May 8th, 2008
description
Transcript of May 8th, 2008
May 8th, 2008
Creeping Inflation: How much of a concern? What should the
response be?
XXVII Meeting of the Latin American Network of Central Banks and Finance Ministries
Alberto TorresBanco de México
Outline
1. Real Food and Oil Price Changes
2. Implications for Monetary Policy
3. Additional Considerations
3
Commodity Price Indexes(Index Jan 2003 = 100)
Source: IMF.
1. Real Food and Oil Price Changes
80
130
180
230
280
330
380
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Jan-
05
Jul-0
5
Jan-
06
Jul-0
6
Jan-
07
Jul-0
7
Jan-
08
90
140
190
240
290
340
390
440Non FuelFoodCrude OilMetals (right axis)
4
Real Food Price Changes(Annual % Change of Real Price)
Source: IMF. Calculations by Banco de México.
1. Real Food and Oil Price Changes
-40
-30
-20
-10
0
10
20
30
40
50
Jan-
81
Jan-
83
Jan-
85
Jan-
87
Jan-
89
Jan-
91
Jan-
93
Jan-
95
Jan-
97
Jan-
99
Jan-
01
Jan-
03
Jan-
05
Jan-
07
Food Mean per regime
5
1. Real Food and Oil Price Changes
40
20
0
-20
Distribution of Real Food Price Changes(Annual % Change of Real Price)
Jan.81-Nov.85 Dec.85-Jan.97 Feb.97-Dec.99Jan.00-Aug.02 Sep.02-Mar.08
Source: IMF. Calculations by Banco de México.
6
Real Food Price Changes(Proportion of Time Above Threshold)
1. Real Food and Oil Price Changes
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.80 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38
Threshold
Pro
port
ion
abov
e T
hres
hold
.
Jan. 81 - Nov. 85
Dec. 85 - Jan. 97Feb. 97 - Dec. 99
Jan. 00 -Aug. 02Sept. 02 -Mar. 08
A
B
Source: IMF. Calculations by Banco de México.
7
Real Food Price Changes(Mean Above Threshold)
1. Real Food and Oil Price Changes
0
2
4
6
8
10
12
14
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38
Threshold
Con
ditio
nal m
ean
Jan. 81 - Nov. 85
Dec. 85 - Jan. 97
Feb. 97 - Dec. 99
Jan. 00 -Aug. 02
Sept. 02 -Mar. 08A
B
Source: IMF. Calculations by Banco de México.
8
Real Crude Oil Price Changes(Annual % Change of Real Price)
Source: IMF. Calculations by Banco de México.
1. Real Food and Oil Price Changes
-100
-50
0
50
100
150
200
Jan-
81
Jan-
83
Jan-
85
Jan-
87
Jan-
89
Jan-
91
Jan-
93
Jan-
95
Jan-
97
Jan-
99
Jan-
01
Jan-
03
Jan-
05
Jan-
07
Crude Oil
Mean per regime
9
1. Real Food and Oil Price Changes
150
100
50
0
-50
Jan.81-Jan.87 Feb.87-Jul.91 Aug.91-Mar.99 Abr.99-Mar.08
Distribution of Real Crude Oil Price Changes(Annual % Change of Real Price)
Source: IMF. Calculations by Banco de México.
10
1. Real Food and Oil Price Changes
Regimes
I -9.79 8.33 9.30 59 Jan-81 Nov-85
II -1.74 7.26 18.77 134 Dec-85 Jan-97
III -12.48 3.82 -5.52 35 Feb-97 Dec-99
IV -2.58 3.75 5.14 32 Jan-00 Aug-02
V 7.57 10.02 37.96 67 Sep-02 Mar-08
PeriodMean s.d.Duration (months)
Max.
Food(Annual % Change of Real Price)
Regimes
I -16.47 16.29 2.18 73 Jan-81 Jan-87
II 11.12 29.36 91.11 54 Feb-87 Jul-91
III -8.19 19.03 40.53 92 Aug-91 Mar-99
IV 23.83 33.34 144.75 108 Apr-99 Mar-08
Max.Duration (months)
PeriodMean s.d.
Crude Oil(Annual % Change of Real Price)
Outline
1. Real Food and Oil Price Changes
2. Implications for Monetary Policy
3. Additional Considerations
12
As is well-known in the economic literature (e.g. Clarida, Gali and Gertler, 1999; Walsh, 2003; Woodford, 2003; and others) the optimal monetary policy response to any shock is the solution to a problem where:
The policy maker minimizes a quadratic loss function that reflects society’s preferences for inflation and output stabilization.
This optimization is made subject to the structure of the economy, which is typically assumed linear (or log-linear).
In addition, shocks are assumed to follow an AR(1) process with white noise disturbances.
The solution to this problem provides an optimal feedback rule for the monetary policy instrument which will be a linear, time-invariant function of all the variables and shocks that form part of the economy.
2. Implications for Monetary Policy
13
However, we are not currently in this type of framework:
For many central banks, high inflation may be more costly than low inflation.
The economy seems to behave differently in recessions than in booms (e.g., Hamilton (1989)).
The shocks we are currently facing, as shown above, follow a very complex stochastic process, with regime shifts, time varying variances and extreme values.
In addition, there is uncertainty about the duration of the “high inflation regimes” in commodity prices.
In this context, the optimal response of monetary policy is likely to be non-linear and time-varying, and will tend to focus on risk management.
2. Implications for Monetary Policy
14
Following the risk management approach, the response to this environment should be preemptive, significant and transparent:
Failure to act timely may lead to a contamination of the price-setting process; in particular, may affect the formation of inflation expectations.
The response has to be strong, as central banks may prefer to insure against low probability, costly outcomes.
The central bank has to clearly explain the rationale for its policy actions.
But, as we will now see, how preemptive and strong the response should be, depends on the particular circumstances of each economy.
2. Implications for Monetary Policy
15
2005 – 2007 Inflation Change and Inflation Persistence
2. Implications for Monetary Policy
Source: WEO, IMF. Calculations by Banco de México.
UKPor
Can
Jap Ire
SpaGre
Fra
Ita
Ger
HK
USAKorTai
Sin
Mal
Tha
Phi
Ind
-8
-6
-4
-2
0
2
40
.00
0.1
0
0.2
0
0.3
0
0.4
0
0.5
0
0.6
0
0.7
0
0.8
0
0.9
0
1.0
0
Inflation Persistence
Cha
nge
in I
nfla
tion
fro
m 2
005
to
2007
ColPan
Sal
ChiPar
MexEcu
Arg
Gua
Bra
Jam
CR
Peru
Nic
VenUruBol
All Countries
Only LA
16
2. Implications for Monetary Policy
Source: WEO, IMF. Calculations by Banco de México.
2005 – 2007 Inflation Change and Low Inflation Regime
IndPhil
Thai
HKSin
Gre
Por
Mal
Ire
Spa
Ita
Fra
CanGer
Jap
USATai
UK
Kor
-8
-6
-4
-2
0
2
40 5 10
15
20
25 30
Duration of Low Inflation Periods (Years)
Ch
an
ge
in I
nfla
tion
fro
m 2
00
5 t
o 2
00
7
VenUru
PeruPar
Pan
Bol
Mex
Col Chi
Bra
Bol
Arg
Ecu
Sal
Gua
Jam
Nic
All Countries
Only LA
17
2005 – 2007 Inflation Change and CPI Food Weights
2. Implications for Monetary Policy
Source: WEO, IMF. Calculations by Banco de México.
PhilInd
Thai
Mal
UKGer Ire
USAKor
SinHK
Por
Gre SpaTai
JapCan
Fra
Ita
-8
-6
-4
-2
0
2
40 10 20
30
40 50
60
CPI Food Weight
Ch
an
ge
in I
nfla
tion
fro
m 2
00
5 t
o 2
00
7
MexCol
Ecu
PanChiPar
Nic
Gua
VenUru
CR
Peru
Jam
Bra
Bol
Arg
All Countries
Only LA
18
Cumulative Change in Policy Target Rates and Inflation Persistence
2. Implications for Monetary Policy
Source: WEO, IMF. Calculations by Banco de México.
Fra
IrePor
UKJap
Can
USA
KorGer
Thai
Mal
HK
Ind
GreSpa
Ita
-700
-600
-500
-400
-300
-200
-100
0
100
200
300
0.0
0.1 0.2
0.3
0.4
0.5
0.6
0.7
0.8 0.9
1.0
Inflation Persistence
Cu
mu
lativ
e C
ha
ng
e in
Po
licy
Ra
te (
Ba
sis
Po
ints
)
CR
Peru
Gua
Bra
Chi
Uru Col
Mex
All Countries
Only LA
19Source: WEO, IMF. Calculations by Banco de México.
Cumulative Change in Policy Target Rates and Low Inflation Regime
Jap
ThaCan
KorFraIrePor
HK
USA
UK
GreMal
GerItaSpa
Ind
-700
-600
-500
-400
-300
-200
-100
0
100
200
300
0 5 10
15
20
25 30
Duration of Low Inflation Periods (Years)
Cu
mu
lativ
e C
ha
ng
e in
Po
licy
Ra
te
(Ba
sis
Po
ints
)
GuaChi
PerMex
ColUru
Bra
CR
2. Implications for Monetary Policy
All Countries
Only LA
20
2. Implications for Monetary Policy
Source: WEO, IMF. Calculations by Banco de México.
Cumulative Change in Policy Target Rates and CPI Food Weights
ItaIre
US
IndCan
Tha
UK Mal
HK
GerJap
Spa
Fra
Kor GrePor
-800
-600
-400
-200
0
200
400
6000 10 20
30
40 50
60
CPI Food Weight
Cu
mu
lativ
e C
ha
ng
e in
Po
licy
Ra
te (
Ba
sis
Po
ints
)
Bra
Chi
Uru
GuaPer
CR
Col
Mex
All Countries
Only LA
21
The optimal monetary policy response to “creeping inflation” depends on each country’s particular circumstances:
The inflationary history of the country and, in particular, the extent to which a low inflation equilibrium has been sustained.
The weight that food and energy goods have on the CPI.
The degree of persistence that each economy’s inflation process exhibits to price shocks.
The phase of the cycle the country is located in.
The impact of the current environment on the country’s terms of trade.
2. Implications for Monetary Policy
22
The evidence suggests that the impact on inflation levels and inflation volatility of the worldwide shocks we have observed in the past years tends to be heterogeneous across countries. In particular:
Inflation seems to have responded more to the price shocks in countries that still exhibit a higher degree of inflation persistence.
Inflation volatility seems to be larger in those countries where the weight of foodstuffs in their consumer prices is higher, as well as in countries where the attainment of a low inflation equilibrium has been more recent.
2. Implications for Monetary Policy
23
Thus, the same external shocks may imply different monetary responses in different countries, given their own specific characteristics.
In particular, countries that face higher risks of suffering large inflation increases and price volatility (due to their consumption baskets and their inflation history) may have found themselves in the need to respond more aggressively to the current price shocks than other countries.
Indeed, the evidence does suggest that countries that are more vulnerable in these terms have acted accordingly, by restricting their monetary policy stance.
2. Implications for Monetary Policy
24
Given the evidence in the first part of this talk, a relevant question we should try to address with more research is: for how long will we be facing the current high commodity inflation regime?
Up to this point, the discussion has centered on the policy responses to the current environment, given the policy frameworks that the central banks currently have.
The answer to the question posed above could nonetheless have implications for the issue of whether central banks should rethink the definition of their monetary policy objectives.
2. Implications for Monetary Policy
Outline
1. Real Food and Oil Price Changes
2. Implications for Monetary Policy
3. Additional Considerations
26
Creeping inflation from the current shocks to energy and food prices may imply a restrictive bias in the monetary policy stance:
This is especially true in countries where inflation is persistent, the low inflation equilibrium has not been sustained for a long time and where food and energy have a large weight in consumers’ spending.
This, in turn, reflects the high costs that a breakdown of expectations-based nominal anchors that sustain the low-inflation equilibrium may have on these economies’ performance.
Indeed, some countries may face a combination of the above mentioned features that may lead them to maintain a restrictive bias in their monetary policy, even when they may be currently facing the low phase of their business cycle.
3. Additional Considerations
27
The issues raised above focus on the implications of this high inflation regime for monetary policy.
We have to ask to what extent we need to consider a more broad view of the policy response that we should undertake, given this environment. In particular we need to ask:
Which other policy instruments are available to face the current environment?
What is the optimal mix of policy responses to this environment, in order to minimize negative effects on welfare?
3. Additional Considerations
28
The policy mix clearly depends on the structure of each economy and on the shocks that each country has faced:
Those who faced an improvement in terms of trade may use specific policies to redistribute the aggregate gains of the shocks to those groups that may have been hurt from price changes.
Those that have faced a terms of trade deterioration also need to determine the optimal policy mix to minimize the welfare costs of this shock.
3. Additional Considerations
29
Fiscal policy
May be helpful to redistribute losses (or gains, if terms of trade have improved), across different economic agents.
Competition policy
A non-competitive environment may exacerbate the impact of price shocks on domestic markets. Thus, antitrust agencies should avoid collusive practices in this environment of high price increases.
3. Additional Considerations
30
Real Crude Oil Price Changes(Proportion of Time Above Threshold)
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.80 8 16 24 32 40 48 56 64 72 80 88 96 104
112
120
128
136
144
Threshold
Pro
port
ion
abov
e T
hres
hold
.
Jan. 81 - Jan. 87
Feb. 87 - Jul. 91
Aug. 91 - Mar. 99
Apr. 99 -Mar. 08
Source: IMF. Calculations by Banco de México.
Appendix
31
Real Crude Oil Price Changes(Mean Above Threshold)
0
10
20
30
40
50
600 8 16 24 32 40 48 56 64 72 80 88 96 104
112
120
128
136
144
Threshold
Con
ditio
nal M
ean
Jan. 81 - Jan. 87
Feb. 87 - Jul. 91
Aug. 91 - Mar. 99
Apr. 99 -Mar. 08
Source: IMF. Calculations by Banco de México.
Appendix