1、L-2. Monetary and Exchange Rate Policy Frameworks and StrategiesPresenterRay BrooksJoint China-IMF Training ProgramCourse on Macroeconomic Management and Financial Sector IssuesCT 14.051OutlineWhat are the ultimate goals of monetary policy?What are the alternative frameworks and how do they work?How

2、 to choose a monetary framework?What choices were made in the past?How well did they perform?Chinas choicesThis training material is the property of the International Monetary Fund (IMF) and is intended for use in IMFs Institute for Capacity development (ICD) courses. Any reuse requires the permissi

3、on of ICD.2I. What are the ultimate goals of monetary policy?1.Price stability2.Output and employment3. Exchange rate stability4. Post global crisis, calls to also target financial stability3The relationship between inflation and cyclical unemployment has changed over time 4Apparent that the slope o

4、f Phillips curve has fallenSource: April 2013 WEOWhat can monetary policy do?Can effectively control prices and exchange rates nominal variablesCan serve as a nominal anchor in the economyCan contribute to economic growth and help create jobs through low and stable inflationBut it cannot be a real a

5、nchorunemployment, growth, and real exchange rate cannot be affected persistentlyMonetary policy affects demand, not supply Too much demand stimulus stokes inflationStabilize output around its potential and inflation around the inflation targetJointly minimize volatility of output and inflation sy;

6、spQuantityPriceADASLong-run ASExchange Rate Policy : OverviewIn the short run, the nominal ER level affects the real exchange rate:If domestic inflation is high, a fixed exchange rate might appreciate the RER.“The real exchange rate is always flexible”An appreciated RER affects competitiveness of ex

7、ports and can lead to current account deficits.A flexible ER might be a powerful tool to restore external equilibrium.8II. What are the Alternative Monetary and Exchange rate Frameworks and how do they work?“There are many ways to skin a cat”Stone and Bhundia classificationCompatible choicesCountrie

8、s need to choose a monetary policy strategy (e.g., money growth targets or inflation targets) and an exchange rate arrangementThe two choices must be compatibleThe Impossible Trinity CAPITAL CONTROLSMonetaryindependenceHard PegPUREFLOATCapital Mobilityincreasing capital mobilityExchange ratestabilit

9、yChinaU.S., JapanEU11The “impossible trinity”It is impossible to simultaneously maintain:a fixed exchange rateand autonomous monetary policy to pursue goals for domestic economic activity and price stabilityifthe economy relies on a large volume of potentially volatile and internationally mobile sou

10、rces of financeFour Viable Alternative Monetary and Exchange Rate RegimesExchange rate targetingMonetary aggregates targetingInflation targetingOther “eclectic” frameworks HARD PEGSExchange arrangements with no separate legal tender Currency union DollarizationCurrency board INTERMEDIATE(Soft Pegs)C

11、onventional pegStabilized arrangementPeg with horizontal bandsCrawling pegCrawl-like arrangement FLOATINGFloatingFree floatingRange of Options for Exchange Rate141. Exchange rate targetingThe exchange rate is the nominal anchorPre-World-War-I gold standardBretton-Woods regime (1945-71)All countries

12、pegging to gold through the U.S. dollarArgentinas currency board (1991-2001)“Hard” pegDollar peg in South Korea, Thailand, Indonesia“Soft” pegWest Africa Monetary Union, European Monetary Union (regional system)How does ER targeting work?Keep the ER on target (level, “crawl”, and so on)As long as th

13、e capital account is at least partly open, domestic interest rate world interest rate + risk premiumThe “l(fā)aw of one price” (PPP) will take care of inflation convergence (dz = p* - p)Maintain liquidity in the banking systemIts a comparatively simple regime to operate!“The devil is in the detail”A cou

14、ntry may say that they are maintaining a crawling peg / managed float / free float, but:Have no volatility of the exchange rateWhile officially floating, some central banks used to phone commercial bank with “suggested” ERsAccumulate international reservesDistinguish de jure and de facto regimes!Chi

15、na is de jure managed floating arrangementBut de facto classified as a “crawl-like arrangement” by IMF in 2013 Article IV (as the RMB-U.S.$ rate has remained in a 2 percent crawling band)Chinas peg was stable against US$ mid-1990s to mid 2000s but nominal effective exchange rate movedChinas real eff

16、ective exchange rate has appreciated more than the nominal rate2. Monetary aggregates targeting Monetary growth is the nominal anchor.Based on the quantity theory of money (Friedman, 1956): MV=PYInflation from “many dollars behind few goods.”Monetary policy instruments adjusted to target growth rate

17、 of money supply (e.g., broad money)2. Monetary aggregates targeting The exchange rate has to float as long as the capital account is openThe fiscal position must be under control.Why? M2 = NFA+NDA.Examples:Industrial countries (the late-1970s to mid-1980s)About 30 countries today (mostly low-income

18、)Inspired the ECBs Monetary Pillar.How does MT work?1. Provide liquidity consistent with your2. intermediate target (M2 growth)3. to achieve your ultimate objective (p*)Need to believe in p = f(M)3. Inflation targeting Inflation forecast is the nominal anchorAdjust monetary policy instruments to kee

19、p the central banks forecast of inflation consistent with a pre-announced targetExamples:New Zealand, Chile, U.K., Czech Republic, Poland, Romania, Thailand, Brazil, Ghana.Is the forecast of inflation on target?YesShould policy respond?No change in instrument Determine size of responseNoNo change in

20、 instrumentYesNo Change instrument“Escape clauses” permit departure from the target Communicate Communicate Communicate How does IT work?244. Eclectic monetary policy What is the nominal anchor?Adjust monetary policy instruments to pursue stable economic growth and low inflation, but with no formall

21、y pre-announced targetsExamples:U.S., Euro Area, Japan, India, .How does eclectic policy work?Central banks have inflation objectives, but not as explicit on target and horizon as formal IT countriesECB: “inflation below, but close to, 2percent”Fed: “ the goals of maximum employment, stable prices,

22、and moderate long-term interest rates”.Decisions are also based on forecasts of inflationGood system to forecast inflation and a good understanding of the transmission mechanism is crucialDifference between ITs and “eclectics” is a different level of communication, although convergence.Group (Break

23、into groups of 5-6 to discuss question below. Nominate one person from your group who will summarize the discussion)What are the key factors behind Chinas choice of monetary and exchange rate framework in recent years?27III. How to choose a monetary frameworkThere are always pros and consWhat is the

24、 appropriate monetary and exchange rate policy regime?Many considerations are relevantSimilar countries sometimes make different choicesThe best choice for any particular country may change over time Choice of monetary frameworkEach monetary framework has its advantages and disadvantages. The choice

25、 depends on policy objectives and their relative importance:Reduce/stabilize inflationStabilize output fluctuationsU.S.: “maximum sustainable employment and low inflation”Avoid financial crises (financial stability)International or regional economic integration1. Exchange rate targetingProvided the

26、authorities have a clear commitment to ER stability, expectations of inflation will stabilizeShort-run deviations are inevitableA long list of risksRisks of exchange rate targetingFiscal dominance undermines the regimeThe peg currency may not be consistent with trade patterns (ex. Argentinean and Br

27、azilian pegs to the U.S.$ in the 1990s and subsequent exits)Pegs encourage build up of balance sheet vulnerabilitiesPrivate sectorused to stable exchange rateignores exchange rate risk (plus bailout expectations)Build up in foreign currency debt (Asian crisis, Hungary and Romania lately)Chinas Curre

28、nt Account Surplus has fallen in recent years and REER has appreciated33Impossible trinity againLoss of monetary policy as a stabilization toolWith international capital mobility, impossible to target exchange rate and use monetary policy for output stabilizationBut the loss of independent monetary

29、policy may be offset by benefits of regional integration e.g. Euro area, WAEMUEliminating exchange rate risk lowers transactions costs and increases tradeBottom line on ER targetingSimple to operate“Gains from trade”can help “import” low inflationFiscal dominanceNeed to find the right peg currency (

30、or basket)Loss of monetary policy as a stabilization toolHigher risk of speculative attacks and crises Financial sector vulnerabilities as private sector takes on exchange rate riskCosts of sterilization for central banksaSource: Andrew Cheng, 2013 PBC Conference on Capital Flows2. Monetary Aggregat

31、es targetingFor monetary targeting to achieve price stability, there must be a stable relationship between monetary aggregates and inflation In many countries, this has broken down over the years because of financial innovations making velocity unstable and difficult to forecast. Monetary targeting

32、has lost much of its appealVelocity of M2 was unstable in 70s and 80s, esp. in Germany and JapanIn China too, the link between money and nominal GDP has been not been stable 39Bottom line on monetary targetingOperational simplicity and theoretically sound but the regime is not intuitiveThe public do

33、es not understand what is “broad money”, “narrow money”, etc Empirically dubiousThe short-run money-to-inflation nexus disappeared in the 1970sThe causality from money to output/prices does not hold in the data3. Flexible exchange rate & inflation targetingExplicit inflation target and transparent f

34、ramework, may help establish credibility Monetary policy needs to be free to pursue the inflation objectiveAs is other frameworks, fiscal dominance would damage the system; but perhaps to a lesser degree than in ER targetingFlexible ER and ITOperationally complex: need to know the whole monetary tra

35、nsmissionRequires a working link from policy rates interbank rates long ratesWith no ER anchor, the nominal ER can be volatile (“fear of floating syndrome”)With a weak ER pass-through, the real ER is also volatile shocks to outputEmphasis on price stability may cloud other CB responsibilities (finan

36、cial stability) Need to Learn to FloatFear of floating exchange rate is a barrier to many emerging markets in adopting ITVoluntary transitionprior to the transition, countries tend to have:stronger banking supervision, including to reduce currency mismatches on balance sheetsmore developed securitie

37、s markets; increased central bank independence, with emphasis on price stability then adopt inflation targeting.Crisis-driven transitionafter the transition, countries improve banking supervision and develop securities markets.43Lessons from Three CasesNew Zealand Credibility problem initiallyStarte

38、d with strict approachBecame more flexible over time, as inflation expectations became anchoredChile and Israel were able to use inflation targeting to disinflate successfullyIsrael showed that can adopt inflation targetting even without meeting preconditions44Bottom line on inflation targetingA “no

39、minal anchor” without a ER commitmentMonetary policy retains independency under full capital mobilityFosters transparency and accountabilityTechnically demandingFocus on price stability may be at the expense of other objectives “Fear of floating” considerationsOne lesson from the Great Recession: ce

40、ntral banks must do more than just target inflationIs Inflation Targeting Dead?Old view: Monetary policy should aim for a low and stable inflation rate.New view: Stable inflation is necessary but not sufficient for macroeconomic stability. Monetary policy should react more strongly to indicators oth

41、er than output and inflation to mitigate damaging asset price boom-bust cycles. Low inflation limits the scope of monetary policy in deflationary recessions. Raise the inflation target?About 2/3s of IT central banks currently target headline inflation over the medium-term of less than 3 percent474.

42、Flexible exchange rate & eclectic monetary policyNo explicit commitment to a “nominal anchor, such as exchange rate, money, or infaltion - Lots of discretionIt may work if the Central Bank already has a lot of credibility (Fed, Swiss National Bank)It may not work to achieve disinflationIV. What Choi

43、ces were made in the PAstBretton-Woods era (1946-1971)Fixed exchange rates currencies pegged to the U.S. dollar & U.S. dollar pegged to goldStabilizing the domestic economy was a primary objective of monetary policyControls on international capital flows1950s to 1970s was a period of financial repre

44、ssion in advanced countriesIndustrial countries after 1971European countries went from pegs narrow bands wide bands a common currencyOther industrial countries adopted monetary aggregate targets in the late 1970s or early 1980s but abandoned them a few years laterMost of non-euro industrial countrie

45、s have adopted formal inflation targets (Australia, Canada, Iceland, New Zealand, Norway, Sweden, United Kingdom) Also more than 20 emerging market countriesMonetary Policy Framework (2000)Source: IMF Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER), 2001Note: The monetary a

46、ggregate target category includes countries that adopt monetary aggregate target framework in addition to fund supported or other monetary countries, and also countries that only adopt fund supported or other monetary programs. Exchange rate anchor and Inflation-targeting framework categories include countries that also adopt fund supported or other monetary in addition to their respective framework program (more than one nominal anchor). 52Monetary Policy Framework (2011)Source: IMF Ann