Chapter

Chapter 2 Evolution of Monetary Policy Frameworks

Author(s):
Ana Corbacho, and Shanaka Peiris
Published Date:
October 2018
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Introduction

The experience of the economies of the Association of Southeast Asian Nations–5 (ASEAN-5) during the Asian financial crisis prompted central banks to rethink monetary policy frameworks and exchange rate regimes. Before the crisis, ASEAN-5 economies were characterized by tightly managed exchange rates and relatively open capital accounts, providing limited scope for central banks to set domestic interest rates. When the crisis hit in 1997–98, severe exchange rate depreciation exposed significant vulnerabilities in the ASEAN-5, such as excessive borrowing and currency mismatches by firms and banks. Major structural reforms followed the crisis, including rethinking the monetary policy framework, evaluating the appropriateness of the exchange rate regime, and revamping financial sector regulatory frameworks.

This chapter examines the evolution of the ASEAN-5 economies’ monetary policy frameworks from the onset of the Asian financial crisis to the present.1 It first assesses monetary policy frameworks in these economies using a core set of principles of effective frameworks in countries with scope for independent monetary policy. It then describes how the transition toward a more consistent forward-looking monetary policy framework was supported by greater exchange rate flexibility. The chapter concludes by highlighting the ASEAN-5 economies’ monetary policy frameworks, which have, on the whole, performed well since the crisis, delivering both price and economic stability. The flexible inflation-targeting frameworks put in place after the crisis, alongside the move to greater exchange rate flexibility, have served the ASEAN-5 economies well and offer lessons for other emerging market and developing economies.

Effective Monetary Policy Frameworks and the ASEAN-5

A consensus has emerged on the set of principles that characterize effective policy frameworks in countries with scope for independent monetary policy (IMF 2015). The monetary policy framework encompasses the institutional setup of the central bank2 as well as the specification of its goals, instruments, strategy, operating targets and procedures, and communication. The monetary policy strategy guides the setting of the central bank’s operating targets and its operating procedures and specifies how its policy instruments should be adjusted to implement those targets. Central bank communication promotes transparency and accountability, helping shape market expectations and support the public’s understanding of the policy framework and policy decisions.

Since the Asian financial crisis, ASEAN-5 monetary policy frameworks have evolved to embody the key principles of effective frameworks. The central banks gained operational independence to pursue their price-stability mandates. Several legal amendments explicitly give the ASEAN-5 central banks operational independence from fiscal dominance. In recognition of the importance of regulating the monetary and banking environment free from political considerations, the Bangko Sentral ng Pilipinas (BSP) and Bank Indonesia (BI) gained operational autonomy in monetary policy formulation in 1993 and 1999, respectively. Central bank acts were revised for Bank Negara Malaysia (BNM) in 2009 and the Bank of Thailand (BOT) in 2008 to enhance and formalize the central banks’ operational independence. Meanwhile, since its establishment in 1971 and particularly since the revision of the Monetary Authority of Singapore (MAS) Act in 1999, the MAS has enjoyed de jure independence in setting policies to implement its goals and objectives. With de jure operational autonomy, the primary objective of monetary policy is price stability, although—as in other emerging market economies—many central banks must also consider output, employment, and external conditions.3

Operational autonomy helped establish clear governance structures that empowered independent policy decision-making processes. Although central bank board members and governors are generally appointed by heads of state or government, their legally mandated functions and duties clearly indicate that direct operational administration, as well as final decisions on monetary policy, fall within the powers of the central bank authorities (Table 2.1). To help the central banks’ highest policymaking bodies evaluate the appropriate monetary policy stance, separate high-level committees and advisory groups—focusing on monetary policy assessment and implementation—were also put in place as an integral part of the overall institutional setting.

Table 2.1.ASEAN-5 Central Banks’ Governance Structure
IndonesiaMalaysiaPhilippinesSingaporeThailand
Board Members
Number of MembersAt least 6, at most 9At least 9, at most 127At least 5, at most 1412
Years of Term5Governor: 5; others: 3Governor and 4 members: 6; 2 members: 33Governor: 5; others: 3
Appointed byPresidentMinister; others: Yang di-Pertuan Agong (elected monarch)PresidentPresidentKing and Cabinet of Ministers
ChairmanGovernorGovernorGovernorAppointee of the presidentAppointee of the king
Decision-Making and Voting ProcessConsensusSimple majority vote in a quorumConcurrence of at least 4 membersMajority vote in a quorumMajority vote in a quorum
Minimum Number of Statutory MeetingsOnce a weekOnce a monthOnce a weekOnce every 3 monthsOnce a month
Governor
Years of Term556Up to 55
Appointed byPresidentYang di-Pertuan AgongPresidentPresidentKing
High-Level Committee or Meeting on Monetary PolicyBoard’s once-a-week meetingMonetary Policy CommitteeAdvisory CommitteeMonetary and Investment Policy MeetingMonetary Policy Board
Sources: Central bank laws; and official websites.Note: ASEAN-5 = Indonesia, Malaysia, Philippines, Singapore, Thailand.
Sources: Central bank laws; and official websites.Note: ASEAN-5 = Indonesia, Malaysia, Philippines, Singapore, Thailand.

The ASEAN-5 economies have adopted forward-looking monetary policy frameworks aimed at achieving price stability. The frameworks recognize that a single policy instrument cannot be expected to deliver on multiple objectives (for example, growth, financial and external stability) and that monetary policy must be complemented by other policy instruments in order to meet the other objectives. With the aim of providing effective nominal anchors, Indonesia, the Philippines, and Thailand adopted flexible inflation-targeting frameworks to replace their previous monetary targeting approaches. Thailand adopted inflation targeting in May 2000, after the central bank had made an extensive appraisal of the Thai economy and external developments at the conclusion of the IMF-supported program.4 The Philippines began to modify its monetary aggregate targeting approach in 1995 to put more emphasis on price stability and to address the variable time lags in the effects of monetary policy on the real economy. The BSP announced inflation targets in January 2000 and formally adopted the inflation-targeting framework in January 2002. Indonesia abandoned its crawling band exchange rate system in 1997 in the wake of the Asian financial crisis, and the central bank moved toward a new nominal anchor to achieve macroeconomic stability. The BI initially adopted monetary base targeting under the IMF program, but it began announcing inflation targets in early 2000, until July 2005, when it adopted a flexible inflation-targeting framework.

Malaysia and Singapore followed different approaches, ultimately targeting price stability as the primary objective. The BNM adopted a fixed exchange rate regime in the aftermath of the Asian financial crisis, but in 2005 it moved to a flexible exchange rate regime. The BNM’s monetary policy framework focuses on price stability and the sustainability of economic growth, as well as considering the impact of monetary policy on financial stability. Although the BNM does not have an inflation target, it communicates its inflation forecast along with drivers of and risks to the inflation outlook, which are factored into the decision on monetary policy. Meanwhile, Singapore has developed a unique, implicit exchange rate–based inflation-targeting regime centered on the small and open nature of its economy (Box 2.1 and Khor and others 2007).

The ASEAN-5 central banks have set medium-term objectives and intermediate targets that serve as the foundation for their monetary policy actions. Medium-term inflation targets5 in Indonesia, the Philippines, and Thailand are debated and set by selected government agencies.6 Upon the recommendation of the central banks, the Indonesian and Philippine governments announce their three- and two-year-ahead headline inflation targets, respectively (Figure 2.1). Thailand used quarterly average core inflation as the target in 2000–08, but shifted to a one-year-ahead core inflation forecast in 2009–14. In 2015, Thailand adopted a new inflation target using annual average headline inflation, with a corresponding tolerance band.

Figure 2.1.
ASEAN-5 Actual and Targeted or Forecast Inflation1,2

Sources: Central bank reports; and Haver Analytics.

Note: ASEAN-5 = Indonesia, Malaysia, Philippines, Singapore, Thailand; BNM = Bank Negara Malaysia; IT = inflation targeting; NEER = nominal effective exchange rate.

1 Core inflation data in panels 1 through 6 exclude prices of food and fuel or energy prices in each of the ASEAN-5 countries, except in Singapore. Monetary Authority of Singapore core inflation excludes accommodation and private road transport.

2 Thailand used quarterly average core inflation as the policy target in 2000–14 and has used average annual headline inflation since 2015.

3 Actual inflation exceeded the upper limit of the inflation target if in red; fell below the lower limit of inflation if in pink; and was within the inflation target range if in green.

4 Table figures represent actual headline or core inflation, depending on the country’s policy target. Figures for Thailand refer to fourth-quarter average core inflation in 2000–14 and annual average headline inflation in 2015. For the Republic of Korea, annual average core inflation refers to 2000–06, and annual headline inflation refers to 2007 onward. In Indonesia, figures refer to end-year-month (December) year-over-year change in consumer price inflation. The rest of the countries use annual average inflation as the policy target.

Malaysia and Singapore also announce year-ahead inflation forecasts as part of their macroeconomic outlook assessments. However, the BNM and the MAS have developed different intermediate targets to assist them in achieving their forward-looking policy objectives.7 Singapore uses the nominal effective exchange rate (NEER) as an intermediate target, while the BNM uses the short-term interest rate as its policy instrument. In general, the view is that the medium-term objective needs to be both achievable and, over time, achieved, in order to be credible (IMF 2015a). However, when intermediate targets did not fall within the target range, ASEAN-5 central banks have explained to the public the reasons for missing the target, the rationale for the monetary policy decisions undertaken, and the policy approach going forward.

Monetary Policy in Singapore

Singapore’s monetary policy has been centered on the management of the exchange rate since the early 1980s, with the primary objective of promoting medium-term price stability as a sound basis for sustainable economic growth. This monetary policy regime choice is shaped by the small and open nature of the economy. The Singapore dollar is managed against a basket of currencies of Singapore’s major trading partners. The Monetary Authority of Singapore operates a managed float regime for the Singapore dollar, and the trade-weighted exchange rate is allowed to fluctuate within a policy band. The exchange rate policy band is periodically reviewed to ensure that it remains consistent with the underlying fundamentals of the economy; the general direction has been gradual appreciation, which has been effective in keeping inflation rates below those of its major trading partners (Figure 2.1.1). Within this framework, the level, slope, and width of the nominal effective exchange rate (NEER) band can be adjusted to change the monetary policy stance. The exchange rate band facilitates short-term nominal exchange rate flexibility, while the slope and the width of the corridor anchor medium-term NEER expectations, which in turn anchor inflation expectations. The exact location and parameters of the band and the weights of the currencies in the NEER basket are not made public.

Figure 2.1.1.
Nominal Effective Exchange Rate and Policy Band

(January 1, 2010 = 100)

Sources: IMF, Information Notice System; and IMF staff estimates.

Note: Midpoint, lower, and upper bounds of the policy band are IMF staff estimates. NEER = nominal effective exchange rate.

The ASEAN-5 inflation-targeting central banks have developed forecasting and policy analysis systems to further enhance forecasting performance and communicate their use to anchor expectations. In Indonesia, the central bank’s forecasting and policy analysis system involves several models, such as the Aggregate Rational Inflation-Targeting Model for Bank Indonesia, which is a stripped-down dynamic stochastic general equilibrium (DSGE)–type four-equation forecasting policy analysis system. It is the central bank’s core forecasting model. This model is complemented by several small-scale and medium-term macroeconomic structural models (Warjiyo 2014). The BSP’s workhorse inflation forecasting models include the Multiple Equation Model, Single Equation Model, and quarterly Medium-Term Macroeconometric Model (BSP 2014). The BSP also developed a semistructural forecasting and policy analysis system model in 2012 that can benefit from IMF Global Projection Model simulations for the external block. The BOT uses the Bank of Thailand Macroeconometric Model, which consists of 25 behavioral equations and 44 identities, and covers the real, monetary, external, and public sectors. Other BOT forecasting models include a DSGE model, vector autoregression models, and corporate and household models, couched within a macroeconomic modeling framework similar to its macroeconometric model. The MAS flagship model is the Monetary Model of Singapore (MMS), which is a macroeconomic computable general equilibrium model essentially derived from microeconomic optimization principles. It is used to analyze policy effects dynamically at both the economy and industry levels. The MMS is supported by the Satellite Model of Singapore, which is essentially a DSGE model.

The ASEAN-5 central banks have refined their operational frameworks to align market conditions with the announced policy stance and operate an interest rate corridor system (Figure 2.2), except for Singapore (see Box 2.1). The policy target rates are positioned in the middle of the corridor formed by the standing deposit and lending facilities. In general, the standing facility rates have been adjusted in tandem with the policy rate. By announcing changes to the policy rates, central banks signal their monetary policy stances to guide market interest rate movements that eventually act as benchmarks for lending and deposit rates. An effectively implemented monetary operations framework that supports the money markets allows banks to predictably place surplus liquidity with, and obtain short-term funding from, each other or the central bank at rates related to the policy rates (IMF 2015). For ASEAN-5 economies, central bank operations have been able to align market rates with the announced interest rate corridor over time. In the Philippines, short-term money market rates were for some years much lower than the de facto policy rate corridor. To address this issue, in 2015, the BSP adopted an interest rate corridor system and introduced a term deposit auction facility to absorb liquidity and support price discovery in the money market. In addition, it initiated in-house development of its systems for liquidity forecasting and auction-based monetary operations as part of the implementation of the interest rate corridor system (BSP 2015). As a result, the overnight interest rate has gradually increased. Similarly, Indonesia’s overnight interbank rate was effectively at the bottom of the policy interest rate corridor for some years, reflecting the challenges the central bank faced in ramping up open market operations with limited instruments. However, this has been addressed through the 2015 reform of the policy rate and the interest rate corridor system.

Figure 2.2.
Policy and Market Interest Rates

A range of policy instruments allows for different responses, depending on specific market conditions, to supplement monetary policy. Various policy toolkits have enabled ASEAN-5 central banks to guide their respective operational targets through liquidity management in the money market. Standing deposit and lending facilities, conducting open market operations in foreign exchange markets, outright buying and selling of government securities, imposing bank reserve requirement ratios, and establishing various banking regulations (that is, relaxing or tightening lending and deposit conditions) are some of the policy instruments already at the disposal of central banks to absorb or inject liquidity into the market (see Annex 2.1).

From a larger perspective, central bank policies implemented since the Asian financial crisis have molded the characteristics of the ASEAN-5 monetary policy frameworks. The exact characteristics of the frameworks differ, and refinements that central banks have made to the frameworks in response to liquidity shocks from capital flows have played an important role. However, the ASEAN-5 central banks have always highlighted the importance of clear statements of internally consistent policy goals, the institutional arrangements that give them the freedom to pursue these goals, and transparency and effective communication with respect to these goals and policy actions. Independent operational frameworks and clear communication of policy decisions to the general public and market participants through regular reports, press conferences, and dialogue enhance the central banks’ accountability for fulfilling their objectives. The central bank transparency scores for the ASEAN-5 are comparable to those of other inflation-targeting emerging market economies, reflecting their strong communication and transparency practices (Figure 2.3).

Figure 2.3.
Degree of Central Bank Transparency

Source: Dincer and Eichengreen 2014.

Note: The de jure transparency index was developed by Dincer and Eichengreen (2014). It ranges from 0 to 15 and is the sum of scores on questions concerning political, economic, procedural, policy, and operational transparency. Median values of transparency scores were used for country groupings. EMDEs = emerging market and developing economies; IT = inflation targeting.

Toward Greater Exchange Rate Flexibility

The transition to more consistent forward-looking monetary policy frameworks was supported by greater exchange rate flexibility. To present the evolution of the ASEAN-5’s policy choices, monetary trilemma triangles are calibrated for each country following Aizenman, Chinn, and Ito 2013, with some adjustments (see Figure 2.4 and Annex 2.1).8 The analysis focuses on three noncrisis periods—1990–96, 2000–07, and 2010–14—to avoid outliers. Comparing the post–global financial crisis period (2010–14) with the pre–Asian financial crisis period (1990–96), all ASEAN-5 economies have moved toward greater monetary policy autonomy, generally by forgoing exchange rate stability (Figure 2.4). The move toward greater exchange rate flexibility took place alongside institutional and operational reforms, as in other emerging market economies (IMF 2015b).

Figure 2.4.
ASEAN-5: Trilemma Triangles

Sources: Aizenman, Chinn, and Ito 2013; and IMF staff estimates.

However, the transition from the pre–Asian financial crisis to the post–global financial crisis regimes has been different across countries:

  • Before the Asian financial crisis, Indonesia had a crawling peg exchange rate system and an open capital account, which limited its ability to set interest rates. After the crisis, Indonesia adopted a more flexible exchange rate regime, which allowed for greater independence in setting its interest rate. Since the global financial crisis, Indonesia has increased its exchange rate flexibility and introduced capital flow management measures, providing further autonomy for setting interest rates.

  • Before the Asian financial crisis, Malaysia had a managed exchange rate and an open capital account, which provided limited scope for setting domestic interest rates. After the crisis, Malaysia fixed the exchange rate and managed the capital account to be able to gain some monetary independence. Malaysia de-pegged its exchange rate in 2005, adopted a more flexible exchange rate regime, and liberalized its capital account, which provided it with greater autonomy for setting interest rates during and after the global financial crisis.

  • Before the Asian financial crisis, the Philippines had a relatively closed capital account and a managed exchange rate regime, which allowed for a fair degree of monetary policy independence. After the crisis, the Philippines gradually liberalized its capital account restrictions and continued to manage its exchange rate to build up foreign exchange reserves, reducing its independence in setting interest rates. In more recent years, the Philippines has adopted a more flexible exchange rate regime, which has increased its independence in setting interest rates.

  • Singapore’s position in the monetary policy trilemma has remained relatively unchanged. As a financial center, Singapore has a highly open capital account. It also has a unique monetary policy regime centered on the management of the exchange rate. Thus, it has limited control over the setting of interest rates, which are market determined.

  • Before the Asian financial crisis, Thailand had a managed exchange rate regime and an open capital account, which provided limited scope for setting interest rates. After the crisis, Thailand adopted a more flexible exchange rate regime and managed its capital account more tightly, which provided some interest rate autonomy. In more recent years, Thailand has allowed even more exchange rate flexibility and gained more interest rate autonomy.

The IMF’s Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) shows a similar transition of exchange rate frameworks in the ASEAN-5 countries. Based on the AREAER classification, the ASEAN-5 economies have moved toward greater exchange rate flexibility, with all five classified as de jure managed or free floaters since 2008 (Figure 2.5).9 However, this move has been less pronounced in the de facto classification, with four economies classified as managed floaters by 2015 and none classified as free floaters. This is consistent with the experience of many advanced and emerging market economies that have successfully adopted inflation targeting, where the move toward a floating exchange rate regime was gradual and exchange rate considerations continued to play a role in the conduct of monetary policy, especially during crisis periods (IMF 2015). In fact, the number of inflation-targeting emerging market and developing economies classified as de facto managed floaters has risen through time, although fewer countries have been classified in the intermediate category.

Figure 2.5.
De Jure and De Facto Exchange Rate Classifications

Source: IMF, Annual Report on Exchange Arrangements and Exchange Restrictions, 2000–16.

Note: IT = inflation targeting.

Empirical analysis also confirms that ASEAN-5 currencies became more flexible after the Asian financial crisis—even more so after the global financial crisis.10Table 2.2 shows the coefficients of variation of the ASEAN-5 exchange rates against the US dollar at various horizons (10, 50, and 250 working days) between 1991 and 2015. Except for Malaysia during 1998–2005, the volatility of the ASEAN-5’s exchange rates against the US dollar has risen since the Asian financial crisis for all time horizons, indicating that the ASEAN-5 central banks have let their exchange rates fluctuate more freely. The volatility of the ASEAN-5 currencies against the US dollar also increases with the length of the time horizon, suggesting that central banks try to dampen short-term volatility, but allow their exchange rates to move substantially over longer periods. Still, the ASEAN-5 exchange rates exhibit lower volatility at every horizon than other free-floating currencies, such as the Japanese yen, suggesting that the extensive use of foreign exchange intervention in the ASEAN-5 economies had an impact not only on short-term but also on longer-term exchange rate volatility.

Table 2.2.Exchange Rate Volatility—Coefficient of Variation
10-day50-day250-day
Pre-AFCPre-GFCGFCPost-GFCPre-AFCPre-GFCGFCPost-GFCPre-AFCPre-GFCGFCPost-GFC
ASEAN-5
Indonesia0.100.831.330.500.312.204.171.271.145.895.784.04
Malaysia0.230.090.620.540.610.231.771.251.760.783.792.89
Philippines0.240.400.750.390.781.041.870.883.092.995.601.91
Singapore0.240.300.730.390.600.741.900.901.691.733.282.23
Thailand0.180.470.430.330.401.181.010.870.793.174.342.15
Other Asian Free Floaters
Australia0.510.782.450.851.141.765.911.972.553.9011.695.43
New Zealand0.420.852.200.920.951.965.092.082.444.5910.765.07
Japan0.710.701.280.671.731.602.751.514.553.744.634.08
Source: IMF staff estimates.Note: Time periods: Pre-AFC (1991 to June 1997); Pre-GFC (1999 to July 2008); GFC (September 2008 to February 2009); Post-GFC (March 2009 to latest data). AFC = Asian financial crisis; GFC = global financial crisis.
Source: IMF staff estimates.Note: Time periods: Pre-AFC (1991 to June 1997); Pre-GFC (1999 to July 2008); GFC (September 2008 to February 2009); Post-GFC (March 2009 to latest data). AFC = Asian financial crisis; GFC = global financial crisis.

The lower de facto exchange rate flexibility in the ASEAN-5 economies compared with advanced economies and some other emerging market economies does warrant closer examination to identify and understand the role of the exchange rate in the evolving monetary policy frameworks. In response to the global financial crisis, the ASEAN-5 central banks were compelled to adapt their policy frameworks and toolkits to strengthen policy autonomy and dampen risks. Part of the response included foreign exchange intervention and the active use of reserve buffers during capital inflow and outflow episodes to avoid excessive exchange rate volatility. Macroprudential and capital flow management measures also supplemented monetary policy to address market pressures and the buildup of systemic risks. Part II of this book delves into the spillovers from global financial factors and the global financial crisis as well as the policy responses in the ASEAN-5.

Performance

The ASEAN-5 monetary policy frameworks have, on the whole, performed well since the Asian financial crisis, delivering strong inflation performance, similar to that of other inflation-targeting emerging market and developing economies. Most of these economies achieved lower inflation amid marginal declines in growth between 1991–2000 and 2001–14. However, countries that adopted inflation targeting have reduced inflation and volatility more than those that didn’t (IMF 2015a, 2016a). The ASEAN-5 economies have also reduced output and inflation volatility, reaching levels achieved by inflation-targeting economies after adopting such regimes (Figure 2.6). Looking more closely, the ASEAN-5 inflation targeters (Indonesia, Philippines, Thailand) have performed even better, with higher GDP growth and lower inflation as well as lower volatility in GDP growth and inflation.11 This outcome highlights the benefits of the flexible inflation-targeting frameworks put in place after the Asian financial crisis, alongside the move to greater exchange rate flexibility, for ASEAN-5 economies and provides lessons for other emerging market and developing economies.

Flexible inflation targeting has also generally achieved its objectives while accommodating global shocks. The run-up in commodity prices during 2007–08 was the first significant common global price shock affecting the ASEAN-5 economies since the Asian financial crisis. Although evidence shows that, in general, countries with inflation-targeting frameworks managed shocks better than their nontargeting counterparts (Habermeier and others 2009), in some ASEAN-5 economies (Indonesia, Malaysia, Philippines), on average, headline inflation increased more than in other inflation-targeting emerging market and developing economies in 2007–08 (Figure 2.7). However, the increase in headline inflation did not become anchored at the higher level and fell back within the target range thereafter. Following the global financial crisis, inflation pressure remained subdued across the globe, and in most emerging markets, inflation declined during 2015–16, mainly because of lower prices for oil and other commodities (IMF 2016b). ASEAN-5 central banks took a variety of monetary policy actions during this period, depending on their assessments of the first- and second-round effects of the lower commodity prices. Inflation in some countries (Indonesia, Malaysia, Philippines) picked up in 2016 (reflecting partly the removal of subsidies on energy prices in Indonesia and Malaysia), but in Singapore and Thailand, it has remained low. Chapter 7 elaborates on the challenges of low inflation following the global financial crisis and the implications for monetary policy frameworks in the years ahead.

Figure 2.6.
ASEAN-5: Growth and Inflation

Source: IMF staff calculations.

Note: Following Roger (2010), hollow symbols represent periods from 1991 to 2000 or up to the year of IT adoption. Filled-in symbols represent periods from 2001 or a year after IT adoption to 2014. Straight lines represent the direction of movement between the two periods. Median values of country averages were used for real GDP growth, median of median values for inflation. Median standard deviations for growth and inflation were used for volatility. CPI = consumer price index; EMDE = emerging market and developing economy; IT = inflation targeting; SD = standard deviation.

Figure 2.7.
Global Commodity Prices and Inflation, 2007–10

Sources: Haver Analytics; and CEIC Data Co., Ltd.

Note: EMDEs = emerging market and developing economies; IT = inflation targeting. Samples for emerging market, developing, and ASEAN-5 economies comprise 50 countries.

Conclusion

In the past two decades, monetary policy frameworks in the ASEAN-5 economies have evolved substantially. Before the Asian financial crisis, these economies had tightly pegged exchange rates, which became a source of vulnerability along with excessive borrowing and currency mismatches by firms and banks. As a result, exchange rates came under severe pressure and depreciated sharply when the regional currencies came under speculative attack and investors panicked, leading to massive capital outflows. After the Asian financial crisis, the ASEAN-5 economies adjusted their policy frameworks to allow for more exchange rate flexibility and have gained more monetary policy autonomy in the context of more open capital accounts. The ASEAN-5 countries also embarked on substantial reforms to strengthen financial regulatory frameworks and built up their foreign reserves as insurance against external volatility.

On the whole, the ASEAN-5 economies’ monetary policy frameworks have performed well, delivering both price and output stability during a period of significant domestic and regional turbulence and transformation. Flexible inflation-targeting frameworks, including a unique exchange rate–based targeting approach in Singapore, have served the ASEAN-5 economies well in response to external shocks and could provide lessons to other emerging market and developing economies. Not surprisingly, success—that is, positive outcomes—in most cases entailed significant changes to operating frameworks and refinement of policy objectives in response to challenges in the external environment. The ASEAN-5 economies’ forward-looking monetary policy frameworks, active and independent liquidity management operations to align market conditions with the announced policy stance, and improved central bank transparency were important ingredients of their success.

Annex 2.1. ASEAN-5: Monetary Policy Frameworks
ANNEX 2.1ASEAN-5: Monetary Policy Frameworks
IndonesiaMalaysiaPhilippinesSingaporeThailand
Mandate, Objective, and Strategy
1. Central Bank MandateAchieve and maintain a stable value for the rupiahPromote price stability and the sustainability of economic growth, as well as considering the impact of monetary policy on financial stabilityPromote and maintain price stability; provide proactive leadership in bringing about a strong financial system conducive to sustainable growth of the economyMaintain price stability, foster a sound and reputable financial center and promote financial stability, ensure prudent and effective management of foreign reserves, and grow Singapore as an internationally competitive financial centerMaintain monetary stability and stability of the financial and payment systems
2. Primary Monetary Policy ObjectiveStable prices of goods and services, stable exchange ratePrice stabilityPrice stabilityPrice stabilityPrice stability
3. Stated Monetary Policy FrameworkInflation targeting (as of 2005)OtherInflation targeting (as of 2002)Implicit inflation targetingInflation targeting (as of 2000)
4. Medium-Term Inflation Target1Government-approved inflation target 2013–15: 4.0% ±1 pptNoneGovernment-approved inflation target 2015–18: 3.0% ±1 pptComfort level of about 2%Government-approved inflation target 2015: 2.5% ±1.5 ppt
5. Intermediate Monetary Policy Target2BI inflation forecast
  • 2015: below midpoint of 4%

NoneBSP inflation forecast
  • 2015: below the range of 3.0% ±1.0 ppt

  • 2016: low end of 3.0% ±1.0 ppt

  • 2017: midpoint of 3.0% ±1.0 ppt

Explicitly stated: NEER, with undisclosed location and parameters of the band and weights of currencies in NEER basketBOT inflation forecast
  • 2015: −0.9%

  • 2016: 1.2%

Independence
6. De Jure Operational IndependenceYes, with exceptional cases for lending to systemically important banksYesYesYesYes
7. Setting of De Jure Operational Targets (e.g., inflation or intermediate targets)With government intervention on inflation targetYes—BNM sets its own targetsNeeds intergovernmental committee approval for inflation targetYes—MAS sets its own inflation targetsNeeds finance minister and cabinet approval for inflation target
Policy Instruments
8. Central Banks’ Policy Rate or StanceBI policy rate (7-day reverse repo rate), deposit and lending ratesBNM overnight policy rateBSP overnight reverse repo or borrowing rate, overnight repo or lending rate, and Special Deposit Account rateMAS indicates level, slope, and width of NEER band every 6 monthsBOT 1-day bilateral repo rate
9. Reserve RequirementYesYesYesYesYes
Statutory Reserve Requirement Ratio (RRR)Primary RRR (7%) 1 secondary RRR on liquid assets (2.5%)3.5%, commercial banks20%, universal and commercial banks3%, all banks1%, commercial banks
10. Open Market Operations
  • Issuance of BI certificates

  • Repo and reverse repo transactions on government securities

  • Outright sale and purchase of government securities

  • Foreign exchange buying and selling against the rupiah

  • Uncollateralized direct borrowing

  • Repo and reverse repo of government securities

  • Issuance of BNM notes

  • Outright sale and purchase of government securities

  • Foreign exchange swaps

  • Repo and reverse repo transactions on government securities

  • Outright sale and purchase of government securities

  • Foreign exchange swaps

  • Issuance of short-term MAS bills

  • Repo and reverse repo transactions on Singapore government securities

  • Foreign exchange swaps

  • Issuance of BOT bills

  • Bilateral repo transactions on purchase and sale of securities

  • Outright sale and purchase of primarily BOT and government bonds

  • Foreign exchange swaps

11.Standing FacilitiesDeposit and lending facilitiesDeposit and lending facilities
  • Fixed-term deposit (Special Deposit Accounts) facility

  • Lending (rediscounted rates) facility

  • Overnight deposit and lending facilities

  • Overnight renminbi foreign currency lending facility

Deposit and lending facilities
Transparency and Communications
Explanation of
12. Monetary Policy ObjectiveYesYesYesYesYes
13. Monetary Policy FrameworkYesYesYesYesYes
14. Intermediate TargetYes, inflation targetYes, short-term interest rate movementsYes, inflation targetYes, direction of NEER policy bandYes, inflation target
15. Decision-Making ProcessYesYesYesYesYes
16. Rationale or Basis for Monetary Policy Decisions or StanceYesYesYesYesYes
Timing of Publication
17. Inflation ReportMonthlyNot availableQuarterlySemiannualQuarterly
18. Public Release of Monetary Policy StanceSame daySame daySame daySame daySame day
19. Minutes or Highlights of Monetary Policy MeetingsEach monthNot availableOne month after meeting dateNot availableTwo weeks after meeting date
Accountability
20. Report on Monetary Policy OperationYes, quarterly report to Parliament and the publicYes, regular reporting to the minister of finance on policies related to principal objectivesYes, annual report to the president and Congress and to the publicYes, semiannual monetary policy statement and report on macroeconomic developments to the publicYes, semestral report to the cabinet
21. Public Document or Explanation if Target is MissedYes, report to Parliament and the publicYes, open letter to the presidentYes, open letter to the minister of finance
Sources: IMF, ASEAN-5 desk survey; and central banks’ websites.Note: BI = Bank Indonesia; BNM = Bank Negara Malaysia; BOT = Bank of Thailand; BSP = Bangko Sentral ng Pilipinas; MAS = Monetary Authority of Singapore; NEER = nominal effective exchange rate; ppt = percentage point.

The numerical medium-term inflation objective is distinct from the near-term inflation forecast. The inflation objective is rarely modified, and not as a result of short-term political pressure or critical circumstances, but rather as part of a systematic and transparent review of the entire monetary policy framework (IMF 2015).

The intermediate target refers to a variable correlated with the ultimate objective that monetary policy can affect more directly and that the central bank treats as if it were the target for monetary policy, or as a proxy for the ultimate policy objective. Intermediate targets are tools to assist in achieving the policy objectives and not policy objectives in themselves (IMF 2015).

Sources: IMF, ASEAN-5 desk survey; and central banks’ websites.Note: BI = Bank Indonesia; BNM = Bank Negara Malaysia; BOT = Bank of Thailand; BSP = Bangko Sentral ng Pilipinas; MAS = Monetary Authority of Singapore; NEER = nominal effective exchange rate; ppt = percentage point.

The numerical medium-term inflation objective is distinct from the near-term inflation forecast. The inflation objective is rarely modified, and not as a result of short-term political pressure or critical circumstances, but rather as part of a systematic and transparent review of the entire monetary policy framework (IMF 2015).

The intermediate target refers to a variable correlated with the ultimate objective that monetary policy can affect more directly and that the central bank treats as if it were the target for monetary policy, or as a proxy for the ultimate policy objective. Intermediate targets are tools to assist in achieving the policy objectives and not policy objectives in themselves (IMF 2015).

Annex 2.2. ASEAN-5 Monetary Policy Regimes: A View Through the Impossible Trinity

The impossible trinity, or trilemma, is a simple framework that can illustrate the evolution of monetary policy regimes in the ASEAN-5 economies. This framework states that a country may simultaneously choose any two, but not all three, of the following policy goals: monetary policy autonomy, exchange rate stability, and capital account openness. In practice, however, countries rarely face the binary choices stated above. Instead, they choose intermediate levels of capital account openness and exchange rate stability to retain some monetary policy autonomy. A key message of the impossible trinity is that policymakers face a trade-off: greater achievement of one policy goal requires less achievement of either or both of the other two.

A major challenge of the impossible trinity framework is gauging the achievement of each policy goal. Previous studies have measured these variables for a large sample of countries, with different levels of complexity in their specifications. For example, Aizenman, Chinn, and Ito (2013) use a simple specification to construct trilemma indices for 184 countries between 1970 and 2010. Monetary policy autonomy was measured as the reciprocal of the annual correlation of the monthly market interest rates of the home country and the base country (the United States in most cases). Exchange rate stability was defined as the inverse of the annual standard deviations of the monthly bilateral exchange rate between the home and the base country. Capital account openness was measured by the de jure index developed by Chinn and Ito (2006). Each index was normalized to lie between zero and one, in which one is full achievement.

Although intuitive and publicly available, the Aizenman, Chinn, and Ito 2013 indices suffer from several shortcomings: (1) exchange rate stability and monetary policy autonomy are measured in relation to only one other country and thus may be biased if the local currency is tied to a currency basket; (2) monetary policy autonomy is subject to spurious correlation in the presence of common shocks, in which case home and base country interest rates may move in the same direction even though monetary policy is fully autonomous; (3) the framework may not capture non–interest rate monetary policy moves such as changes in banks’ reserve requirements; and (4) capital account openness measures the existence of de jure capital controls, but not their intensity or their de facto impact.

Ito and Kawai (2012) built a more robust set of trilemma indices, addressing some of the issues associated with the Aizenman, Chinn, and Ito 2013 indices; however, the Ito and Kawai indices are not publicly available. Thus, Aizenman, Chin, and Ito 2013 indices are used here to assess the evolution of monetary policy regimes in the ASEAN-5 economies since 1990. This annex also explores how the picture changes if a de facto capital account openness measure is used.

Impossible Trinity Indices—Aizenman, Chinn, and Ito 2013

Annex Figure 2.2.1 presents Aizenman, Chinn, and Ito’s (2013) impossible trinity indices for the ASEAN-5 economies between 1990 and 2014. Several messages emerge:

  • Exchange rate stability in Indonesia and Thailand was high before the Asian financial crisis, fell substantially during 1997–99, and has returned to middle levels since the early 2000s. Exchange rate stability in the Philippines and Singapore was stable during the whole period. In Malaysia it was at the middle level before the Asian financial crisis, fell during 1997–98, and rose sharply during 1999–2005 as the ringgit was pegged to the US dollar. It has fallen to middle levels since 2006. All five countries had similar exchange rate stability levels in the wake of the global financial crisis.

  • Monetary policy autonomy in Malaysia and Singapore was at the middle level during the whole period; in Indonesia it was at the middle level during 1990–2012, but it was high during 2013–14 following the taper tantrum episode. Monetary policy autonomy in the Philippines was more volatile: high in the early 1990s, mid to low during 1994–2008, high during 2010–12, and low during 2013–14. In Thailand it was at the middle level during 1990–2002, low during 2003–06, and high during 2010–14.

  • The Chinn and Ito 2006 de jure capital account openness index suggests that the capital accounts of Indonesia and Malaysia have become less open over time. The index also suggests that the Philippines and Thailand had relatively closed capital accounts during the whole period, especially since 2010. Singapore had an open capital account during the whole sample period.

Annex Figure 2.2.1.
ASEAN-5: Impossible Trinity Indices

Sources: Aizenman, Chinn, and Ito 2012; and IMF staff calculations.

Note: KA openness is measured as the sum of foreign assets (excluding foreign reserves) and foreign liabilities divided by GDP. These series for 1990–2010 are from the Wealth of Nations database of Lane and Milesi-Ferretti (2007), complemented with net international investment position data for 2012–14. This ratio is divided by that of the 70th percentile to normalize it between 0 and 1. A country is considered to have a fully open capital account (a value of 1) if the ratio is equal to or larger than the 70th percentile. ER = exchange rate; KA = capital account; MP = monetary policy.

One issue with these trilemma indices is that their sum is generally less than two.12 Singapore, Indonesia (1990–96), and Malaysia (1999–2005) are the only cases in which the indices sum close to two. For all other countries and periods, the sum of the indices is well below two, suggesting that countries did not make full use of their policy space. However, this outcome may reflect mismeasurement, especially the de jure capital account openness index, which considers only the existence of capital controls, but not their intensity nor their de facto impact. The next section explores how this assessment changes when a de facto capital account openness measure is used.

Adding a De Facto Measure of Capital Account Openness

De facto capital account openness is measured as the sum of foreign assets (excluding foreign reserves) and foreign liabilities divided by GDP. These series in 1990–2010 are from the Wealth of Nations database of Lane and Milesi-Ferretti (2007), complemented with net international investment position data for 2012–14. This ratio is divided by that of the 70th percentile to normalize it between zero and one. A country is considered to have a fully open capital account (a value of one) if the ratio is equal to or larger than the 70th percentile. Consistent with the de jure index, the de facto index suggests that Singapore had a fully open capital account during the whole period (Figure 2.2.1). For Malaysia, however, the de facto index suggests a more open capital account than the de jure index. For Indonesia, on the other hand, the de facto index suggests a more closed capital account than the de jure index. The Philippines and Thailand had low capital account openness during 1990–2005 under both measures, but the de facto measure suggests that Thailand achieved higher capital account openness following the global financial crisis, while it remained low in the Philippines during this period.

Annex Figure 2.2.2.
ASEAN-5: De Facto Capital Account Openness Index

Sources: Aizenman, Chinn, and Ito 2012; and IMF staff calculations.

Using the de facto capital account openness index instead of the de jure index yields a sum of trilemma indices close to two for Singapore and Malaysia, but below two for Indonesia, the Philippines, and Thailand (Figure 2.2.2). This result suggests that the mismeasurement of capital account openness does not explain the low value of this sum for the latter three countries; rather, it reflects problems with the measurement of exchange rate stability and monetary policy autonomy. Improving these measures is beyond the scope of this annex, but to illustrate the point, the exchange rate stability and monetary policy autonomy indices are renormalized proportionally so that the trilemma indices sum to two in each year for each country, with no index larger than one. This is done while keeping the de facto measure of capital account openness.

The normalized trilemma indices, with de facto capital account openness, indicate that the ASEAN-5 economies have moved toward greater monetary policy autonomy since 2010 (Annex Figure 2.2.3).

Annex Figure 2.2.3.
ASEAN-5: Normalized Impossible Trinity Indices with De Facto Financial Openness

Source: Aizenman, Chinn, and Ito 2012.

Note: ER stability and MP autonomy have been renormalized proportionally so that all three indices sum to two each year. ER = exchange rate; KA = capital account; MP = monetary policy.

Evolution of Monetary Policy Regimes—Impossible Trinity Triangles

Having trilemma indices that sum to two in each year allows us to analyze the evolution of monetary policy regimes in the ASEAN-5 countries using impossible trinity triangles. The analysis focuses on three periods (to exclude crisis years): 1990–96, 2000–07, and 2010–14. Comparing the post–global financial crisis period (2010–14) with the pre–Asian financial crisis period (1990–96), all ASEAN-5 economies have moved toward greater monetary policy autonomy, generally by forgoing exchange rate stability, and in some cases by reducing capital account openness. However, the transition from the pre–Asian financial crisis to the post–global financial crisis regime has been different across countries (as in Figure 2.1):

  • Indonesia raised its monetary policy autonomy after the Asian financial crisis by forgoing exchange rate stability and some capital account openness. Its autonomy remained high after the global financial crisis, but its exchange rate stability rose at the expense of lower capital account openness.

  • Malaysia reduced its monetary policy autonomy and capital account openness after the Asian financial crisis to achieve greater exchange rate stability, but raised its monetary policy autonomy and capital account openness significantly after the global financial crisis as the ringgit was allowed to float.

  • The Philippines reduced its monetary policy autonomy following the Asian financial crisis to achieve greater exchange rate stability, but its autonomy rose following the global financial crisis at the cost of lower capital account openness and somewhat lower exchange rate stability.

  • Singapore maintained middle levels of exchange rate stability and monetary policy autonomy, and a fully open capital account, during all three periods.

  • Thailand marginally raised its monetary policy autonomy and capital account openness following the Asian financial crisis at the cost of lower exchange rate stability, but raised its autonomy more markedly after the global financial crisis by forgoing exchange rate stability.

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Chapter 3 focuses on reforms related to the financial sector.

The institutional setup includes the central bank’s statutory mandate, governance structure, and decision-making processes.

External stability is also an explicit objective in Indonesia as observed in a few other emerging market economies (see Ostry and others 2012).

The BOT found that the relationship between money supply and output growth had become less stable over time, particularly since the Asian financial crisis, and concluded that targeting the money supply would be less effective than directly targeting inflation.

The numerical medium-term inflation objective is distinct from the near-term inflation forecast. The inflation objective is modified rarely, and changes to it are not based on short-term political pressures or conjunctural circumstances, but rather as part of a systematic and transparent review of the entire monetary policy framework (IMF 2015a).

The medium-term inflation objective is determined by the national government in Indonesia; by the Development Budget Coordinating Committee composed of government economic agencies in the Philippines; and by the BOT’s Monetary Policy Committee and minister of finance, for the minister’s endorsement for cabinet approval.

The intermediate target refers to a variable correlated with the ultimate objective that monetary policy can affect more directly and that the central bank treats as if it were the target for monetary policy, or as a proxy for the ultimate policy objective (Laurens and others 2015). Intermediate targets are tools central banks use to help achieve policy objectives, but they are not policy objectives in themselves (IMF 2015a).

This framework, first introduced by Mundell and Fleming in the 1960s, states that a country may simultaneously choose any two, but not all three, of the following policy goals: monetary policy autonomy, exchange rate stability, and capital account openness. In practice, however, countries rarely face the binary choices stated above. Instead, they choose intermediate levels of all three goals. The three indices are normalized to lie between 0 and 1 and to sum to 2 every year.

Singapore’s monetary policy framework is an exception and classified by the AREAER (2016) as an exchange rate anchor, although the MAS is ultimately targeting price stability (inflation) as its main monetary policy objective.

Consistent with this conclusion, Klyuev and Dao (2016) find little evidence that the ASEAN-5 currencies or a subset thereof are bound together in a tight “club” or peg to a reserve currency or basket of currencies. They provide formal unit root tests in the exchange rates of the ASEAN-5 currencies against the US dollar, the yen, and the renminbi, as well as against each other, for different periods. Results confirm the narrative of quasi dollar pegs before the Asian financial crisis. After the global financial crisis, the ASEAN-5 currencies remained nonstationary against the US dollar, the yen, and the renminbi, indicating the absence of a tight relationship with any of these major currencies.

A country’s economic performance may not necessarily reflect the adoption of a specific monetary policy framework. Rather, some country-specific, one-off shocks may also have influenced growth and inflation performance in the period under consideration.

Full achievement of one policy goal means an index equal to one. If a country fully achieves two goals, it must give up the third completely, with the sum of the indices equal to two. If the indices are linear, intermediate achievement means index values between zero and one, with the sum of the three indices equal to two.

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