Post on 03-Jan-2016
1
CENTRAL BANK OF CHILE
Rodrigo Valdés(with José de Gregorio and Andrea
Tokman)
IADB - MAY 13, 2005
Flexible Exchange Rates with Inflation Targeting in Chile:
Experience and Issues
2
Agenda
1. The road to a flex ER regime in Chile2. The current policy framework
Description Brief evaluation
3. The ER and the framework at work4. Issues
Volatility and hedging Extreme valuations Passthrough
5. Concluding remarks
3
1. The Road to a Flexible ER Regime in
Chile
4
Road to Flex ER
• Problems with ER inflexibility. Crises in 1962 and 1982 with fixed ER. Recession after Asian crisis and ER band
• ER band suffered multiple adjustments affecting its credibility; ER usually near low limit
• Fear of floating in 1998 due to:– Passthrough in overheated economy and large CA deficit – Mismatches
• Capital controls during the 90s– Useful? Not central; ER regime more problematic– Dismantled after the crisis
5 N F O R M E
The Road to Flex
Source: Central Bank of Chile
250
350
450
550
650
750
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05
Band Exchange Rate
Exchange Rate and Band: 1990-2005(pesos per US$)
6 N F O R M E
The Road to Flex
Source: Central Bank of Chile
Real Exchange Rate: 1982-2005(up is peso depreciation)
40
50
60
70
80
90
100
110
120
82 84 86 88 90 92 94 96 98 00 02 04
7
2. The Current Framework: FFIT + Flex ER
I N F O R M E D E P O L Í T I C A M O N E T A R I A
8
The Current Framework
• Since 2000 IT with a 2 to 4% band, centered in 3% for CPI with policy horizon of 12-24 months ( “infant stage” IT with annual targets before)
• Forward-looking nature and band accommodates – MP lags – Unnecessary output volatility
• No contingencies announced• Headline CPI, but core measures used to
evaluate, forecast and communicate
9
The Current Framework
• In practice, 12-24 month forecasts are the operational objective
• Standard instruments to communicate MP:– Monetary Policy Report– Communiqués – MP meeting minutes
• Floating ER regime, but CB reserves the right to intervene in exceptional circumstances – Overreaction with negative consequences– Transparency
10
The Current Framework
Has served well the economy...• From gradual decline in inflation in the 90s to
– Average 2.7% since 2000, max 4.7%, min -0.7%– 2/3 of the time within the band
• Powerful anchor for medium term expected inflation
• MP has been strongly countercyclical – More than in the 90s
• RER adjustment to negative shocks in 2001 and 2002
11
-1%
4%
9%
14%
19%
24%
29%
34%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04
Target Inflation
N F O R M E
The Current Framework
Source: Central Bank of Chile
CPI Inflation and Inflation Target: 1990-2005(percentage)
12
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5S
ep-
01
Mar
-02
Sep
-02
Ma
r-03
Se
p-0
3
Mar
-04
Sep
-04
Ma
r-05
2 Years-Ahead Bond 5 Years-Ahead Bond 1 Year-Ahead Survey 2 Years-Ahead Survey
N F O R M E
The Current Framework
Source: Central Bank of Chile
Expected Inflation Measures(percentage)
13
Real Interest Rate - Neutral Interest Rate
-6
-4
-2
0
2
4
6
8
10
12
-8 -6 -4 -2 0 2 4 6
Output Gap
2004.2
2004.42003.4
1999.4
1999.2
1998.3
1993.1
1997.11994.41997.4
N F O R M E
The Current Framework
Source: Central Bank of Chile
Countercyclical MP under IT
14 N F O R M E
The Current Framework
Source: Central Bank of Chile
RER Adjustment and External Conditions
RER(1986=100)
Copper Price(dollars/lb)
LatinAmerican
EMBI
TradingPartners’
Growth90s 92.0 1.009 771 (*) 3.1%
2000 86.0 0.823 665 3.8%2001 95.8 0.715 867 1.6%2002 96.9 0.707 965 1.9%2003 104.3 0.807 700 2.8%2004 99.3 1.300 527 4.5%
(*) average for 1998 and 1999 only.
15
3. The ER and the Framework
at Work
16
ER and the Framework at Work
• MP reaction to ER is not mechanic; the nature of the shock matters– Expected path of the ER
• UIP enhanced with equilibrium RER discussion
– Effect on inflation • Direct and indirect effects• Core model: passthrough 20% in one year; 25 in two years
• Examples:– End 2003 appreciation followed by interest rate cuts– Mid 2002 depreciation together with interest rate cuts
17
ER and the Framework at Work
• Two intervention episodes (2001 and 2002) • Why?
– Probable overreaction with inflation (and MP) consequences
– Informed call by CB board
• Fixed period (4 months), maximum amounts (US$ 4 bn)
• Large effects on announcement (including trend)• Actual interventions used a portion of resources
18
450
500
550
600
650
700
750
800P
eso
s p
er D
oll
ar
First Intervention Period
Second Intervention Period
sept 11
redef. int package
N F O R M E
ER and the Framework at Work
Source: Central Bank of Chile
Exchange Rate Interventions
19
4. Issues
20
0
2
4
6
8
10
12
14
16
18
201/
2/19
90
1/2/
1991
1/2/
1992
1/2/
1993
1/2/
1994
1/2/
1995
1/2/
1996
1/2/
1997
1/2/
1998
1/2/
1999
1/2/
2000
1/2/
2001
1/2/
2002
1/2/
2003
1/2/
2004
N F O R M E
Issues: Volatility
Source: Central Bank of Chile
Exchange Rate Volatility(30-day standard deviation of daily averages)
21
0
5
10
15
20
25
Arg
$
Rea
l
Mex
$
Chi
le$
Yen
Aus
$
NZ
$
Saf
r$
Can
$
Sue
d$
Eur
o
1990-1998 1999-2002 2003-2005 (mar)
N F O R M E
Issues: Volatility
Source: Riskmetrics
Exchange Rate Volatility
22 N F O R M E
Issues: Hedging
FX Derivatives Market in ChileYear Market (million of dollars): Turnover as % of: % firms with
(December) Local Foreign Total GDP Total trade FX hedges1993 2,822 - 2,822 0.06 0.14 8.01994 9,415 - 9,415 0.18 0.40 10.01995 21,124 - 21,124 0.32 0.66 15.01996 47,828 - 47,828 0.63 1.38 17.01997 112,050 - 112,050 1.35 2.89 21.01998 112,150 - 112,150 1.41 3.10 21.01999 125,494 20 125,514 1.72 3.79 26.02000 139,228 11,646 150,874 2.01 4.00 29.02001 143,192 20,308 163,500 2.39 4.53 35.02002 130,686 30,414 161,101 2.39 4.55 31.02003 165,835 41,592 207,427 2.88 5.13 33.0
Source: Central Bank of Chile.
23 N F O R M E
Issues: Hedging
Source: BIS
FX Market Turnover/GDP, April 2004
Russia 17.2 Czech Rep 6.8 Colombia 2.6S. Africa 15.2 Mexico 5.8 Philippines 2.1Slovakia 12.6 Thailand 5.0 Brazil 1.7Hungary 8.4 Malaysia 3.9 Slovenia 1.4Chile 8.4 Turkey 3.6 Argentina 1.3Korea 8.2 India 2.8 Peru 1.2Poland 7.6 Indonesia 2.8 Average 5.8
24 N F O R M E
Issues: Extreme Valuations
Source: Author’s calculations
Residuals Long RunEquil.
HPLow HPHigh
Average of Squared MissaligmentTablita + Fixed (79.I - 82.II) 24.7% 31.0% 15.1% 22.9%Narrow band (85.II - 91.IV) 8.4% 21.5% 4.3% 23.1%Wider band (93.I - 99.III) 9.9% 9.6% 3.1% 12.5%Float (00.IV - 04.IV) 10.7% 7.5% 4.6% 4.7%
Maximum UndervaluationTablita + Fixed 5.1% * 19.1% 6.8%Narrow band 16.7% 33.3% 9.7% 33.3%Wider band 3.9% 9.3% 4.6% 8.2%Float 22.6% 15.7% 9.1% 8.6%
Maximum OvervaluationTablita + Fixed -41.6% -41.3% -23.8% -37.4%Narrow band * * -5.9% *Wider band -19.4% -16.8% -6.5% -21.9%Float -2.8% -3.3% -7.5% -8.3%
25
Cuad Misalignment
0.0080
0.0085
0.0090
0.0095
0.0100
0.0105
Fixed Intermediate Floating
N F O R M E
Issues: Extreme Valuations
Source: Author’s calculations
Sq. Root Quadratic Misalignment and ER Regime
(5-year averages)
26 N F O R M E
Issues: Passthrough
Source: Author’s calculations
One-year Passthrough Coefficient
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
1994
M01
1994
M09
1995
M05
1996
M01
1996
M09
1997
M05
1998
M01
1998
M09
1999
M05
2000
M01
2000
M09
2001
M05
2002
M01
2002
M09
2003
M05
2004
M01
2004
M09
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
27
5. Concluding Remarks
28
Concluding Remarks
• Framework has worked well…– Inflation under control and countercyclical MP– RER has adjusted substantially and there is more
stability (with other developments, e.g. fiscal policy)
• Volatility has increased (as elsewhere?)– There is more hedging in deeper markets– Extreme valuations seem less likely
• Is the model a blueprint for everybody? – Institutions needed for benefits of financial opening – Overcoming fear of floating needs credible anti-inflation
stance and limited balance sheet effects