1

Monetary Policy in East Asia: Does Targeting Inflation Require

‘Inflation Targeting’?

Hans GenbergProfessor, Graduate Institute of International Studies, Geneva

Research Fellow, HKIMR

2

Outline

• Inflation and monetary policy in East Asia:‘If it isn’t broken, don’t fix it’

• Inflation targeting must not be a one-size-fit-all strategy

• Target inflation, yes - ‘inflation targeting’, maybe

• Some suggestions for research

3

East Asia does not have an ‘inflation problem’

Table 1. Inflation rates in selected countries, 1991-2000.

Average Standarddeviation

Australia 2.22 1.50New Zealand 1.75 1.06Singapore 1.73 1.18Korea 5.10 2.44Malaysia 3.55 1.09Thailand 4.54 2.28Hong KongSAR

5.35 5.39

Philippines 8.60 3.83

4

Chart1: Inflation rates

-1.00

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

10.00

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

AUSTRALIA NEW ZEALAND SINGAPORE

5

Chart 2: Inflation rates

0

1

2

3

4

5

6

7

8

9

10

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

KOREA MALAYSIA THAILAND

6

Chart 3:Inflation rates

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

HONG KONG SAR PHILIPPINES

7

Is there a need to change strategy?

• Fear of pegging• What are the objectives of monetary policy• Need for a nominal anchor

8

What will countries do?

• New Zealand and Australia - No, but there is some talk of a monetary union

• Hong Kong - A basket peg? • Korea and Thailand - have adopted inflation

targeting. How will it be implemented?• Malaysia and Singapore - exchange-rate based

strategies• Philippines - inflation targeting as well?

9

Inflation Targeting

• Fundamentally about the objectives of monetary policyand

• How to achieve these objectives

• Countries differ - the implementation of inflation targeting in industrialized countries does not necessarily fit elsewhere

10

Targeting inflation vs. Inflation Targeting

• The need for a nominal anchor• Monetary policy can not do it alone• Inflation targeting can not mean targeting

only inflation• Implementation must be country specific

11

Alternative nominal anchors

• The exchange rate• Monetary or credit aggregates• An inflation target

12

The importance of policy consistency

• Large fiscal imbalances complicate inflation targeting – Deficit financing– Changes in the equilibrium real interest rate

• Agreement of what monetary policy can and cannot accomplish

• Central Bank independence is not enough – ‘The government giveth and the government taketh

away’

13

Objectives of monetary policy

• Strict inflation targeting (‘inflation nutters’)– Inflation – to provide a nominal anchor

• Flexible inflation targeting (inflation targeting does not mean targeting only inflation)– Inflation– Output variability– What about the exchange rate?

14

The exchange rate among the targets?

• Exchange-rate volatility and trade– Theory (ambiguous but presumption that higher

uncertainty would reduce trade). – Empirical evidence

• Time-series evidence does not show much effect• Recent cross-section evidence finds stronger

relationship

• Trade promotes welfare through increased incomes and growth

15

Implementation must be country specific

• The choice of goals• The choice of intermediate target• What should be the operating target?• Inflation reports, communication with the

public, central bank independence and all that

16

Some important areas for research

• Fixed rules are relatively easy to carry out• Targeting inflation implies more discretion

and responsibility for the central bank• This requires more knowledge

17

The transmission mechanism

• The central bank must choose an operating procedure that allows it to control inflation while at the same time getting as close as possible to other subsidiary goals

• The transmission mechanism of monetary policy defines the policy strategy

18

Inflation

Output gap

Exchangerate

Interestrate

Monetary policyinstrument

?

‘Noise’

Alternative transmission mechanisms

19

Inflation

Output gap

Interestrate

Exchangerate

Monetary policyinstrument

?

‘Noise’

Alternative transmission mechanisms

20

Inflation

Output gapInterest

rate

Exchangerate

Monetary policyinstrument?

‘Noise’

‘Noise’

Alternative transmission mechanisms

21

Should the interest rate or the exchange rate be the residual?

• What constitutes a neutral monetary policy?• Vulnerability of the economy to interest rate

vs exchange rate volatility• Sources of chocks and nature of financial

relationships in the economy

22

Is there a need for international policy co-ordination?

• Independent inflation targeting means greater exchange rate volatility

• The risk of competitive depreciations/appreciations

23

Three parting reminders

• Inflation targeting is about goals of monetary policy– It does not imply that there is only one goal

• Implementation of monetary policy has to be country specific– IT is consistent with many different approaches

• Knowledge of the transmission of monetary policy will become more important

24

Your comments are welcome

genberg@hei.unige.ch