Targeting inflation in Asia and the Pacific

1. Targeting inflation in Asia and the Pacific Andrew Filardo* Hans Genberg** *Bank for International Settlements **Hong Kong Monetary Authority The views expressed are those of the authors and do not necessarily represent those of the Bank for International Settlements or the Hong Kong Monetary Authority.

2. Inflation targeting vs.targeting inflation • Inflation performance in the region has been good • True for inflation targeting central banks but also for others • Targeting inflation is important • Inflation objective can be achieved in more ways than one.

3. Agenda • A review of policy objectives and strategies of central banks in Asia and the Pacific • Evolution of central bank independence and other aspects of governance • The inflation record in IT and non-IT economies • Inflation rates • Inflation persistence • Properties of inflation forecasts • Effects of the recent commodity price cycle • Policy implications

4. Central bank policy objectives

5. Inflation targeting central banks

6. Non-IT central banks

7. Improved governance structures • Greater legal and political independence • Greater ability to carry out independent exchange rate policy • Increased ability to carry out monetary policy independently of fiscal policy • Increased transparency and accountability • For IT central banks: Greater emphasis on price stability as the primary objective

8. Improved governance, 1996-2005

9. The inflation record

10. Some more detail • Inflation persistence • Properties of inflation forecasts • Impact of commodity price cycle

11. Inflation persistence • Inflation is less persistent in IT economies • Smaller AR coefficient • Transitory shocks relatively more important

12. Changing AR(1) inflation persistence .

13. Changing IMA(1) inflation persistence The greater , the greater the proportion of the inflation variance accounted for by the transitory component.

14. Properties of inflation forecasts • Use Consensus Forecasts to investigate whether: • Better central bank governance reduces the dispersion of inflation forecasts • Inflation forecasts are more homogeneous in IT economies?

15. The Kullback-Leibler divergence measure

18. Impact of commodity price cycle Asia Mature economies Headline Excluding food and energy

20. Summary or empirical evidence • Admirable inflation performance • Difficult to document differences between explicit IT economies and non-IT economies Why? • Common shocks → Common outcomes • Social consensus about importance of inflation control. • Central bank objectives • Governance structures

21. Policy challenges 1 • How to reconcile primary focus on inflation with increasing concern in society about other objectives? • Volatility of capital flows/sudden stops • Exchange rate misalignments • Financial stability and economic growth • Policy frameworks must be such as to prevent these factors from undermining the consensus in favour of inflation control.

22. Policy challenges 2 • Need as many independent instruments as you have objectives. • Impeccable logic in theory but: • In some cases the trade-off between objectives may translate into a trade-off between inflation in the near term vs. inflation later • What if other instruments are not used? • There may still be a case for coordination. • Lexicographic approach • Assumes independence between objectives • Not what central banks have been observed to do recently

23. Policy challenges 3 • Practice • Expanded perspectives. Pay attention to emerging imbalances • Two pillars (ECB), two perspectives (BoJ) • Theory: • State-dependent preferences?, escape clauses? • Work in progress

24. Forecast accuracy • Forecast Accuracy = F(governance indicator, IT dummy, controls) • Preliminary results: • Better governance → smaller forecast errors • IT → smaller forecast errors • Governance indicator drives out IT dummy