inflation targeting: five years from the inside peter duronelly, cfa chief investment officer...
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Inflation Targeting: Five Years From The Inside
Peter Duronelly, CFAchief investment officerBudapest Alapkezelő Zrt.
2
Five Years Of IT
June, 2001: inflation targeting
Purpose: meeting Maastricht to introduce the euro by January, 2007
Result: complete failure; no euro in sight, but not for monetary policy mistakes
Despite the failure to introduce the euro inflation targeting is successful
Magyar Nemzeti Bank’s credibilty has increased (from already high levels)
overspill effect of price shocks are controlled
governments acknowledge the central bank’s mission
by predicting the central bank’s behaviour financial markets send signals on the potential future path of monetary policy
3
Extrenal Factors To Inflation Targeting
‘The Great Moderation’: decreased volatility of global output and inflation
Reasons: global division of labor, technological advances, higher energy efficiency AND better monetary policy.
Many central banks either operate in an IT framework or behave as they had formal inflation targets.
Central bank credibility can be monetized on by saving interest expenditures due to lower risk premia on government debt.
Low volatility of inflation low inflation
Even small open economies can go for inflation targeting.
4
Life In „Bretton-Woods II”
An export-led strategy of peripheral countries with undervalued and quasi-fixed exhange rates.
Through rapid improvement in total factor productivity and pool of available labor inflation is low despite fast economic growth. The center country acts as an open economy converting its internal inflationary pressures into a current account deficit.
Official outflows of the peripheral countries help keep international interest rates low, lower then inflation would imply.
Hungary has been able to free-ride the easy liquidity and has converted excess demand into a current account deficit at minimal cost. Financial markets have failed to punish lax economic policies, leading to the postponement of Eurozone accession.
Hungary has survived by being the „country of unfinished crises”.
5
What Is The Equilibrium Level Of Interest Rates?
Countries of lower level of capital stock may have dual equilibium of real interest rates.
Real economy: marginal product of capital
Financial markets: uncovered interest rate parity condition
The existence of multiple equilibria can generate volatile monetary policy actions in case of swinging risk premiums
111 REERErr ef
edK
ed MPr
real economy financial markets
6
A Simple Visualisation Of Multiple Equilibria In EURHUF
245,00 – 255,00
275,00?
285,00?
???
The currency has stable and unstable equilibrium levels.
If we sell off from a stable equilibrium, we may not swing back to normal but roll over.
MNB can do to things to be sure to get back to normal
pray
hike agressively
7
Inflation Targeting: An Istitution Of Democratic Control
Politicians and policy makers act in ways which may conflict
long term interest of the public.
Buying votes of particular groups by spreading the costs in the
form of higher inflation is always a compelling way to perform
well on the elections.
An inflation targeting central bank has the right, the means, and
even the obligation to keep inflation where it is supposed to be
not regarding volatility of economic output.
8
Outlook For Inflation Targeting
The grace period in the global economy and on the financial markets will not last for ever.
At least the volatility of global inflation will ultimately go up.
The growing complexity of financial markets is also to be monitored.
Meeting Maastricht is still project — even after five years of inflation targeting.
Thank you for your attention!
10
Inflation Goes Back To Target After External Shocks
0
2
4
6
8
10
12
01
/ 0
1
05
/ 0
1
09
/ 0
1
01
/ 0
2
05
/ 0
2
09
/ 0
2
01
/ 0
3
05
/ 0
3
09
/ 0
3
01
/ 0
4
05
/ 0
4
09
/ 0
4
01
/ 0
5
05
/ 0
5
09
/ 0
5
01
/ 0
6
05
/ 0
6
09
/ 0
6
01
/ 0
7
05
/ 0
7
09
/ 0
7
01
/ 0
8
MNB inflation targets Reuters consensus for
Dec 2007
Source: KSH, MNB, Reuters
11
Money Markets Have Properly Forecast Monetary Policy
0
2
4
6
8
10
12
14
16
05
/ 0
1
08
/ 0
1
11
/ 0
1
02
/ 0
2
05
/ 0
2
08
/ 0
2
11
/ 0
2
02
/ 0
3
05
/ 0
3
08
/ 0
3
11
/ 0
3
02
/ 0
4
05
/ 0
4
08
/ 0
4
11
/ 0
4
02
/ 0
5
05
/ 0
5
08
/ 0
5
11
/ 0
5
02
/ 0
6
05
/ 0
6
08
/ 0
6
11
/ 0
6
base rate
3X6 mm fwd
Source: Bloomberg, Budapest Alapkezelő
12
Volatility Of G7 Growth And Inflation
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
19
65
19
68
19
71
19
74
19
76
19
79
19
82
19
85
19
87
19
90
19
93
19
96
19
98
20
01
20
04
GDP
inflation
Source: OECD, Budapest Alapkezelő 5-year rolling standard deviation of quarterly yoy indices
13
Inflation Under Bretton Woods
0
5
10
15
20
25
30
35
1960
1962
1964
1966
1968
1970
1972
1974
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1998
2000
2002
2004
world cpi
Source: Bloomberg, IMF
Bretton Woods
„Bretton Woods
II.”
14
Real Interest Rates: Deviation From Long Term Averages
-8%
-6%
-4%
-2%
0%
2%
4%
6%
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
EZ
US
JN
Source: IMF 5-year rolling standard deviation of quarterly yoy indices
15
Swinging Premium Prompts Agressive Monetary Policy Actions
0
2
4
6
8
10
12
14
05
/ 0
1
08
/ 0
1
11
/ 0
1
02
/ 0
2
05
/ 0
2
08
/ 0
2
11
/ 0
2
02
/ 0
3
05
/ 0
3
08
/ 0
3
11
/ 0
3
02
/ 0
4
05
/ 0
4
08
/ 0
4
11
/ 0
4
02
/ 0
5
05
/ 0
5
08
/ 0
5
11
/ 0
5
02
/ 0
6
05
/ 0
6
08
/ 0
6
11
/ 0
6
-4
-2
0
2
4
6
8
10
12
base rate
risk premium over 12MEUR
Source: Bloomberg, Budapest Alapkezelő
16
Oustanding OTC Derivatives
0%
100%
200%
300%
400%
500%
600%
700%
800%
900%
19
98
19
98
19
99
19
99
20
00
20
00
20
01
20
01
20
02
20
02
20
03
20
03
20
04
20
04
20
05
20
05
20
06
as % of world GDP
Source: BIS, IMF, Budapest Alapkezelő