Abstract
Argentina: Selected Issues
Enhancing the Effectiveness of Inflation Targeting in Argentina1
This note identifies key reforms to strengthen the effectiveness of inflation targeting in Argentina. The Central Bank of the Republic of Argentina (BCRA) launched inflation targeting in September 2016, with the objective of reducing inflation to 5 percent in 2019. The reforms involve strengthening the institutional underpinnings of monetary policy and adjusting its policy and operational framework.
A. Introduction
1. Inflation in Argentina has been chronic throughout most of its modern history. By the 1950s, Argentina already featured two-digit inflation and, from 1975 onward, it accelerated and reached three-digit rates. To cope with persistent inflation, successive stabilization plans—of a variety of nature—were put in place, but most of them eventually failed. Thus, inflation hit a record high of more than 3,000 percent by the late 1980s (see Box 1). The Convertibility Plan introduced in the early 1990s, which had a currency board arrangement (CBA) as anchor, defeated inflation. However, price stability lasted only a decade as the CBA was abandoned in the midst of a financial crisis and inflation re-emerged as a result of expansionary fiscal and monetary policies.
2. The BCRA formally adopted inflation targeting in September 2016. The BCRA confirmed the path of disinflation established at the beginning of the year, which aims at achieving 5 percent, with a tolerance band of +/- 150 bps, in 2019—the inflation targets for 2017 and 2018 were ratified at 12–17 percent and 8–12 percent, respectively. The BCRA also announced the adoption of a 7-day repo rate as a policy rate, that will substitute todays’ 35-day Lebac rate. Policy decisions will be taken by a new Monetary Policy Council.
3. This note identifies key reforms to enhance the effectiveness of inflation targeting in Argentina. These reforms involve strengthening the institutional underpinnings of monetary policy and adjusting its policy and operational framework. The rest of this paper is organized as follows: Section B characterizes the transition to inflation targeting in Argentina and argues that the targets set for disinflation seem to be ambitious; Section C highlights key institutional reforms that may help to shift expectations forward; Section D identifies changes in the policy and operational framework to enhance the effectiveness of inflation targeting.
A Snapshot of Inflation and Stabilization Plans in Argentina in the Last 50 Years
Inflation has been a feature of the Argentinean economy since the 1940s. It started to climb after the Second World War, but surged in the mid-1970s to top 400 percent. After a short declining it soared to even higher levels by the 1980s before reaching record highs in the early 1990s. Argentina enjoyed price stability during most of the 1990s, but inflation rebounded when the currency board arrangement (CBA) collapsed in the early 2000s. Price stability was never achieved again. On the contrary, inflation has entrenched at levels of 20 to 30 percent in the last years.
50 Years of Inflation and Stabilization Plans in Argentina
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: Great Buenos Aires CPI up to 2012 and City of Buenos Aires CPI thereafter.Throughout these years several stabilization programs were implemented, but most of them were eventually ineffective. As inflation accelerated and became socially costly governments responded with a variety of stabilization plans. Often, stabilization efforts relied on the exchange rate to anchor inflation. The so-called “tablita” in the second half of the 1970s and the Convertibility plan that introduced the CBA in the early 1990s are cases in point.1 Argentina also experienced alternative stabilization programs, which relied on income policies to tackle inflation inertia. The Plan Austral and Plan Primavera in the 1980s illustrate these heterodox adjustment programs.2
1/ For a discussion of these stabilization plans see, for example, Fernandez (1985) on the “Tablita” plan, and Galiani and others (2003) on the Convertibility Plan. 2/ Among others, heterodox economic programs are described and analyzed in Machinea and Fanelli (1988), and Heymann (1991).B. The Road to Inflation Targeting
4. Argentina has been living with moderate inflation during 2013–15.2 Central bank financing to the government—close to 5 percent of GDP during 2013–15—was a key source of persistent inflation. By the end of 2015, inflation accelerated due to the impact of the large currency depreciation that followed the liberalization of the foreign exchange market in December (Figure 1). Inflation gained momentum in April as a result of the adjustments in administrative prices decreed by the government. As of August 2016, inflation is above 40 percent y-o-y.
Moderate Inflation in Argentina
(Buenos Aires and San Luis indices, Percentage rate y-o-y)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Sources: Buenos Aires Ciudad Estadística y Censos and San Luis- Dirección Provincial de Estadística y Censos.5. After exiting the peg in December 2015, the BCRA briefly introduced a monetary-targeting regime, but soon abandoned it and started the transition to inflation targeting. Under the monetary-targeting regime, base money became initially the new operational variable. The BCRA scaled up open market operations to reduce its rate of growth thus signaling a contractionary policy stance. Yet the BCRA did not identify any intermediate target as nominal anchor. In late February, the BCRA adopted the 35-day LEBAC interest rate as the new operational target, signaling a transition to inflation target (see in Appendix 1 a taxonomy of monetary policy regimes).3 It also announced that as monetary aggregates will become endogenous, they will no longer be subject of policy targeting. At the same time, the BCRA kept the exchange rate flexible, although intervening with the implicit objective of maintaining the exchange rate within a 14–16 pesos/USD range.
6. The BCRA committed to reduce the monthly rate of inflation to about 1.5 percent or less in the last quarter of 2016. This target is a variation of the 20–25 percent inflation target set for end-2016 by the Ministry of Economy at the beginning of the year. To achieve its policy objective, the BCRA initially tightened monetary policy. The policy rate was increased to 38 percent in March. Since May, however, the BCRA started to ease monetary policy by cutting the policy rate at a gradual pace to 26.75 percent by mid-October. The BCRA has explained this policy relaxation as a response to a decline in inflation expectations (Figure 2). Simultaneously, the BCRA increased reserve requirements 1.5 percentage points (to 14.5 percent for time deposits) and 2.5 percentage points (to 19.5 percent for sight deposits) in June. A similar increase took place in July.
Inflation Expectations
(12-months ahead, Percentage rate y-o-y)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: Universidad Torcuato Di Tella, Inflation expectations survey.Ambitious inflation targets
7. Argentina will launch inflation targeting from a much higher level than in other countries that followed a similar path in the past. The experience of other countries shows that they preferred to introduced inflation targeting when the annual increase in prices was already close to 10 percent (Figure 3). Before adopting inflation targeting, many of these countries went through gradual disinflation, using alternative policy regimes. Some countries, like Chile, Colombia, Czech Republic, and Poland, used first the exchange rate as an intermediate target to fight moderate inflation and moved to inflation target only when prices were increasing less or slightly more than 10 percent year-on-year.4 Mexico and Peru also implemented a gradual pace of disinflation but targeting monetary aggregates, before shifting to inflation targeting. In other countries like Turkey, the central bank announced a gradual transition to inflation targeting that lasted several years, before officially adopting the new monetary policy regime. During these years, the Central Bank of Turkey and the government laid the ground for introducing inflation targeting (see Appendix 2). Argentina is, thus, unique as it adopted inflation targeting when inflation was about 40 percent y-o-y, or near 20 annualizing monthly core inflation.
Inflation at Inception of Inflation Targeting
(Percentage rate y-o-y)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: IMF AREAER, 2015, Monetary Policy Framework Classification.8. With inflation at moderate levels, inflation targets in Argentina seem ambitious. The experience of other countries shows that defeating moderate inflation lasted many years. Starting in 1980, some 35 emerging markets, primarily from Eastern Europe and Latin America, and some advanced economies, went through periods of moderate inflation—defined as episodes characterized by inflation rates in the range of 10–40 percent that followed three or more consecutive years of high or moderate inflation that created the incentives for indexing contracts.5 In 30 of these countries, moderate inflation lasted four years or more before declining to single digit inflation, and in almost half of these cases it lasted more than 10 years (Figure 4). In Latin America, Chile reduced inflation from about 30 to 5 percent from 1985 to 1998, whereas in Colombia similar disinflation lasted from 1980 to 2003. In Mexico defeating inflation took 5 years following the “tequila” crisis. While convergence to low inflation may be shorter nowadays, as central banks have developed the technology to build credibility and arrest inflation, there are factors in Argentina that may hinder the achievement of the inflation targets.
Moderate Inflation Episodes and Convergence to Low Inflation
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: IMF’s International Financial Statistics and author’s calculations.9. Wage indexation is currently at play in Argentina. As it normally happens with moderate inflation, contracts in the economy—in particular wage negotiations—tend to be indexed backwards, thus generating inflation inertia.6 Wage negotiations in Argentina, follow this rationale. The average increase in wages negotiated on a bi-annual basis for 2016 is 21 percent, and 34 percent for those negotiated for the whole year, above the inflation target for 2016—although below the level at which inflation may end this year.7
10. Inertia may become a drag for the BCRA’s anti-inflation efforts. Inflation in Argentina appears to have an inertial component, comparable to that experienced by other Latin American countries when they had moderate inflation (see Box 2). Because wage negotiations tend to be set under backward-looking considerations, and given that inflation overshooting in 2016 reduced real wages, it is unlikely that wage negotiations for the new year will become forward looking and aligned with the BCRA’s inflation target for end-2017.
11. The size of the fiscal deficit also cast doubts about the feasibility of achieving the inflation targets. The primary deficit for 2016 and the one projected for 2017 are expected to be more than 4 percent of GDP. This is a sizable imbalance by international standards—when countries adopted inflation targeting (Figure 5). Moreover, the fiscal deficit is still partially financed by the BCRA—about two percent of GDP in 2016 and 1.5 percent of GDP in 2017. Central bank financing to the government not only tend to feed inflation pressures, but is a source of fiscal dominance, which reduces in practice the BCRA’s operational independence and undermines its capacity to buildup credibility.
Primary Balance at Inflation Targeting Inception
(Sample of inflation targeting countries, Percent of GDP)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Sources: IMF World Economic Outlook, IMF WHD for Brazil, and Intelligence Unit for Thailand.Inflation Inertia in Argentina and Other Selected Latin American Countries
Inertial inflation seems to be entrenched in Argentina. A simple measure of inflation inertia suggests that inflation has been a constant feature in Argentina since 1980, except for the 1990s, when the currency board was in place and, to some extent. during the mid-2000s. Inertial inflation in the last five years has increased. It seems to be higher than in Chile and Colombia, and similar than in Mexico, at the time these economies featured moderate inflation—in the second half of the 1980s and most of the 1990s. In these countries, it took more than 10 years to achieve one-digit inflation as inertia declined.
Inflation Inertia in Argentina and Selected Latin American Economies
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Note: The charts present estimates of inflationary inertia in Argentina, Chile, Colombia and Mexico using univariate rolling regressions. They plot estimated AR(1) coefficients of univariate regressions of monthly inflation rates using a 36-month rolling window and 95 percent confidence bands of the univariate regressions of month-on-month inflation rates.1 Similar calculations have been used in the literature (see, for example, Edwards and Lefort, 2002).12. As a result of inflation inertia and lax fiscal policy, dissinflation may not fall at the pace required to hit the 2017 target. Reducing inflation to close to 20 percent by end 2017 may be feasible with the current policy stance—keeping the policy rate at 3–4 percent in real terms with respect to inflation expectations. However, this may not be enough to hit the 12–17 percent inflation target. Because of the inflation inertia and lax fiscal policy, the BCRA may be bounded to make an extra policy tightening and allow the peso to appreciate significantly to help disinflation, although at the cost hindering economic recovery. Moreover, if the exchange rate appreciation persists in an environment of lax fiscal policy, a future currency crisis cannot be ruled out, thereby undermining disinflation achievements and the BCRA’s credibility.
13. Stronger institutional arrangements for monetary policy could help mitigate the negative effects induced by inflation inertia and years of fiscal dominance. To the extent that this reform entrenches the BCRA’s commitment to price stability and closes the door for central bank financing to the government, it can help inflation expectations to become increasingly forward-looking. Lower inertia will also make disinflation possible at lower interest rates than otherwise, requiring less sacrifice in terms of output and employment. In addition, the amplifier impact that inertia inflicts on inflation in response to shocks will fade over time, thus favoring a more stable declining path.
C. Strengthening the Institutional Foundations of Monetary Policy
14. In recent years the BCRA lost its monetary policy independence and become subject to fiscal dominance. The approval of the Organic Law 24.144 in 1992 had already strengthened the political and operational independence of the BCRA. However, following the collapse of the currency board arrangement in 2003, the approval of various reforms of the central bank law, in particular, Law 26.739 of 2012 reversed the BCRA’s independence. Such reforms aimed at putting monetary policy under the government’s influence with the view of helping to finance the fiscal deficit. Figure 6 illustrates this reversal by comparing central bank independence throughout the Argentinean history, using as a measure a slightly simplified version of the Cukierman, Webb, and Neyapti (CWN) index (Cukierman and others, 1992).8
Independence of the BCRA
(Historical view)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: Laws of the BCRA, and calculations based on a simplified CWN15. Strengthening the BCRA’s independence is likely to enhance the effectiveness of inflation targeting.9 Central bank independence is important to isolate monetary policy from political influence and give the central bank the means necessary to fight inflation. If market participants perceive there is no such independence, an inflation bias will remain, requiring interest rates to be higher to achieve the same inflation target. This is why most emerging market economies that adopted inflation targeting enhanced central bank independence and strengthened accountability. Argentina ranks well below other inflation target emerging markets in terms of central bank independence and accountability (Figure 7).10 The BCRA’s two main institutional weaknesses are its multiple mandate and the inappropriate relationship with the government.
Central Bank Independence
(Sample of inflation targeting in emerging markets)
Citation: IMF Staff Country Reports 2016, 347; 10.5089/9781475552645.002.A005
Source: Countries’ central bank laws, and calculations using an expanded CWN index of central bank independence.16. Narrowing the BCRA’s mandate to focus monetary policy on achieving price stability is key to ensure consistency with the essence of inflation targeting. This reform should be adopted as soon as possible. Today, Article 3 of the BCRA Law establishes that monetary and financial policies are subordinated to government policies and should also promote employment and the country’s development with social equity. The way this mandate is structured overburdens the BCRA and leads to a number of distortions. Specifically:
subordinating the BCRA to government policies opens the door for time inconsistency. The BCRA is legally vulnerable to make policy decisions that are contaminated with short-term political interests, which can induce market participants to have an inflation bias with respect to the BCRA’s inflation targets, thus requiring a larger sacrifice ratio to keep inflation on target;
promoting development and social equity does not respond directly to monetary policy. Moreover, it can even be in conflict with the objective of price stability, thus making central bank accountability difficult in practice.
monetary policy should not explicitly promote employment either. Unlike in advanced economies, employment in emerging markets are vulnerable to terms of trade and political development shocks. Thus, holding the BCRA responsible for creating employment risks undermining monetary policy credibility and makes it difficult to hold the BCRA accountable.
17. The BCRA mandate should focus on its core functions. On monetary policy, the BCRA should aim at preserving price stability while maintaining the objective of financial stability given that it has banking regulation and supervision responsibilities.
18. To the extent possible, the central bank law should be amended to explicitly delink monetary policy formulation from government policies. Governments are potentially more interested in pursuing short-term goals—sometimes associated with electoral calendars, at the expense of not preserving price stability. Article 3 in the 1992 Law illustrates how to phrase an alternative text that grants political autonomy to the BCRA.
19. Eliminating fiscal dominance is critical to strengthen the operational independence of the BCRA and build up credibility. While operational independence is typically about ensuring that the central bank manages its short-term interest rate without government interference, in Argentina it is mostly about restricting fiscal dominance under the form of central bank financing to the government. Article 20 of the central bank law includes a number of provisions that render a level of credit to the government—extended at a zero interest rate—that is large by international standards. Thus, a legal reform is warranted to eliminate all forms of central bank financing to the government. As a second best, the law could limit the sources of central bank financing to only transitory advances up to 10 percent of government revenues in the previous 12 months—as set in Article 20. However, this money should be paid back not later than in 180 days and charged a market interest rate. All other forms of government financing established in this article should be banned.11 Good practices to rule central bank financing to the government are summarized in Box 3. As for the unrealized profits associated with currency depreciations, a legal reform is necessary to prevent these funds from being transferred to the government. They should be kept on a reserve account up to some relative level to be used whenever currency appreciations generate losses.
Key Principles to Rule Central Bank Credit to the Government1
As a first best, central banks should not finance government expenditure. The central bank may be allowed to purchase government securities in the secondary market for monetary policy purposes. Restrictions to monetizing the fiscal deficit are even more compelling when countries feature fixed or quasi-fixed exchange regimes to avoid fueling a possible traumatic exit from the peg.
As a second best, financing to the government may be allowed on a temporary basis. Central bank lending to the government is warranted to smooth out tax revenue fluctuations. Therefore, they could be tolerated until either a tax reform permits a stable stream of revenues over time or markets are deep enough to smooth out revenue fluctuations. These loans should be extended on a short-term basis, up to six months and, in any case, they should be paid back within the same fiscal year.
Financing should be confined to the central government. Extending credit to other areas of the state, such as local governments and public enterprises, should be banned.
The terms and conditions of these loans should be established by law. Central bank financing should be capped at a small proportion of annual government revenues (on a case-by-case basis) and should be priced at market interest rates. Communication between the government and the central bank for the disbursement and cancellation of these loans is necessary to facilitate the central bank’s systemic liquidity management.
Central bank credit to the government should be transparent. These transactions should be disclosed on a regular basis, including the amount and financial conditions applied to these loans.
1/ See Jácome and others (2012).D. Further Refinements on the Monetary Policy Framework
20. While the BCRA has recently made important strides to revamp their monetary policy framework, further progress is warranted to enhance the effectiveness of inflation targeting. The BCRA could take monetary policy decisions in a more structured manner. It could establish more formal procedures to rule its key policy meetings. It could also refine its policy and operational framework to analyze, formulate, and support monetary policy decisions in an integrated fashion, thus providing a path for future interest rates that are consistent with achieving its policy objectives. A more integrated and structured monetary policy framework also facilitates a better central bank communication.
Improving decision making
21. A key institutional arrangement of inflation targeting central banks is the policy meeting to decide about the policy rate. There are no best practices for the design of an institutional arrangement for monetary policy decisions, but group decision making is the norm. 12 Compared to one-sided views of an individual central banker, group decision making is based on diverse views, and is likely to produce better interpretation of information, data, and results from considering alternative scenarios. In general, societies tend to be reluctant to delegate on a single person the adoption of policy decisions—such as the level of interest rates that have direct implications on inflation and economic activity—in institutions that enjoy political independence.
22. The BCRA could better structure policy decision making by either instituting a regular policy meeting of its board or by creating a monetary policy committee (MPC). This institutional arrangement will replace the current setup, where decisions on the policy rate are informally discussed by an ad-hoc committee, and are legally taken by the BCRA governor. In either arrangement, policy rate decisions would be the result of group decision making. There is no standard international practice that favors either of these arrangements. An MPC exists in some countries, while in others the central bank board is in charge of deciding about the policy rate (see Table 1). 13 The latter is the prevailing arrangement in Latin America (Brazil, Chile, Colombia, Mexico, Peru) as only in Guatemala an MPC exists. In the sample of inflation targeting countries in Table 1, the central bank board plays the role of the MPC in most cases, the decision-making body is comprised of 5 to 10 members and external members are appointed in some cases.14 No consensus is required to take decisions, and the preannounced meetings take place either eight or 12 times in the year, except in Australia and Mexico.
Monetary Policy Decision-Making in Selected Inflation Targeting Countries
Monetary Policy Decision-Making in Selected Inflation Targeting Countries
| MPC or Central Bank Board/Council | Number of members | External members | Decision-making process | Meetings per year | |
|---|---|---|---|---|---|
| Australia | Board | 9 | 6 | Consensus | 11 |
| Brazil | Board | 9 | No | Vote | 8 |
| Canada | Board | 6 | No | Consensus | 8 |
| Chile | Board | 5 | No | Vote | 12 |
| Colombia | Board | 7 | No | Vote | 12 |
| Czech Republic | Board | 7 | No | Vote | 8 |
| Indonesia | Board | 6-9 | No | Consensus | 12 |
| Mexico | Board | 5 | No | Consensus | 11 |
| New Zealand | Governor | 1 | N/A | N/A | 8 |
| Peru | Board | 7 | 6 | Vote | 12 |
| Poland | MPC | 10 | 9 | Vote | 12 |
| Thailand | MPC | 7 | 4 | Vote | 8 |
| Turkey | MPC | 7 | 1 | Vote | 12 |
| United Kingdom | MPC | 9 | 4 | Vote | 12 |
Monetary Policy Decision-Making in Selected Inflation Targeting Countries
| MPC or Central Bank Board/Council | Number of members | External members | Decision-making process | Meetings per year | |
|---|---|---|---|---|---|
| Australia | Board | 9 | 6 | Consensus | 11 |
| Brazil | Board | 9 | No | Vote | 8 |
| Canada | Board | 6 | No | Consensus | 8 |
| Chile | Board | 5 | No | Vote | 12 |
| Colombia | Board | 7 | No | Vote | 12 |
| Czech Republic | Board | 7 | No | Vote | 8 |
| Indonesia | Board | 6-9 | No | Consensus | 12 |
| Mexico | Board | 5 | No | Consensus | 11 |
| New Zealand | Governor | 1 | N/A | N/A | 8 |
| Peru | Board | 7 | 6 | Vote | 12 |
| Poland | MPC | 10 | 9 | Vote | 12 |
| Thailand | MPC | 7 | 4 | Vote | 8 |
| Turkey | MPC | 7 | 1 | Vote | 12 |
| United Kingdom | MPC | 9 | 4 | Vote | 12 |
23. The BCRA Board, or the MPC, should meet regularly on a preannounced calendar. Extraordinary meetings are warranted, in particular while the Argentinean economy is still on a stabilization mode—to decide on the policy rate. Meetings should be governed by well-established protocols for policy decisions, including their frequency, the quorum required to take decisions, whether they are taken by majority or unanimously, what the role of the chairman is, and how decisions are communicated. To take decisions, the BCRA Board or the MPC would need the support of the BCRA’s divisions responsible for modeling, financial market analysis, monetary analysis, and domestic and international conjunctural analysis. The decisions would be immediately communicated and explained to the public in a clear and systematic fashion. In case an MPC is created, it should have a permanent and structured existence, and should be vested with legal powers to support policy rate decisions.
24. Policy meetings should be less frequent than today. Having an inflation rate of about 40 percent could make the case for having frequent meetings because of the instability such inflation levels inflict on the economy. However, it also suggests that policy decisions should not be taken frequently because data is unstable and often mostly reflect noise and not changes in underlying inflationary trends. Similarly, at least during the disinflation phase, inflation and inflation expectations may be volatile. The possible ill effects stemming from this second consideration outweigh the likely benefits of the first.
The policy framework
25. Building a forecasting and policy analysis system is important to support the inflation targeting regime.15 As a first step, the BCRA need to achieve a clear understanding of the transmission mechanism of monetary policy. Building on this understanding, the policy framework should consist of four interlinked blocks: (i) data monitoring and management; (ii) short-term forecasting; (iii) medium-term forecasting; and (iv) reporting. The picture of a transmission mechanism has to bring a solid idea about the way key variables react to monetary policy instruments, as well as to other shocks affecting the economy.
26. Argentina needs to preserve and perfect the quality of inflation and output data. Since the previous consumer price index (CPI) was widely manipulated, the new CPI may only gain credibility overtime. At the beginning, negotiations of contracts, in particular of wage increases, may be impaired by the lack of trust on the inflation data. Policymakers’ analysis would also suffer from this deficiency as they face inconsistent data series and series that are not appropriately seasonally adjusted. Similar problems arise from GDP data weaknesses because of the limitations they impose for calculating the output gap.
27. The BCRA needs to refine some of its monetary operations. The BCRA may consider two alternatives for the term of the policy rate—an overnight rate and a seven-day rate—and either target a market rate or attach it to a central bank policy instrument.16 As a tentative proposal, the BCRA could consider adopting a policy rate attached to a seven-day term deposit facility offered two times per week, which would provide an effective policy signal and anchor to short-term interest rates. The BCRA would also conduct ad hoc open market operations on any day when overnight rates deviated materially from the policy rate. While building its expertise in liquidity forecasting, the BCRA may rely on an interest rate corridor supported by standing facilities—deposit and lending—that are narrow enough to limit interest rate volatility, but at the same time wide enough to encourage interbank borrowing and lending.
28. A clear strategy is also needed to deal with structural liquidity. Market-based instruments are preferred to fully support development of the financial markets. Initial focus should be on 1-month, 3-month and perhaps 6-month maturities. The issuance method should change to fixed-volume auctions, using a multiple price method of allocation.
Communication
29. The CBRA should continue enhancing gradually its communication, explaining policy decisions largely based on forward-looking indicators. The BCRA cannot become immediately as transparent as other inflation targeting central banks because it is still in the process of understanding how monetary policy is transmitted to the real sector. However, it should explain how monetary policy is formulated and implemented, highlighting potential downside risks for achieving the inflation target. This involves making available and disseminating the information and data used to take current policy decisions on a timely basis with emphasis on future or expected information. If economic agents understand the goals pursued by the BCRA and the policy instruments used to achieve such goals, the effectiveness of monetary policy is likely to increase. Enhancing communication and transparency is also a matter of good governance, which becomes particularly important should the BCRA is granted more political independence.
30. By explaining its policy decisions and targets and by delivering on those promises, the BCRA would continue building credibility. The BCRA would need to act consistently with respect to its reaction function. When central bank reactions are unpredictable or inconsistent, uncertainty leads to market volatility because economic agents do not know what to expect. As a result, market expectations about inflation may drift upwards from the central bank’s target, thus requiring an extra tightening effort. Consistency between policy actions and communications is a necessary condition to buildup credibility, which would reinforce the effectiveness of monetary policy.
31. Yet, communication should go beyond explaining the rationale for policy decisions and stress that low and stable inflation is welfare improving. This should take the form of an educational campaign that reaches the society at large, with the view of building up support for an autonomous—from political pressures—and accountable BCRA. Reaching out the public at large is important in Argentina given its recent history of central bank independence reversal. Such initiatives will help the public understand the benefits of low and stable inflation toward fostering broad-based economic growth, and the rationale for providing a central bank with an appropriate degree of operational independence to carry out that mission. The BCRA can produce educational materials to inform students about basic elements of monetary policy, including the role of money, the concept of inflation, and the rationale for the anti-inflation mandate of the central bank. The BCRA can also engage in active outreach to business associations, labor unions, and various other types of community organizations.
References
Banco Central de la República Argentina (2016), “Informe de Política Monetaria (Julio).
Berg, Andrew, Philipe Karan, and Douglas Laxton (2006a), “A Practical Model Approach to Monetary Policy Analysis—Overview,” IMF Working Paper 06/80, (Washington, D.C., International Monetary Fund).
Berg, Andrew, Philipe Karan, and Douglas Laxton (2006b), “A Practical Model Approach to Monetary Policy Analysis—A How- To Guide,” IMF Working Paper 06/80, (Washington, D.C., International Monetary Fund).
Berger, Helge, Volker Nitsch, and Tonny Lybek (2006), “Central Bank Boards around the World: Why does Membership Size Differ?” IMF Working Paper 06/281, (Washington, D.C., International Monetary Fund).
Blinder, Alan (2007), “Monetary Policy by Committee,” European Journal of Political Economy,” Vol. 23, pp. 106–123.
Cottarelli, Carlo and Peter Doyle (1999), “Disinflation in Transition, 1993–1997,” Occasional Paper No. 179, (Washington, D.C., International Monetary Fund).
Cukierman Alex, Steven Webb, and Bilin Neyapti (1992), "Measuring the Independence of Central Banks and its Effect on Policy Outcomes,” The World Bank Economic Review, Vol. 6 (September), pp. 352–398.
Dornbusch, Rudiger and Stanley Fischer (1994), “Moderate Inflation,” The World Bank Economic Review, Vol. 7, pp. 1–44.
Edwards, Sebastián and Fernando Lefort (2002), “Stabilization, Persistence, and Inflationary Convergence: A Comparative Analysis,” Central Banking, Analysis, and Economic Policies Book Series, in: Lefort, Fernando, Klaus Schmidt-Hebbel and Norman Loayza Eds., Indexation, Inflation and Monetary Policy, vol. 2, chapter 3, pages 065–104, Central Bank of Chile.
Fernandez, Roque (1985), “The Expectations Management Approach to Stabilization in Argentina during 1976–1982,” World Development, Vol. 13, No 8, pp. 871–892 (August).
Frankel, Jeffrey (2011), “Monetary Policy in Emerging Markets,” Chapter 25, Handbook of Monetary Economics, Vol. 3B, Elsevier
Galiani, Sebastián, Daniel Heymann, and Mariano Tommasi (2003), “Great Expectations and Hard Times: The Argentine Convertibility Plan,” Economia, vol. 4 (Spring), pp. 109–160.
Gómez, Javier, Jose Darío Uribe, and Hernando Vargas (2002). “The Implementation of Inflation Targeting in Colombia.” Document presented at the conference on “Inflation Targeting, Macroeconomic Modeling and Forecasting,” Banco de la República and Bank of England, Bogotá, January
Hammond, Gill (2009), “State of the Art of Inflation Targeting,” Handbook No. 29, Centre for Central Banking Studies, Bank of England.
Heymann, Daniel (1991), “From Sharp Disinflation to Hyperinflation, Twice: The Argentine Experience, 1985–1989,” in Lessons of Economic Stabilization and its Aftermath, in Michael Bruno, Stanley Fischer, Elhanan Helpman, and Nissan Liviatan Eds., MIT Press, Cambridge, Massachusetts.
Jácome, Luis I. and Francisco Vázquez (2008), “Any Link Between Legal Central Bank Independence and Inflation? Evidence from Latin America and the Caribbean,” European Journal of Political Economy, Vol. 24 (December), pp. 788–801.
Jácome, Luis I., Marcela Matamoros-Indorf, Mrinalini Sharma, and Simon Townsend (2012), “Central Bank Credit to the Government: What Can We Learn from International Practices?” IMF Working Paper 12/16, Washington: International Monetary Fund.
Kara, A. Hakan, 2006, “Turkish Experience with Implicit Inflation Targeting,” Working Paper No. 06/03, Central Bank of Turkey.
Machinea, Jose Luis and Jose María Fanelli (1988), “Stopping Hyperinflation: The Case of the Austral Plan in Argentina, 1985–87,” in Inflation Stabilization: The Experience of Israel, Argentina, Brazil, Bolivia, and Mexico,” Michael Bruno, Guido Di Tella, Rudiger Dornbusch, and Stanley Fischer Eds. MIT Press, Cambridge, Massachusetts.
Otker-Robe, Inci, David Vavra, and a team of economists (2007), “Moving to Greater Exchange Rate Flexibility: Operational Aspects Based on Lessons from Detailed Country Experiences,” Occasional Paper No. 256, (Washington, D.C., International Monetary Fund).
Vandenbussche, Jerome (2006), “Elements of Optimal Monetary Policy Committee Design,” IMF Working Paper 06/277, (Washington, D.C., International Monetary Fund).
Appendix I. Monetary Policy
Taxonomy of Monetary Policy Regimes
Monetary policy formulation and implementation should be consistent with the policy regime in place. Central banks should make their monetary policy goal explicit and behave accordingly. They should identify clearly the intermediate target and the corresponding operational target they use as the key policy instrument in their reaction function. When central bank reactions are inconsistent or unpredictable, market uncertainty and volatility tend to be higher because market participants cannot understand monetary policy. In this environment, market expectations about inflation may drift from central banks’ targets.
The taxonomy below shows the components of the main monetary policy regimes and the role they play in a consistent manner. For each policy regime there is a primary policy instrument, which is the key tool used to achieve the operational target or modify the operational variable. The operational target is expected to be correlated with intermediate target. Changes in the operational target signal changes in the stance of monetary policy. The intermediate target is the nominal anchor and is connected with the final objective. Finally, each policy regime has a main shock absorber.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Appendix II. Turkey’s Transition to Inflation Targeting
Turkey spent almost four years building the blocks for the adoption of inflation targeting. During this transitory period (2002 to 2005) a new central bank law was approved, which set the institutional foundations of a more independent and forward looking monetary policy. In addition, the Central Bank of Turkey (CBT) built institutional capacity to implement inflation targeting. By end 2005, before launching inflation targeting, inflation had declined to single digits.
The CBT implemented what it called an “implicit inflation targeting.” It announced a multiyear inflation target consistent with targets set in the stand-by program negotiated with the IMF, and used monetary aggregates—also negotiated with the IMF—as intermediate targets. However, the latter would be revised if an inconsistency emerged between the final objective and the intermediate target. The decision-making process, though, was discretionary and opaque as policy decisions were unpredictable and not well communicated (Kara, 2006). Behind the scenes, the central bank made important strides to improve data availability. It improved the methodology for the calculation of the consumer price index and started to conduct surveys, in particular of inflation expectations. As data improved, the central bank could improve the analysis of the monetary policy transmission mechanism, and was in a better position to forecast inflation.
In the wake of the financial crisis, Turkey approved a bold reform of the central bank law. The new law was aimed at building the blocks for a more independent monetary policy and, ultimately, at laying the ground for adopting inflation targeting. Key provisions of the 2001 legislation were the following: (i) clarifying the mandate of the CBT by stipulating that its primary objective is to achieve and maintain price stability. The central bank was also assigned the mandate of maintaining financial stability; (ii) granting political and instruments independence to the CBT by empowering it to formulate monetary policy at its own discretion, using autonomously monetary policy instruments; (iii) Banning central bank advances and credit to the government and the rest of the public sector, which brought to end the monetization of fiscal deficit that fueled in the past inflation; and (iv) Holding the central bank accountable. The governor of the CBT was required to submit twice a year a report to the Council of Ministers and the Planned and Budget Commission of the National Assembly on the operations of the bank and the monetary policy pursued. The CBT was also required to inform the public and disclose the reasons for not achieving the monetary targets.
Inflation was on target by 2005, thus exceeding all expectations. With the support of a disciplined fiscal policy, the annual inflation rate fell from 68 percent in 2001 to less than 8 percent by end 2005—the target set for this year. At the same time, exchange rate volatility declined and so did the country’s risk premium, while nominal and real interest rates came down and the exchange rate pass-through weakened. These positive outcomes help strengthening the credibility of the CBT thereby creating a favorable environment for the introduction of a full-fledged inflation targeting at the beginning of 2006.
Prepared by Luis Jacome.
The definition of moderate inflation varies slightly in the literature, referring to an increase in prices in the range of 10 to 40 percent (see Dornbusch and Fischer (1993), Cottarelli and Doyle (1999), and Frankel (2011)).
BCRA conducts open market operations with its own paper, called LEBAC (Letras del Banco Central), which are issued at different maturities.
See Otker-Robe and Vavra (2007) on Chile, Czech Republic, and Poland, and Gómez and others (2002) on Colombia.
The countries and the associated episodes are the following: Albania: 1993–99; Armenia: 1995–98; Azerbaijan: 1996–97; Belarus: 2002–06; Bolivia: 1986–92; Brazil: 1995–97; Bulgaria: 1998–2001; Chile: 1980–95; Colombia: 1980–2000; Costa Rica: 1983–2009; Dominican Republic: 1984–92; Egypt: 1980–94; Georgia: 1996–97; Ghana: 1985–2009; Greece: 1983–95; Guatemala: 1990–97; Hungary: 1991–99; Iceland: 1980–91; Israel: 1987–97; Kazakhstan: 1996–98; Kyrgyz Republic: 1995–2000; Mexico: 1989–2000; Moldova: 1995–2009; New Zealand: 1980–88; Paraguay: 1980–95; Peru: 1994–97; Poland: 1992–2001; Russia: 1996–2010; South Africa: 1980–93; Tajikistan: 1998–2004; Tanzania: 1980–99; Turkmenistan: 1998–2002; Ukraine: 1997–2001; Uruguay: 1994–99; Uzbekistan: 1998–2014.
See for example Dornbusch and Fischer (1994).
This increase in wages correspond to the “paritarias” negotiations, which cover 90 percent of the workers in the private sector (BCRA, 2016).
This slightly simplified CWN index of central bank independence is based on the legal provisions of central bank laws and related legislation. The overall value of the index fluctuates on a continuous scale from zero to one, with higher values indicating stronger legal central bank independence.
Empirical evidence shows that central bank independence and inflation in Latin America are negatively correlated (see Jácome and Vázquez, 2008).
The expanded version of the CWN index of central bank independence is also based on the legal provisions of central bank laws and related legislation and adds some categories such as accountability. It incorporates a broader view of political independence—to include all members of the central bank board and not only the Governor—, lender-of-last-resort provisions, central banks’ financial independence (whether central banks have capital at all times), and their accountability and transparency. The overall value of the index also fluctuates on a continuous scale from zero to one, with higher values indicating stronger legal central bank independence.
Article 20 authorizes the BCRA to extend: (i) transitory advances up to an amount equivalent to 12 percent of base money; (ii) advances to the government up 10 percent of the government revenues in the last 12 months; and (iii) additional transitory advances for up to 10 percent of the revenues in cash obtained by the government in the last 12 months.
New Zealand and Israel are exceptions to this norm, since in those central banks the governor is the sole policy decision maker.
For an expanded discussion about why MPCs exist and how they work, see for example Blinder (2007).
The size and composition of the MPC, and how its members are selected, vary across countries. For a discussion, see for example Berger and others (2006) and Vandenbussche (2006).
This is a standard policy framework built by many central banks that adopted inflation targeting. Berg and others, 2006a and 2006b, provides a description of this framework and how it operates.
An expanded discussion about the pros and cons of these two alternatives and its operational aspects was submitted to the BCRA authorities in August 2016.
