Monetary Policy Implementation During US Policy Normalization
JP Morgan Investor Seminar Washington, DC, 10 October 2014
1
Javier Guzmn Calafell, Deputy Governor, Banco de Mxico
2
Outline
Introduction 1
Beyond 2015 3
Monetary Policy Implementation During US Policy Normalization
Monetary Policy in 2014-15 a. The External Environment b. Domestic Conditions
2
3
Since 2001, monetary policy in Mexico is implemented under an inflation targeting regime.
In this context:
A permanent inflation target of 3 percent, with a variability interval of +/- 1 percent, has been set.
A systematic analysis of inflation and its determinants is carried out, on the basis of a wide range of indicators and tools.
The efficient convergence of inflation to the target (i.e. at the lowest possible cost in terms of economic activity) is sought.
Monetary Policy Implementation During US Policy Normalization
It is also worth noting that in the aftermath of the global financial crisis, the Banco de Mxico, in coordination with other authorities, is attaching increasing relevance to financial stability.
010
20
30
40
50
60
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Headline inflation
Sep Introduction of inflation targeting
4
With the support of major efforts on the fiscal side, such a strategy has allowed continued progress in the reduction of inflation
Source: Banco de Mxico.
1/ Target for the overnight interbank interest rate adopted on 21 January 2008.
Headline Inflation and Overnight Interbank Interest Rate Annual %
Monetary Policy Implementation During US Policy Normalization
0
1
2
3
4
5
6
7
8
9
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Overnight interbank interest rate1/
Headline inflation
Sep
5
and to maintain stable medium and long term inflation expectations even in the presence of substantial shocks.
Inflation Expectations and Inflation Shocks Annual %
Sources: Banco de Mxico and INEGI.
Monetary Policy Implementation During US Policy Normalization
0
2
4
6
8
10
12
14
16
-20
-10
0
10
20
30
40
50
60
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Sep
Inflation Expectations: 12 months
2 years 4 years
MXN/USD Exchange Rate Fruits and Vegetables
6
Outline
Introduction 1
Beyond 2015 3
Monetary Policy in 2014-15 a. The External Environment
b. Domestic Conditions 2
Monetary Policy Implementation During US Policy Normalization
7
Since Mexicos economy is very open, the implementation of monetary policy is heavily influenced by external developments.
Source: Own calculations with data from World Economic Outlook and Direction of Trade Statistics, IMF.
Trade Openness Exports and Imports as % of GDP, 2013
Financial Openness Chinn-Ito Index1/, 2012
1/ Measures a country's degree of de jure capital account openness (0-1 scale), based on the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER).
Source: Chinn and Ito (2006) : "What Matters for Financial Development? Capital Controls, Institutions, and Interactions, JDE 81(1):163-192 (October).
Monetary Policy Implementation During US Policy Normalization
0.69
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
Per
u
Ko
rea
Mex
ico
Ch
ile
Ru
ssia
Turk
ey
Po
lan
d
Bra
zil
Ind
on
esia
Co
lom
bia
Ind
ia
Ch
ina
S. A
fric
a
63.4
0
10
20
30
40
50
60
70
80
90
Ko
rea
Po
lan
d
S. A
fric
a
Mex
ico
Ch
ile
Turk
ey
Per
u
Ch
ina
Ind
on
esia
Ind
ia
Ru
ssia
Co
lom
bia
Bra
zil
U.S., 78.8
Canada, 2.8
Eurozone, 4.4
U.K., 0.4
China, 1.7
Japan, 0.6
Other, 11.4
8
The recent behavior of the world economy and its projected evolution for the rest of 2014 and in 2015 favors the expansion of Mexican exports.
Mexican Exports by Country of Destination % of Total, 2013
Source: INEGI.
Major Economies: Real GDP Index 4Q-2007 = 100, s.a.
s.a./ Seasonally adjusted. Source: Haver Analytics.
Monetary Policy Implementation During US Policy Normalization
91
96
100
104
109
0
50
100
150
200
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
United States
United Kingdom
Japan
Eurozone
China
2Q 2014
9
In particular, analysts estimate US GDP growth above potential.
US: Real Gross Domestic Product Quarterly annualized rate, s.a.
s.a./ Seasonally adjusted. 1/ Mid-point of the central tendency interval of FOMC participants projections for the long-run change in real GDP. Sources: BEA , Federal Reserve and Blue Chip.
-4
-2
0
2
4
6
I 201
3
II 2
01
3
III 2
013
IV 2
01
3
I 201
4
II 2
01
4
III 2
014
IV 2
01
4
I 201
5
II 2
01
5
III 2
015
IV 2
01
5
Gross Domestic Product Potential GDP1/
Forecast
Monetary Policy Implementation During US Policy Normalization
02
4
6
8
10
12
14
16
18
Co
rpo
rate
AA
A
Co
rpo
rate
BB
B
Co
rpo
rate
hig
h y
ield
*
AB
S
MB
S
Age
nci
es
Co
rpo
rate
AA
A
Co
rpo
rate
BB
B
Co
rpo
rate
hig
h y
ield
*
10-year range Current (7-Oct-14)
23% 27%
10 10
On the other hand, the expected increase in interest rates in the US will pose additional challenges for monetary policy in Mexico and other emerging market economies. Risks are enhanced by the continued search for yield
Volatility indexes for selected financial assets
Source: Banco de Mxico with data from Bloomberg 1/ MOVE (Merrill Option Volatility Estimate). 2/ VIX(CBOE Volatility Index). 3/ CVIX: 3-month implicit volatility of the most operated currencies. 4/ Actual volatility of the CRB index (index composed of 19 commodity futures contracts).
Yield to maturity of selected fixed income securities
Percent United States Europe
Source: Bank of America - Merrill Lynch. *Bonds with credit rating lower than BBB-.
Monetary Policy Implementation During US Policy Normalization
Basis points Percent
0
10
20
30
40
50
60
70
80
90
S&P 500 2/ Currencyindex 3/
Commodityindex 4/
10-year range
0
50
100
150
200
250
300
Treasury notes 1/
Current (8-Oct-14)
11
and the fact that markets seem to be overly optimistic about the pace of interest rate adjustments in the US.
Federal Funds Rate Futures and FOMC Projections
%
Federal Funds Rate Implicit in the OIS1/ Curve and FOMC Projections
%
Source: FOMCs projections and own calculations with data from Bloomberg. 1/ Overnight Index Swap.
Source: Bloomberg and FOMC Economic Projections.
Monetary Policy Implementation During US Policy Normalization
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Jun
-12
Sep
-12
Dec
-12
Mar
-13
Jun
-13
Sep
-13
Dec
-13
Mar
-14
Jun
-14
Sep
-14
Dec
-14
Mar
-15
Jun
-15
Sep
-15
Dec
-15
Mar
-16
Jun
-16
Sep
-16
Dec
-16
FFR implicit in OIS curve
Median FOMC Mar-14 Median FOMC Dec-13
Median FOMC Jun-14
Median FOMC Sep-14
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Sep
-14
Dec
-14
Mar
-15
Jun
-15
Sep
-15
Dec
-15
Mar
-16
Jun
-16
Sep
-16
Dec
-16
11
FFR Futures 30-Jun-14
FFR Futures 08-Oct-14
Median FOMC Mar-14 Median FOMC Dec-13
Median FOMC Jun-14 Median FOMC Sep-14
12 Monetary Policy Implementation During US Policy Normalization
However, it is important to note that markets have differentiated across countries.
50
70
90
110
130
150
170
190
210
230
Jan
-13
Ap
r-1
3
Jul-
13
Oct
-13
Jan
-14
Ap
r-1
4
Jul-
14
Oct
-14
Oct
Mexico
Chile
Turkey
S. Africa
Peru
Brazil
Colombia
2014
Poland
1/ 5-year CDS. Source: Bloomberg, with data through 8 October 2014.
Emerging Markets: Credit Default Swaps 1/
Index 01-Jan-2013 = 100
Russia
Korea
13
Outline
Introduction 1
Beyond 2015 3
Monetary Policy in 2014-15 a. The External Environment
b. Domestic Conditions 2
Monetary Policy Implementation During US Policy Normalization
14
Economic activity showed clear signs of recovery during the first half of 2014.
Real Gross Domestic Product Annual % and Quarterly Annualized Rate, s.a.
s.a./ Seasonally adjusted. Source: INEGI.
Monetary Policy Implementation During US Policy Normalization
3.1
5.0
3.2
1.4
-4.7
5.2
3.9 4.0
1.4 1.8
4.2
-6
-4
-2
0
2
4
6
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
I-2
014
II-2
01
4
15
Exports were the main factor behind the expansion of economic activity, but a revival of domestic demand was also observed
Aggregate Supply and Demand Quarterly %, s.a.
s.a./ Seasonally adjusted. Source: Banco de Mxico and INEGI.
1.0
0.1
1.4
0.2
1.7
-1.2
3.9
-8
-6
-4
-2
0
2
4
6
GDP Imports PrivateConsumption
Govt.Consumption
PrivateInvestment
Govt.Investment
Exports
2014-I 2014-II
Monetary Policy Implementation During US Policy Normalization
16
which has continued in more recent months.
Monetary Policy Implementation During US Policy Normalization
Retail Sales Index 2003=100, s.a.
s.a. / Seasonally adjusted data. Source: Banco de Mxico with data from INEGI.
Imports of Consumption Goods 1/ and Domestic Sales of Light Vehicles Index 2007 = 100 and Thousands of
annualized units, s.a.
s.a. / Seasonally adjusted data. 1/ Excludes oil and automobile imports. Source: Banco de Mxico and AMIA (Mexican Association of the Automobile Industry).
110
114
118
122
126
130
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Jul
Gross Fixed Investment Index 2008 = 100, s.a.
s.a./ Seasonally adjusted data. Source: INEGI.
85
90
95
100
105
110
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Total
Construction
Jul
600
700
800
900
1,000
1,100
1,200
1,300
1,400
80
90
100
110
120
130
140
150
160
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Imports of Consumption Goods
Domestic Sales of
Light Vehicles
Aug Sep
17 17
Nonetheless, substantial slack persists.
Monetary Policy Implementation During US Policy Normalization
3
4
5
6
7
8
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Urban
National
Aug
National and Urban Unemployment Rates
% of EAP, s.a.
EAP/ Economically Active Population. s.a./ Seasonally adjusted. Source: National Employment Survey (Encuesta Nacional de Ocupacin y Empleo), INEGI.
Output Gap
% of potential output, s.a.
s.a./ Calculated with seasonally adjusted data. Note: The shaded area is the 95% confidence interval of the output gap. Source: Calculated by Banco de Mxico with data from INEGI.
-14
-12
-10
-8
-6
-4
-2
0
2
4
6
8
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
GDP
IGAE
2Q-14 July
Consumer Price Index Annual %
Sources: Banco de Mxico and INEGI.
18 18
In the case of inflation, some upward pressures have been observed recently.
Monetary Policy Implementation During US Policy Normalization
0
1
2
3
4
5
6
7
8
20
01
20
02
20
03
20
04
20
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20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
20
14
Headline
Core
Sep
19 19
However, they result from factors of a temporary nature, and are not demand-driven.
Core Inflation Annual %
Non-Core Inflation Annual %
Sources: Banco de Mxico and INEGI. Sources: Banco de Mxico and INEGI.
Monetary Policy Implementation During US Policy Normalization
-5
0
5
10
15
20
20
09
20
10
20
11
20
12
20
13
20
14
Sep Non-core Livestock
-25
-20
-15
-10
-5
0
5
10
15
20
25
20
09
20
10
20
11
20
12
20
13
20
14
Sep Core Food, Beverage and Tobacco Air Transportation
20
Consequently, medium and long term inflation expectations remain well anchored.
Monetary Policy Implementation During US Policy Normalization
End of 2014 End of 2015 Next 4 and 5-8 Years
Sources: Banco de Mxicos Survey, monthly. Last observation: September 2014. Banamex Survey, bi-weekly. Last observation: 7 October 2014.
Headline Inflation Expectations Median, %
2.5
3.0
3.5
4.0
4.5
Oct
-13
Dec
-13
Feb
-14
Ap
r-1
4
Jun
-14
Au
g-1
4
Sep Oct
2.5
3.0
3.5
4.0
4.5
Jan
-10
Au
g-1
0
Mar
-11
Oct
-11
May
-12
Dec
-12
Jul-
13
Feb
-14
Sep
-14
Sep
Next 5-8 Years
Next 4 Years
2.5
3.0
3.5
4.0
4.5
Jan
-13
Ap
r-1
3
Jul-
13
Oct
-13
Jan
-14
Ap
r-1
4
Jul-
14
Oct
-14
Sep Oct
Banco de Mxico
Banamex Banamex
Banco de Mxico
Oct
-14
21
Looking forward:
Strong external demand;
Expansionary monetary policy;
Fiscal stimulus; and
Increasing levels of confidence.
give support to Banco de Mxicos expectation of 2-2.8% GDP growth in 2014 and 3.2-4.2% in 2015, implying an expansion above potential in 2H-2014 and in 2015.
Monetary Policy Implementation During US Policy Normalization
A negative although gradually closing output gap.
Gasoline price increases based on inflation expectations.
A favorable base effect after the tax reform.
22
A strong cyclical upturn during the rest of this year and the next is expected to coincide with the convergence of inflation to the 3% target in 2015 given:
1.
2.
3.
Monetary Policy Implementation During US Policy Normalization
Uncertainty related to estimates of the output gap.
Faster closing of the output gap if the recovery of economic activity is stronger than currently foreseen.
Additional shocks deriving from the behavior of non-core inflation or other factors.
23
1.
2.
3.
Monetary Policy Implementation During US Policy Normalization
This scenario is subject to a number of risks:
24
Monetary policy normalization in the US represents another risk for the Mexican economy.
Increased financial market volatility and uncertainty.
Tighter external financing.
Potential impact on peso exchange rate and inflation.
Risks have increased as the beginning of interest rate hikes draws closer.
Monetary Policy Implementation During US Policy Normalization
25
Strong macroeconomic position:
Credible monetary and fiscal policies.
Flexible exchange rate regime.
Low current account deficit.
Record high international reserves.
FCL with the IMF.
Relatively low public debt.
Financial stability in the context of enhanced policy framework.
Favorable growth prospects after a major structural reform effort:
Labor markets: November 2012.
Education: September 2013.
Financial sector: January 2014.
Competition: May 2014.
Telecommunications: July 2014.
Energy: August 2014.
Monetary Policy Implementation During US Policy Normalization
The Mexican economy has solid macroeconomic and financial stability bases to resiliently sail through the process.
26
Outline
Introduction 1
Beyond 2015 3
Monetary Policy in 2014-15 a. The External Environment b. Domestic Conditions
2
Monetary Policy Implementation During US Policy Normalization
27
Inflation targeting has proved its merits in Mexico and other countries before, during and in the aftermath of the global financial crisis.
However, the crisis has highlighted a number of issues whose implications for inflation targeting regimes will have to be carefully assessed.
One of them is the need to better understand the role of monetary policy and other instruments in preserving financial stability.
Nonetheless, this does not imply a substantial modification of the fundamental structure of these regimes, nor does it raise question marks on their usefulness to anchor inflation expectations.
Monetary Policy Implementation During US Policy Normalization
Beyond 2015
28 28
Beyond 2015, monetary policy is likely to operate in an environment characterized by world economic growth below that observed before the crisis...
GDP Growth Projections Annual %
Source: IMFs World Economic Outlook, October 2014.
Monetary Policy Implementation During US Policy Normalization
-1
0
1
2
3
4
5
6
7
8
20
13
20
14
20
15
20
16
20
17
20
18
20
19
China
United States
United Kingdom
Japan Eurozone
29 29
and an upward trend in international interest rates, which underlines the importance of strengthening the domestic sources of growth.
Federal Funds Rate Annual %
Sources: FOMC, Bloomberg and Blue Chip.
Monetary Policy Implementation During US Policy Normalization
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
20
11
20
12
20
13
20
14
20
15
20
16
20
17
20
18
20
19
20
20
20
21
20
22
20
23
20
24
20
25
Federal Funds Rate FOMC OIS-implied Futures Blue Chip
30 30
Even before considering the key measures approved in 2014 (financial, competition, telecommunications and energy), Mexicos efforts of structural reform were deemed to be among the most ambitious in the world. Contrary to other experiences, this was not propelled by an economic crisis.
Economic Reform Responsiveness Share of OECD reform recommendations with
significant action taken during 2012-2013
Source: Own calculations based on results presented in OECD (2014), Going for Growth Interim Report, February.
0.57
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
CH
E
NO
R
TUR
CZE
USA
FRA
KO
R
AU
S
AU
T
BEL
CH
L
DEU
NLD
SWE
PO
L
FIN
JPN
SVK
CA
N
EST
LUX
SVN
NZL ITA
GR
C
HU
N
IRL
ISR
MEX
PR
T
DN
K
GB
R
ESP
Monetary Policy Implementation During US Policy Normalization
Main challenges: adequate implementation of structural reforms, tackling other major structural obstacles to growth, continuous strengthening of economic fundamentals.
31 31
The latter should allow the economy to grow at faster rates without pressures on prices.
Monetary Policy Implementation During US Policy Normalization
More flexible and competitive
product and input markets More efficient resource allocation More and better human and
physical capital More incentives for technological
change Stronger institutional framework
Productivity gains
Higher economic
growth
Lower inflationary pressures
32
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