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Monetary Policy Modelling: New Directions
“Practice is ahead of theory, theory is ahead of
modelling ...” Erdem Başcı
Mehmet YörükoğluDeputy Governor
2013 Central Bank Macroeconomic Modelling WorkshopNovember 7-8 2013, Istanbul
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Contents
I. The changing role of monetary policy in the pre
and post-crisis period
II. Changes in monetary policy modelling
approach
III. Turkish experience
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The redesign of monetary policy strategy
How will monetary policy objectives and policy
tools evolve?
How will financial stability considerations be
integrated into the policy process?
What changes to the policy framework will be
adopted?
Challenging questions:
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Pre-crisis consensus
Commitment to a strong nominal anchor
Inflation targeting
Main objective: price stability
Single instrument: interest rate
Subsidiary role for the financial system
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Need for a new monetary policy framework
New role for central banks: avoid development
of financial imbalances
The post-crisis economic environment is
different
Unconventional policy instruments
Why a new policy framework?
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Decoupling
The traditional monetary policy framework was
embraced by both emerging and developed
countries
The crisis created a decoupling
Problems and policy responses differed among
developed and emerging economies.
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Crisis experience: Developed countries
sharp decline in growth,
deflationary pressures,
liquidity problems.
large-scale balance sheet policies,
provision of ample liquidity,
buying risky assets,
forward guidance...
Problems
Measures
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Crisis experience: Emerging economies
volatile cross-border capital flows,
exchange rate appreciation,
rapid credit growth.
increasing bank reserve requirements,
restrictions on credit market,
taxing capital flows...
Problems
Measures
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Capital flows
Improvement in Risk PerceptionsImprovement in Risk Perceptions Capital InflowsCapital Inflows
Balance sheet effects and easing
credit standards
Balance sheet effects and easing
credit standards
External Borrowing Currency appreciationEasier external finance
Capital flows affect economy significantly mainly through credit and exchange rate channels.
Financial Instability Cycle for an Emerging Market Economy
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Turkish Experience
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Financial Stability Concerns: Credit Growth
Source: CBRT.
Fast credit growth...
Total Loan Growth Rates (13 Weeks Moving Average, Annualized, FX Adjusted, Percent)
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Main Sources of Current Account Deficit Finance*(12-months Cumulative, Billion USD)
*Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury. Source: CBRT.
Financial Stability Concerns: Current Account
Current Account Balance(Seasonally Adjusted, Quarterly Average, Billion USD )
Source: TURKSTAT, CBRT.
Current account deficit widened significantly
Most of CA deficit was financed by short-term capital flows
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Real Exchange Rates (ReR) in Turkey(2003=100, Logarithmic scale, Reverse order)
Financial Stability Concerns: Exchange Rates
EM countries are Brazil, Chile, Colombia, Czech Republic, Hungary, India, Indonesia, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, South Korea, Taiwan and Thailand.Source: Bloomberg, CBRT.
Nominal currency appreciated around 20 percent, moving together with other EM currencies
Real exchange rates appreciated significantly compared to its long-term trend
TL and Other EM Currencies Against USD (9 March 2009=1)
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Modification of inflation targeting regime
Adopting financial stability as a supplementary
objective.
Enriching the set of policy instruments:
wide assymmetric interest rate corridor,
reserve option mechanism.
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Interest Rate Corridor
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Reserve Option Mechanism
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Reserve Option Coefficients Use of the ROM
Source: CBRT.
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Results: Credit growth
Total Credit Growth (%)
Credit growth is contained.
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Results: Current Account
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Current Account Balance(12-month Cumulative, Billion USD )
Source: TURKSTAT, CBRT.
Main Sources of Current Account Deficit Finance*
(12-months Cumulative, Billion USD)
Source: TURKSTAT, CBRT.*Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Long-term capital movements are sum of banking and real sectors’ long term net credit and bonds issued by banks and the Treasury.
Significant improvement both in the level and financing of the current account deficit.
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Results: Exchange Rate
Correction of the initial overvaluation in the currency.
Low volatility of currency relative to peer emerging countries.
TL and Other EM Currencies Against USD (1 November 2010=1)
Implied FX Volatility (1-month)
Turkey
EM Currencies (with 20%-80% band
around the mean)
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Overview
Practice is ahead of theory; theory is ahead of modelling ...
Incorporating financial stability along with the price stability, and a better management of global spill-overs
The crisis stimulated research on incorpotating the interactions between financial market imperfections and the real economy in policy models.
To understand the transmission of unconventional policies empirically, future research should continue to exploit the experience of central banks in the last five years.
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Thank You.
Mehmet YörükoğluDeputy Governor
2013 Central Bank Macroeconomic Modelling WorkshopNovember 8, 2013, Istanbul