Exchange Rate Regimes:What Can We Learn from Hong Kong and PhilippinesPaul D. McNelisFordham UniversityApril 2009
Relevance • Bangko Sentral ng Pilipinas is now rated in the top ten of central banks world wide for transparence • Since the Reform Act of 1994 BSP shifted from a backward-looking monetary-targeting scheme to a forward-looking inflation-targeting regime. • Hong Kong experienced acute deflation between 1998 and 2004. Yet it maintained its currency board or hard bet to the dollar. Should HK have changed after the onset of the Asian crisis?
The Data Macro Time Series, Philippines, 1995-2008 Hong Kong, 1984-2008
Two Questions • When the BSP shifted policy toward inflation targeting, did it make a big difference, in terms of economic structural change and welfare? • Would Hong Kong have done better if the HKMA shifted to inflation targeting after the Asian crisis in 1998?
Mythology: Bayesian DSGE Model Dynamic: explains how the economy evolves over time; Stochastic: embeds therandom or unknown shocks (e.g., technological change, oil price volatility and uncertainty in macroeconomic policy making) that hit the economy. General Equilibrium framework: depicts the macro economy as the sum of individual choices and decisions made by firms, households, the government, and the central bank, according to their own preferences and views about the future.
Why? Complements rather than replaces existing models ‘thick’ models because there is no one true model The general equilibrium framework tends to reduce inconsistencies and forces the modelers and policymakers to think of economic linkages in a disciplined manner. The micro-foundations of DSGE models make them more suitable for policy evaluation because the relationships embodied do not change with changes in the policy environment. Key benefit: evaluation of welfare effects
Why Bayesian DSGE? Since the late 1970’s we have shifted to Bayesian Macro-econometrics. Equivalent to moving from the Wright Brothers to A380 fly bye wire jets in 30 years. There have been big structural shifts that weaken the usefulness of historical time series. We have less data that we think, even in developed countries like the USA. In short, all of us have to work with limited data sets. Using classical statistics, no scientific researcher would claim any evidence based on tests with 40 or 100 observations. Recognizes that we only have vague understanding of true relationship among economic variables. The only ‘truth’ is what we observe Makes use of our beliefs (“subjective priors”) and allows the data to modify our priors (learning process)
More Reasons for Bayesian Methods Truth is, Bayesian macro-econometrics is easier. Easier to integrate a likelihood function numerically than it is to maximize it—complexity, curse of dimensionality. Bayesian inference is a way of thinking, not a basket of methods (Sims): we go directly to the data, apply Bayes’ theorem and learn from it. Frequentist statements are beautiful but inconsequential for decision-makers: who cares about a 95% confidence interval Not making use of prior information is an unforgivable sin of omission. Real life is full of bad or incomplete data—we have to make the best out of bad situations. Classical methods have a harder time jumping from point estimates to whole distributions of policy-relevant objects. We search for “pseudo-true parameter values”: how to use a model as a language to express regular features of data, to tell powerful economic histories and exert control over outcomes of interest.
Structure of Model:Conceptual Model (CM) Agents and Decision Makers
Risks in the Conceptual Model Actors: Household, Firms, Central Bank, Banks, Fiscal Authority
Bayesian Macroeconometrics:Philippines and HK Adjusting Conceptual Model by the Data
Conclusions • Welfare improved by quite a bit when the BSP shifted from a backward-looking money targeting regime to a forward-looking inflation-targeting regime • Hong Kong would not have been better off if the HKMA shifted from its currency board to inflation-targeting in the wake of the Asian crisis or deflation. • Both countries have quite a bit of price flexibility. • For HK, foreign interest rates are very important, for Philippines, exports and terms of trade more important.