarity between pvolatile capital flows, need to ensure complementarity between price stability and financial rice stability and financial stability in context of persistent rapid credit expansion (fx bostability in context of persistent rapid credit expansion (fx borrowing, assetrrowing, asset--liability liability mismatches, increasing external private sector indebtedness) alsmismatches, increasing external private sector indebtedness) also as vehicle of carry tradeso as vehicle of carry trades

•• NBR implementation of IT focuses on ensuring compliance with medNBR implementation of IT focuses on ensuring compliance with mediumium--term path term path described by announced annual inflation targets, while not exacedescribed by announced annual inflation targets, while not exacerbating existing rbating existing macroeconomic vulnerabilities whose effects might compromise susmacroeconomic vulnerabilities whose effects might compromise sustainability of secured tainability of secured disinflation gains: disinflation gains: ‘‘macroeconomic riskmacroeconomic risk--management perspectivemanagement perspective’’

•• Explicit calls for consistency from other components of macro poExplicit calls for consistency from other components of macro policy mix (fiscal, incomes, licy mix (fiscal, incomes, structural reform) superseding constraints to monetary policy efstructural reform) superseding constraints to monetary policy effectiveness fectiveness


0

3

6

9

12

15

18Ja

n.05

Apr

.05

Jul.0

5O

ct.0

5Ja

n.06

Apr

.06

Jul.0

6O

ct.0

6Ja

n.07

Apr

.07

Jul.0

7O

ct.0

7Ja

n.08

0

5

10

15

20

25

30

sterilization operations (right-hand scale)NBR policy rate (% p.a.)inflation rate (annual percentage change)average actual interest rate on sterilization operations

RON billion; average daily stockpercent p.a.

NBR Policy Rate, NBR Sterilization Operations and Inflation Rate

Average Interest Ratesin the Banking System

0

5

10

15

20

25

30

Jan.

05A

pr.0

5Ju

l.05

Oct

.05

Jan.

06A

pr.0

6Ju

l.06

Oct

.06

Jan.

07A

pr.0

7Ju

l.07

Oct

.07

Jan.

08

new RON-denominated loans to non-financialcorporations and households

new RON-denominated time deposits from non-financial corporations and households

percent per annum

Source: National Bank of Romania, National Institute of Statistics


Financial Intermediation*

6.49.4

14.116.7

10.2

11.4

12.7

19.9

4.87.4

11.4

11.8

15.4

18.9

17.7

13.4

36.6

16.6

20.8

26.8

0

5

10

15

20

25

30

35

40

2004 2005 2006 2007Source: National Institute of Statistics, National Bank of Romania

percent

loans to non-financial corporations a.o.loans to households

foreign currency-denominated loansRON-denominated loans

*) loans to the private sector / GDP


Loans to the Private Sector

Source: National Bank of Romania, National Institute of Statistics

0

20

40

60

80

100

120D

ec.0

5Fe

b.06

Apr.0

6Ju

n.06

Aug.

06O

ct.0

6D

ec.0

6Fe

b.07

Apr.0

7Ju

n.07

Aug.

07O

ct.0

7D

ec.0

7Fe

b.08

RON-denominated loanstotalforeign currency-denominated loans

0

20

40

60

80

100

120

Dec

.05

Feb.

06Ap

r.06

Jun.

06Au

g.06

Oct

.06

Dec

.06

Feb.

07Ap

r.07

Jun.

07Au

g.07

Oct

.07

Dec

.07

Feb.

08

households

total

non-financial corporations & financialcorporations other than MFIs

real annual percentage change*

*) based on CPI

real annual percentage change*


Nominal Exchange Rate

2.7

2.9

3.1

3.3

3.5

3.7

3.9

4.1

4.3

Jan.

02Ap

r.02

Jul.0

2

Oct

.02

Jan.

03Ap

r.03

Jul.0

3

Oct

.03

Jan.

04

Apr.0

4Ju

l.04

Oct

.04

Jan.

05Ap

r.05

Jul.0

5

Oct

.05

Jan.

06Ap

r.06

Jul.0

6

Oct

.06

Jan.

07Ap

r.07

Jul.0

7

Oct

.07

Jan.

08

Source: National Bank of Romania

RON/EUR (daily data)

NBR's decision to pursue a more flexible exchange rate


Real Exchange Rate of the RON against the EUR

70

80

90

100

110

120

130

140

150

160

170Ja

n.01

May

.01

Sep.

01

Jan.

02

May

.02

Sep.

02

Jan.

03

May

.03

Sep.

03

Jan.

04

May

.04

Sep.

04

Jan.

05

May

.05

Sep.

05

Jan.

06

May

.06

Sep.

06

Jan.

07

May

.07

Sep.

07

Jan.

08

index, 2000 = 100

70

80

90

100

110

120

130

140

150

160

170monthly averages

based on CPI differential between Romania and Euro areabased on PPI differential between Romania and Euro areabased on ULC in industry

Appreciation (+)/Depreciation (–)

Source: National Bank of Romania calculations, National Institute of Statistics, International Financial Statistics


100

110

120

130

140

150

160

170

180

190

20020

01

2002

2003

2004

2005

2006

2007

2008

*

Source: National Institute of Statistics, National Bank of Romania calculations

labour productivity

gross real wage (based on PPI)

2000=100

Real Wage and Labour Productivity in Manufacturing

100

105

110

115

120

2001

2002

2003

2004

2005

2006

2007

2008

*

labour productivity

gross real wage (based on PPI)

previous year =100

*) January


0

50

100

150

200

250

300Fe

b.07

Mar

.07

Apr.0

7

May

.07

Jun.

07

Jul.0

7

Aug.

07

Sep.

07

Oct

.07

Nov

.07

Dec

.07

Jan.

08

Feb.

08

Mar

.08

Latvia Czech Rep. Lithuania

Poland Hungary Bulgaria

Romania

Spreads of Five-year CDS for Emerging Economiesin Central and Eastern Europe

Source: Bloomberg

basis points


Headline Inflation and CORE Inflation

2

3

4

5

6

7

8

9

10

11D

ec.0

4

Mar

.05

Jun.

05

Sep.

05

Dec

.05

Mar

.06

Jun.

06

Sep.

06

Dec

.06

Mar

.07

Jun.

07

Sep.

07

Dec

.07

annual percentage change

CPI (total)CORE1 (CPI – administered prices)CORE2 (CORE1 – volatile prices*)adjusted CORE2**


*) products with volatile prices: vegetables, fruit, eggs, fuels**) the influence of excise duties and vice tax is removed


Tradables and Non-tradables* Prices

0

10

20

30

40M

ar.0

2

Jun.

02

Sep.

02

Dec

.02

Mar

.03

Jun.

03

Sep.

03

Dec

.03

Mar

.04

Jun.

04

Sep.

04

Dec

.04

Mar

.05

Jun.

05

Sep.

05

Dec

.05

Mar

.06

Jun.

06

Sep.

06

Dec

.06

Mar

.07

Jun.

07

Sep.

07

Dec

.07

Source: Eurostat; National Bank of Romania calculations

tradables (goods)

non-tradables (mainly services and goods with administered prices)

*) based on COICOP

annual change (%)


0

1

2

3

4

5

6Se

p.06

Nov

.06

Jan.

07

Mar

.07

May

.07

Jul.0

7

Sep.

07

Nov

.07

Jan.

08

percent

0

1

2

3

4

5

6

deviation (right-side scale)

expected annual inflation rateannual inflation target

percentage points12 months

0

1

2

3

4

5

6

Sep.

06

Nov

.06

Jan.

07

Mar

.07

May

.07

Jul.0

7

Sep.

07

Nov

.07

Jan.

08

percent

0

1

2

3

4

5

6

deviation (right-side scale)

expected annual inflation rate

annual inflation target

percentage points24 months

Inflation Expectations of Banks for the Next:

Source: survey conducted by the NBR


Inflation ProjectionsInflation Projections

2

4

6

8

10

2007III IV

2008I II III IV

2009I II III IV


annual inflation rate*target band**target

annual percentage change

Inflation targets (Dec./Dec.) 2008: 3.8% 2009: 3.5%

**) ±1 percentage points around the (dis)inflation path

*) projection based on consumer basket composition for 2007

Note: according to the February 2008 Inflation Report

The NBR aims to achieve sustainable The NBR aims to achieve sustainable disinflation amid disinflation amid macroeconomicmacroeconomic risk risk

managementmanagement: : hencehence, , the NBR the NBR envisages the timely return of envisages the timely return of

inflation to the downward trajectory inflation to the downward trajectory compatible with the already compatible with the already

announced targets, without widening announced targets, without widening current macroeconomic imbalances current macroeconomic imbalances and by preserving financial stabilityand by preserving financial stability

The NBR does not envisage a change The NBR does not envisage a change in the established inflation targetsin the established inflation targets, ,

but strives towards achieving but strives towards achieving disinflation objectives in a sustainable disinflation objectives in a sustainable and timely manner,and timely manner, as any delay may as any delay may have a negative impact on the have a negative impact on the euroeuro

adoption calendaradoption calendar


Looking AheadLooking Ahead•• Further improvements in CB forecasting Further improvements in CB forecasting

capabilities: DGES model, extensions to capabilities: DGES model, extensions to current model, etc.current model, etc.

•• Ongoing discussion on improvements in Ongoing discussion on improvements in transparency transparency –– need for focus to remain need for focus to remain on issueson issues

•• IT framework in light of euro adoption IT framework in light of euro adoption efforts: choice of mediumefforts: choice of medium--run annual run annual targets, sequencingtargets, sequencing

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