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Inflation Targeting: Five Years From The Inside

Inflation Targeting: Five Years From The Inside. Peter Duronelly, CFA chief investment officer Budapest Alapkezelő Zrt. Five Years Of IT. June, 2001: inflation targeting Purpose: meeting Maastricht to introduce the euro by January, 2007

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Inflation Targeting: Five Years From The Inside

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  1. Inflation Targeting: Five Years From The Inside Peter Duronelly, CFA chief investment officer Budapest 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? real economy financial markets • 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

  6. A Simple Visualisation Of Multiple Equilibria In EURHUF • 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 275,00? 285,00? ??? 245,00 – 255,00

  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.

  9. Thank you for your attention!

  10. Inflation Goes Back To Target After External Shocks MNB inflation targets Reuters consensus for Dec 2007 Source: KSH, MNB, Reuters

  11. Money Markets Have Properly Forecast Monetary Policy Source: Bloomberg, Budapest Alapkezelő

  12. Volatility Of G7 Growth And Inflation Source: OECD, Budapest Alapkezelő 5-year rolling standard deviation of quarterly yoy indices

  13. Inflation Under Bretton Woods Bretton Woods „Bretton Woods II.” Source: Bloomberg, IMF

  14. Real Interest Rates: Deviation From Long Term Averages Source: IMF 5-year rolling standard deviation of quarterly yoy indices

  15. Swinging Premium Prompts Agressive Monetary Policy Actions Source: Bloomberg, Budapest Alapkezelő

  16. Oustanding OTC Derivatives Source: BIS, IMF, Budapest Alapkezelő

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