Monetary policy and external shocks: Colombia
CIII Meeting, CEMLA
Juan José Echavarría Governor, Central Bank
Monetary Policy Responses to external shocks
• Initial conditions• Shocks• Impact and channels• Considerations on policy responses
• Nature of shocks• The exchange rate as shock absorber• Monetary policy
• Policy responses
Monetary Policy Responses to external shocks
• Initial conditions• Shocks• Impact and channels• Considerations on policy responses
• Nature of shocks• The exchange rate as shock absorber• Monetary policy
• Policy responses
• Oil exports represented more than 50% of total exports
• Non commodity exports to oil dependent trading partners larger than 25%
• FDI in the oil sector represented more than 35% of total FDI
• Oil related revenues represented 17% of total public revenues in 2012-2014
$10,101
33%
0%
10%
20%
30%
40%
50%
60%
0
5000
10000
15000
20000
25000
30000
35000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Crude Oil and Petroleum Products Exports
Crude Oil and Petroleum Products Exports (USD millions, F.O.B)
Percentage of Total Exports (right axis)
Source: DANE Source: Banco de la República
• The Colombian economy, highly oil dependent:
$13,593
16%
0%
10%
20%
30%
40%
50%
60%
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
FDI in the Oil Sector
FDI in Other Sectors (USD millions) FDI in the Oil Sector (USD millions)
FDI in the Oil Sector (% of total FDI)
Monetary Policy Responses to external shocks
• Initial conditions• Shocks• Impact and channels• Considerations on policy responses
• Nature of shocks• The exchange rate as shock absorber• Monetary policy
• Policy responses
The Shocks
• Oil price drop• Bad behavior of neighbor oil producer
countries• Beginning of the tightening cycle by
the FED• Increase sovereign risk premia• Large exchange rate devaluation
(90%)• Strong El Niño Phenomenon and
severe droughts
Source: U.S. Energy Information Administration
0
20
40
60
80
100
120
Jan-
14
Apr
-14
Jul-1
4
Oct
-14
Jan-
15
Apr
-15
Jul-1
5
Oct
-15
Jan-
16
Apr
-16
Jul-1
6
Oct
-16
Jan-
17
Apr
-17
Oil Prices (US$/Bl)
WTI Brent
Monetary Policy Responses to external shocks• Initial conditions• Shocks• Impact and channels• Considerations on policy responses
• Nature of shocks• The exchange rate as shock absorber• Monetary policy
• Policy responses
• Terms of trade shocks stronger than in other Latin American countries• The Colombian peso depreciated more
Shocks – Impact and channels
Source: Bloomberg
80
100
120
140
160
180
Jan-
12
Jul-1
2
Jan-
13
Jul-1
3
Jan-
14
Jul-1
4
Jan-
15
Jul-1
5
Jan-
16
Jul-1
6
Jan-
17
Nominal Exchange Rates - Local Currency/USD(Index Jan 2012=100)
Colombia Chile Mexico Peru
Source: Datastream
50
60
70
80
90
100
110
120
Mar
-12
Sep-
12
Mar
-13
Sep-
13
Mar
-14
Sep-
14
Mar
-15
Sep-
15
Mar
-16
Sep-
16
Mar
-17
Terms of Trade(Index 2012=100)
Brasil Colombia Chile México Peru
• Government revenues related to oil fell from 3,3% GDP in 2013 to almost 0% in 3 years.
• The large fall in oil and non-commodity exports widened the current account deficit from 3.4% in 2013 to 6.5% in 2015.
1.6%
2.6%
3.3%
2.6%
1.1%
-0.1% -0.01%
0.2% 0.2%0.4%
-0.5%
0.5%
1.5%
2.5%
3.5%
2011 2012 2013 2014 2015 2016 2017* 2018* 2019* 2020*
Government Revenue Related to Oil (% of GDP)
Taxes Dividends Total
Source: Banco de la RepúblicaSource: Ministry of Finance
-7,000
-6,000
-5,000
-4,000
-3,000
-2,000
-1,000
0
1,000
2,000
I II III IV I II III IV I II III IV I II III IV I II III IV
2012 2013 2014 2015 2016
Current Account and its Components(USD Millions)
Current Transfers Factor Income Balance of Trade (Goods and Services) Current Account
• Higher food and energy prices due to El Niño affected headline and core inflation.
• The large depreciation also influenced local prices despite a low pass-through.
15.71%
2.49%
0%
2%
4%
6%
8%
10%
12%
14%
16%
Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17
Annual Food Inflation(CPI y/y growth)
Source: DANE. Calculations by Banco de la República
5.22%5.35%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
Apr-12 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17
Total Tradable and Non-tradable Inflation(Excluding Food and Regulated Items)
Non-Tradable Tradable
• Core inflation rose above target and increased risk of no convergence after the effects of the shocks faded.
• The shocks, although transitory, affected inflation expectations and activated indexation mechanisms. Only at the end of 2016 inflation began to recede.
5.6%
8.97%
4.66%
0%
2%
4%
6%
8%
10%
Apr
-10
Oct
-10
Apr
-11
Oct
-11
Apr
-12
Oct
-12
Apr
-13
Oct
-13
Apr
-14
Oct
-14
Apr
-15
Oct
-15
Apr
-16
Oct
-16
Apr
-17
Total CPI and CPI Excluding Food(CPI y/y growth)
CPI Excluding Food Headline Inflation
6.75%
0%
2%
4%
6%
8%
10%
Apr
-10
Oct
-10
Apr
-11
Oct
-11
Apr
-12
Oct
-12
Apr
-13
Oct
-13
Apr
-14
Oct
-14
Apr
-15
Oct
-15
Apr
-16
Oct
-16
Apr
-17
Inflation of Regulated Items(CPI y/y growth)
Source: DANE. Calculations by Banco de la República
• Weaker permanent income, lower investments in the oil sector and a slower external demand caused a deceleration of output and absorption.
• Recent indicators suggest that the slowdown could be greater than expected.
1.6%
0.3%
-2%
0%
2%
4%
6%
8%
10%
I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV
2008 2009 2010 2011 2012 2013 2014 2015 2016
Annual Real GDP Growth and Domestic Demand
GDP Domestic Demand
Source: DANE. Calculations by Banco de la República
2%
-21
-30
-20
-10
0
10
20
30
40
-2%
0%
2%
4%
6%
8%
10%
I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I
2008 2009 2010 2011 2012 2013 2014 2015 2016 17
Consumer Confidence Index and Household Consumption Growth
Household Consumption growth Consumer Confidence Index (right axis)
Source: Fedesarrollo and DANE.
Monetary Policy Responses to external shocks
• Initial conditions• Shocks• Impact and channels• Considerations on policy responses
• Nature of shocks• The exchange rate as shock absorber• Monetary policy
• Policy responses
Identification of the nature of shocks• Given the persistent nature of the oil shock, a prudent policy response
would treat it as a permanent phenomenon
Persistent shockPolicy should react to a
fall in permanent national income.
Downward adjustment in domestic expenditure is
required.
▪Macroeconomic policy must accept a deceleration of domestic absorption and output.
▪ Policy should not attempt to restore previous expenditure growth rates.
• If macroeconomic policy did not accept the deceleration of output, risks on fiscal and external sustainability would arise
The exchange rate as shock absorber
• The adjustment to the persistent oil shock includes a sectorial reallocation of production and expenditure. Tradable goods relative prices must rise to induce this reallocation
• Otherwise, the correction of the current account deficit would hinge only on the adjustment of absorption
• Since the currency mismatches of both the private and public sector had been contained, it was possible to allow the exchange rate to depreciate and act as a shocks absorber
Cautious monetary policy
• The recent decline in inflation is mostly driven by the undoing of the supply shocks (food, regulated and tradable good prices).
• In general, any new supply shock may weaken the credibility of the inflation target and raise the cost of reaching it.
Two reasons for a cautious monetary policy response A. Increased inflation inertia (indexation) and imperfect anchoring of inflation
expectations to the target
0
0.1
0.2
0.3
0.4
0.5
0.6
sep-
09
mar
-10
sep-
10
mar
-11
sep-
11
mar
-12
sep-
12
mar
-13
sep-
13
mar
-14
sep-
14
mar
-15
sep-
15
mar
-16
sep-
16
Inflation PersistenceBackward-looking parameter of a Hybrid Phillips curve
Source: Banco de la República
• "Rigid prices" inflation confirms the growing importance of indexation and increased inflation expectations (non tradable goods and services inflation is rising)
Source: Banco de la República
8.03%
5.51%5.12%
-1%
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
Jan-
10
Jul-1
0
Jan-
11
Jul-1
1
Jan-
12
Jul-1
2
Jan-
13
Jul-1
3
Jan-
14
Jul-1
4
Jan-
15
Jul-1
5
Jan-
16
Jul-1
6
Jan-
17
Annual Inflation of Flexible and Rigid Prices Excluding Food and Regulated Items
Flexible Prices Inflation Rigid Prices Inflation
• The credibility of the inflation target was weakened after more than two years of inflation exceeding the 3% target
• Inflation expectations of analysts rose less than headline inflation, but still remain above the 3% target
4.69%4.39%4.16%
2%
3%
4%
5%
6%
7%
8%
9%
I II III IV I II III IV I II III IV I
2014 2015 2016 2017
Headline Inflation ExpectationsQuarterly Survey
Observed Inflation 1 Yr Expectations 2 Yr Expectations
Source: Banco de la República
B. Uncertainty about the new levels of potential growth and natural interest rates• Factors pushing down potential growth and natural interest rates: a)
Lower TOT, b)more expensive imported capital goods c) declining growth of labor force
• Productivity gains from infrastructure and peace are to be seen• Lower potential growth would imply a reduced natural interest rate,…• But possibly increasing external borrowing costs would push them up
è As a result, uncertainty on the size of the output gap or the neutral stance of monetary policy
3.3%2.8%
4.1%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
Annual Observed Growth
Potential Growth
Minimum Potential Growth
Maximum Potential Growth
Estimates of Potential GDP Growth
Source: The maximum and minimum levels of potential non-inflationary growth are calculated by the IMF. The mid level assumesa 2% per capita growth, population growth of 1% and productivity growth of 0,3%.
Estimates of the Neutral Interest Rate for Colombia (IMF)
MethodNeutral Real Interest Rate
Neutral Nominal Interest Rate
Nominal Monetary Policy Gap (bps)
Uncovered Interest Parity 0.6 4.6 -264Expected-Inflation Augmented Taylor Rule 1.0 5.0 -224Consumption Based CAPM 3.1 7.1 -14HP-Filter 2.2 6.2 -104Average 1.7 5.7 -151.5
Source: IMF (2017). Selected Issues Papers
Inflation expectations vs 3% and Ygap
0.09
-1.56
1.09
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
oct-0
3 mar-04
ago-04
en
e-05
jun-05
no
v-05
ab
r-06
sep-06
feb-07
jul-0
7 dic-07
may-08
oct-0
8 mar-09
ago-09
en
e-10
jun-10
no
v-10
ab
r-11
sep-11
feb-12
jul-1
2 dic-12
may-13
oct-1
3 mar-14
ago-14
en
e-15
jun-15
no
v-15
ab
r-16
sep-16
feb-17
inf_esp-inf_meta4% y_gap_trim inf_esp-inf_meta3%
Monetary Policy Responses to external shocks
• Initial Situation• The shocks• Their effects and channels• Considerations for policy responses
• Nature of shocks• Exchange rates as shock absorber• Cautious monetary policy
• Policy responses
• To control inflation and to keepinflation expectations anchored, theCentral Bank raised is key interestrate from 4.5% in September 2015 to7.75% in July 2016
• Public expenditure was reduced and atax reform was adopted
• As inflation began to recede andconsidering the risks of a excessiveslowdown, the Board has reduced thebenchmark interest rate by 125 bps.between December 2016 and April2017
Policy Responses
10%
3%
5.25%
3.25%
4.5%
7.…
6.5%
0%
2%
4%
6%
8%
10%
12%
Jan-
07
Jan-
08
Jan-
09
Jan-
10
Jan-
11
Jan-
12
Jan-
13
Jan-
14
Jan-
15
Jan-
16
Jan-
17
Policy Interest Rate
Source: Banco de la República
GDP Growth: 2017 and 2018(%)
Source: Latin American Consensus Forecast , april 2017
3.6 3.7 3.62.8 2.5 2.3 1.8 1.6 1.5 1.8
0.8 0.50.0
-4.4
4.0 3.6 3.83.0 3.0 3.0
2.6 2.12.5 2.5 2.3 2.4
0.7
-1.0
-5-4-3-2-1012345
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