This Selected Issues paper estimates both Guatemala’s potential output and output gap using a wide range of econometric techniques. The analysis suggests that Guatemala’s potential output growth is about 3.5 percent for the whole sample period and that the output gap is almost closed. Results are highly robust among different methodologies. Among the methods used, several well-known time series filters and two different estimations of a state-space model are included. Additionally, a test for structural breaks in the series of potential GDP is presented. All methodologies conclude that the output gap at the end of 2012 is almost closed at -0.2 percent of potential GDP.

Abstract

This Selected Issues paper estimates both Guatemala’s potential output and output gap using a wide range of econometric techniques. The analysis suggests that Guatemala’s potential output growth is about 3.5 percent for the whole sample period and that the output gap is almost closed. Results are highly robust among different methodologies. Among the methods used, several well-known time series filters and two different estimations of a state-space model are included. Additionally, a test for structural breaks in the series of potential GDP is presented. All methodologies conclude that the output gap at the end of 2012 is almost closed at -0.2 percent of potential GDP.

Analytical Note V. Monetary Policy Stance1

Inflationary pressures have begun to materialize in Guatemala. In this context, assessing whether the actual monetary policy stance is adequate is important. Using several techniques, this note attempts to evaluate the impact of financial conditions on GDP growth and to estimate the neutral real interest rate (NRIR). The results show that financial conditions have been broadly neutral while the monetary policy rate is somewhat above the estimated neutral policy rate. Therefore, it is recommended that the authorities remain vigilant and ready to tighten monetary policy if inflationary pressures persist.

1. Some inflationary signs are starting to appear in Guatemala. The survey of economic expectations conducted by the central bank for April shows that market agents are expecting end-2013 inflation to be 4.65 percent, very close to the central bank’s upper bound for its target band. The monetary board has acknowledged this fact and it recently raised its monetary policy rate by 25 basis points to 5.25 percent.

2. The objective of this note is to evaluate whether the monetary policy stance is appropriate to keep the inflationary pressures under control. To do that, first, a monetary and financial conditions index (FCI) is calculated to analyze the effect of financial conditions on real GDP growth. Second, three different models are estimated to calculate the neutral interest rate (NRIR) for Guatemala.

3. The FCI summarizes information contained in key financial variables and captures the correlation with economic activity. Financial conditions can be defined as the current state of financial variables that influence economic activity. A VAR analysis was used to decompose the contribution of various financial indicators to real GDP growth. The FCI was built as the sum of the cumulative impulse responses of real GDP to each of the relevant financial variables. The financial variables used included a summary measure of interest rates (the real interest rate of bank loans), the real effective exchange rate (REER), the real growth of deposits and of credit to the private sector, and a housing price index (proxied by the housing component of the consumer price index). The model was estimated using quarterly data between 2001 and 2012. The impulse responses were standardized so that a change in each FCI component by one unit can be interpreted as an (annualized) change in real GDP growth by 1 percentage point. Hence, a change in the value of the overall FCI reflects the total contribution of financial conditions to GDP growth.

uA05fig01

Monetary and Financial Conditions Index (2007-2012)

(percentage points of y/y real GDP growth)

Citation: IMF Staff Country Reports 2013, 248; 10.5089/9781475578256.002.A005

Sources: Country authorities and Fund staff estimates.

4. The estimated FCI suggests that overall financial conditions were relatively neutral by the end of 2012.2 There were fairly loose or positive financial conditions in the first quarter which turned more negative or tighter in the rest of the year. Overall, the average contribution of the FCI for the whole of 2012 was positive and approximately 0.7 percent of GDP growth. According to the model, the main drivers of the FCI in 2012 were housing prices, credit, and the real growth of bank deposits. Changes in the real interest rate of loans contributed only marginally to the FCI. Relatively underdeveloped financial markets in Guatemala may limit the interpretation of the results of the model.

5. Another way to assess the appropriate monetary policy stance is to estimate the neutral real interest rate for Guatemala. In order to assess whether the actual policy will have an expansionary or contractionary effect, the NRIR is used to calculate the monetary policy stance, defined as the difference between the actual real policy rate and the estimated neutral real rate.

6. Following Magud and Tsounta (2012), a set of well known methodologies is used to estimate the NRIR. Three different methods are used to estimate the NRIR.3 The first one takes advantage of the uncovered interest parity condition. The second estimates the NRIR using a Taylor rule augmented for inflation expectations. The last method solves a general equilibrium model that focuses on aggregate demand-supply equilibrium. The data used corresponds to the period between 2001 and 2013.

7. According to the estimations, the NRIR is in a range between 1.4 and 2.4 percent. However, some caveats apply for each of these models and results should be interpreted with caution given the limitations of data and the incipient nature of financial markets in Guatemala. Shallow financial markets are a strong constraint for accuracy especially for dynamic general equilibrium models. With this caveat in mind, the main results can be summarized as follows (Table 1).

  • The uncovered interest parity condition (UIPC) estimates the NRIR for Guatemala as 1.4 percentage points. This value assumes an implicit nominal depreciation of 1.6 percent in 2013. Using expected inflation for 2013 from the April survey of economic expectations, the neutral nominal interest rate is 6.3 percent or 105 basis points higher than the current level of the monetary policy rate.

  • The expected-inflation augmented Taylor rule model estimates the NRIR at 2.0 percent. The yield curve can provide information about the relationship between the monetary policy rate and the NRIR. In particular, the gap between the nominal long-term interest rate and the NRIR can be modeled as a function of the gap between inflation and the inflation target. Results show that the nominal neutral level for the monetary policy under this model is 6.9 percent. These results should be interpreted carefully given that they rely on a certain degree of sophistication of a country’s financial markets.

  • The general equilibrium model concludes that the NRIR is 2.4 percent and the nominal neutral monetary policy is 7.3 percent. This model relates and Investment-Savings (IS) curve with a traditional Phillips curve. The IS equation defines the output gap in terms of lagged deviations of GDP and of the monetary policy rate from their potential and neutral levels, respectively. The Phillips curve assumes that inflation deviations from the central bank’s target are explained by their own lags and lags in the output gap. This model depends less than the previous one on the structure of financial markets; however, it still assumes that the monetary transmission channel works efficiently.

Neutral Real Interest Rate for Guatemala

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Sources: Country Authorities and Fund staff estimates.Notes:

All units expressed as percent points unless otherwise stated.

(bps): Basis points

8. To conclude, the main results from the different exercises suggest that the authorities should remain cautious and ready to tighten monetary policy if inflationary pressures persist. To different degrees, all NRIR estimations suggest that the monetary stance is below neutral levels, while the FCI shows financial conditions were largely neutral at the end of 2012. On balance, therefore, considering the inflation targeting framework adopted by Guatemala, further modest hikes in the monetary policy rate may be desirable in order to keep inflation and inflation expectations under control.

1

Prepared by Carlos Rondón.

2

These results are restricted by the usual econometric caveats regarding endogeneity and should not be interpreted as a causal relationship.

3

For more methodological details see Magud, N., and E. Tsounta, 2012, “Too Cut or Not to Cut? That is he (Central Bank’s) Question: In Search of the Neutral Interest Rate in Latin America,” Working Paper 12/243 (Washington: International Monetary Fund).

Guatemala: Selected Issues and Analytical Notes
Author: International Monetary Fund. Middle East and Central Asia Dept.