Inflation Targeting A Monetary Policy Framework for Georgia

1
Inflation TargetingA Monetary Policy Framework
for Georgia?

• Andreas Billmeier
• Tbilisi
• October 22, 2005

2
Outline of Presentation

• The need for a nominal anchor
• Exchange rate targeting
• Monetary/credit aggregate targeting
• Inflation Targeting (IT)
• What is it?
• Meeting the preconditions
• Operational issues
• Country experiences
• Conclusions

3
The Need for a Nominal AnchorEvolution of
Monetary Frameworks

• Nominal anchor for public price expectations
• Common anchors
• Exchange rate targeting
• Targeting monetary or credit aggregates
• Inflation
• How to chose anchor/target ?
• Effectiveness of chosen anchor requires
  renouncing all others

4
Inflation Targeting (1)What is IT?

• A framework for monetary policy characterized by
• Announcement of a target inflation rate over a
  time horizon
• Commitment to achieve and maintain low stable
  inflation
• Monetary policy anchored only by the inflation
  target
• NOT by monetary or ER targets
• Central bank may pursue other goals as long as
  inflation target is preserved
• Enhanced transparency and strengthened
  accountability.
• Set target, forecast inflation, compare, adjust
  policy if needed.

5
IT (2)The Preconditions

• Successful implementation of IT requires
• Price stability is overriding target (not ER,
  growth).
• Central bank is instrument independent
• Compromised by fiscal dominance / weak financial
  sector
• Central bank is accountable to public
• Inflation forecast ? need for econometric model
  (data? stable relationship?)

6
IT (3)Operational Issues

• Clear, transparent, and timely communication of
• Inflation targets
• Policy changes, including justification and
  inflation impact
• Target breaches, causes and remedial actions
• Analysis of policy and performance
• Operational framework to guide monetary policy
• Links between alternative instruments and
  inflation (lags?)
• A forward-looking approach
• A policy rule that links instruments to the
  inflation forecast

7
IT (4)Country Experiences

• Apparent success
• But benign economic environment (low inflation)
• More stringent tests (business cycle, oil prices)
• More empirical research needed to assess the
  impact (esp. emerging markets and developing
  economies)
• Some features
• Transition period slow (Chile and Israel) vs.
  fast (Brazil, Czech Republic, Poland, South
  Africa)
• In some cases, double-digit inflation before IT
  (Chile, Israel)
• (Strong) ER concerns when adopting IT (Israel,
  Spain)

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IT (5)Country Experiences
9
IT (6)Country Experiences
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Conclusions

• In developing countries (and emerging markets),
  monetary policy very important
• ? Large global capital movements danger for ER
  pegs.
• Two impossible trinities
• ? Freely mobile capital ? Stable ER
• ? Independent monetary policy ? Stable interest
  rate
• ? Fixed exchange rates ? Low inflation
• In the longer run, possible to have any two, but
  not all three
• Good arguments to move away from ER/monetary
  targeting
• Increasing interest in Inflation Targeting in
  many countries
• IT framework promising for Georgiabut (long) way
  to go!