Statistical Implications of Inflation Targeting : Getting the Right Numbers and Getting the Numbers Right

Carol Carson, Claudia Dziobek, and Charles Enoch

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 2002
• ISBN:
  9781589061323

NONE

Part I INFORMATION REQUIREMENTS FOR INFLATION TARGETING

Introduction to Part I

IMF MANAGING Director Horst Köhler (Chapter 1) lays out the relevance of inflation targeting for the IMF’s responsibilities to conduct surveillance on global macroeconomic and financial stability and to provide policy advice to member countries. Many countries have moved recently toward flexible exchange rate regimes. Under such regimes inflation targeting provides an anchor for inflation expectations, and the profile and importance of the statistical underpinnings are enhanced. The authors of the remaining chapters in this section concur that information requirements follow directly from the policy requirements of inflation-targeting regimes: a formal commitment to a specific rate of inflation, a designated measure of inflation (for example, the consumer price index), analytical tools to forecast inflation, analytical tools to analyze the monetary transmission mechanism and the central bank’s ability to influence inflation, and a communication policy.

Another common theme is that inflation targeting imposes a high degree of discipline on central banks and national statistical offices. Commitment to a target that can be readily observed by the public—for example, the headline inflation figure—makes the central bank’s performance much more transparent; any failures to achieve the target will be obvious. A number of statistical implications can be observed. Ongoing communication with the public, including through regularly published inflation reports and analysis, becomes a vehicle for establishing credibility and handling any deviations from the target. To some extent, inflation targeting changes the data requirements for setting monetary policy: there is, for example, more emphasis on forward-looking indicators, including property occupancy rates, labor market information (wage and compensation indices), interest rate yield curves, and long-term bond rates. The extent to which these data are available varies greatly across countries. Countries that have more developed financial markets tend to have a richer set of forward-looking data to rely on, and may therefore have the greatest opportunities in pursuing an inflation-targeting regime.

Malcolm Knight, Robert Fay, and Brian O’Reilly (Chapter 2) reflecting on the Canadian experience, stress the long time lags involved in monetary policy and the great amount of information and study necessary for effective policy. Policy actions are taken with a view toward influencing the price level 18 to 24 months down the road, and effectiveness is closely related to credibility. The uncertainly inherent in statistical models, and hence the need to “diversify” in research and models, leads central banks to process vast amounts of information. The authors provide an overview of the basic statistical elements and the framework for evaluating statistical information as developed by the Bank of Canada.

Pali J. Lehohla and Annette Myburgh (Chapter 3) discuss differences in user needs with respect to price indicators, which led Statistics South Africa to produce, in addition to the overall consumer price index, two core price indices and other variants including different regional coverage.

Amando M. Tetangco, Jr. and Ma. Cyd N. Tuano-Amador (Chapter 4) note that inflation targeting leads central banks to place more emphasis on the medium-term perspective and less on day-to-day developments. Data needs, accordingly, are more focused on forward-looking indicators. In the Philippines and elsewhere, the central bank produces quarterly inflation reports, which help focus research with respect to the reaction function and the transmission mechanism of monetary policy. In the case of deviations from the target, the governor must write an open letter explaining the deviation and how the central bank intends to return to the target path. These information requirements are vehicles for better transparency.

Svante Öberg and Hans Lindblom (Chapter 5) describe the experience in Sweden, where the central bank commissions from Statistics Sweden the publication of two monthly measures of “underlying inflation” which exclude “temporary” effects that enter into the CPI as well as the development of additional, forward-looking indicators.

Glenn Stevens (Chapter 6) notes that, while more frequent data are generally believed to be better, some countries with quarterly data, like Australia, have successful inflation-targeting regimes. More important are the availability of credible CPI series and the analytical capacity to “dissect” and interpret these data, especially to separate temporary from permanent price changes. Independence of the data-producing agencies is key to credibility, as is the central bank’s ability to present a comprehensive macroeconomic analysis to the public that includes but is not limited to price developments.

Another theme echoed in many of the chapters is that inflation targeting has meant that central banks or national statistical agencies must develop their ability to research inflation, dissecting data to distinguish between “one-off,” or transitory, factors affecting inflation and more permanent changes, and removing volatile items or those independent of central bank action in order to determine appropriate policy responses.

1 Anchoring Inflation Expectations

HORST KÖHLER

EXCHANGE RATE policy has always been central to the work of the IMF. Ever since the breakdown of the Bretton Woods system, there has been a widespread desire to avoid excessive volatility in the exchange rates of the world’s major currencies. And the IMF’s bilateral and multilateral surveillance has become an important way for the international community to signal its views and seek better coordination of underlying economic policies. Our Research Department’s analysis, for example, points to the recent persistent overvaluation of the U.S. dollar and the undervaluation of the euro. But in a world of highly integrated global capital markets, I do not see any realistic alternative to floating exchange rates among the major currencies. So, our members need to deal with currency misalignments by concentrating on the fundamentals—especially, in the cases of the European Union and Japan, by accelerating the pace of key structural reforms.

Flexible or Anchored Regime?

Looking beyond the major currencies, an important conclusion of the IMF’s research and reviews of country experience is that no single exchange rate regime is appropriate for all members in all circumstances. Nevertheless, there is now an increasing tendency among our members to choose “corner solutions.” A country that is willing to abandon all monetary policy discretion may be able to adopt a hard peg, such as a currency board arrangement. Because this deprives the country of instruments to deal with external shocks, living safely under a hard peg obliges a country to have not only a disciplined fiscal policy, but also particularly sound financial and corporate sectors and considerable wage and price flexibility. As shown tragically in Argentina, when these conditions do not hold, it can be very difficult for a country to arrange a timely exit strategy.

We advise emerging market countries to be very cautious about adopting pegged or heavily managed exchange rate systems. When a country is open to international capital flows, the reaction to any hint of unsustainable macroeconomic policies can be swift and severe. And a country considering an exchange rate peg needs to be fully aware of the associated costs, including the possibility that extraordinarily high interest rates might be required at times of severe financial market pressure. In particular, the country’s domestic financial institutions and businesses must be well prepared to live with such policy adjustments. Where there is doubt that these requirements will be met, a flexible exchange rate regime is a better choice.

For other developing countries, there is in principle a wider range of choice in exchange rate regimes, provided that these are backed by the appropriate macroeconomic and structural policies. And we recognize that very few countries, advanced or developing, are indifferent to the behavior of their exchange rates. But on balance, we see floating exchange rates as the safest solution for a wide range of countries. Unfortunately, this has the disadvantage of leaving the public and markets without a clear anchor, which can make a country vulnerable to accelerating inflation in response to domestic or external shocks.

Inflation targeting has been adopted by several countries with floating exchange rate systems as a way to anchor inflation expectations. Many other countries are actively considering this possibility, and some are committed to do so under IMF-supported programs. After a decade of experience, we have seen inflation-targeting regimes in action, and we are beginning to have a basis for assessing their performance and refining our views on how best to manage them.

Implications of Inflation Targeting

As the IMF stresses to countries that are considering the adoption of inflation targeting, the keys to success are transparency and credibility. Once a political decision has been taken to make the inflation target the primary objective of monetary policy, it is crucial for the monetary authorities to keep the public regularly informed about the actions they have taken to meet that objective and the basis for the judgments that they make. Perhaps even more than other monetary regimes, inflation targeting obliges the central bank to safeguard its credibility in pursuing the inflation goal. For this reason, inflation targeters are almost invariably countries in which the central bank has a high degree of operational independence. But it is also important to avoid a deflationary bias, which would impose unnecessary costs on society and risk undermining the political basis for the inflation-targeting regime and the independence of the central bank.

While there are now many analyses of the experience under inflation targeting, relatively little has been written about the implications for economic statistics. This is an important omission. In preparing for inflation targeting, most countries have adopted an existing, well-known price index as the target—generally the national consumer price index (CPI)—and they have used a selection of available data series in forecasting inflation and assessing the effects of monetary policy. Moving forward, it will be important to explore whether this is the most appropriate index to target, whether some components of the CPI should be systematically excluded from or added to the index, and what new statistics might be needed for related analysis and forecasting.

It is also possible that the institutional arrangements for producing economic statistics may need to be adapted in a country with an inflation-targeting regime. Just as with a central bank, it is important for the national statistical agency to be operationally independent, while receiving adequate resources from the government to do its job. At the same time, there should be good coordination with the central bank. In many countries the central bank sits at one end of town and the statistics agency at another, or—as in my own country—even in another city. The mixture of senior central bank officials and those from statistics agencies represented in this volume provides a particularly valuable opportunity to exchange ideas on these issues.

For countries with inflation-targeting regimes, forward-looking indicators such as stock indices, real estate prices, and derivatives yields provide crucial information for assessing the appropriateness of monetary policy. This type of data is also important for the work of the IMF in promoting stability of domestic and international capital markets, and we often face gaps in information and questions about the suitability of what we do have. While such information is generally produced by markets or private firms, there might be a role for the public sector—in collecting these statistics, setting standards or guidelines, or at least encouraging full disclosure of the methodology that was used to assemble the data.

The IMF’s Ongoing Statistical Work

Finally, the topic of this volume—the statistical implications of inflation targeting—brings together many of the key themes of the IMF’s ongoing work to improve the functioning of the international monetary system—in particular, strengthening IMF surveillance, enhancing transparency, and using internationally recognized standards and codes as new rules of the game for global governance. Our Special Data Dissemination Standard (SDDS) was the first of the IMF’s core standards to be introduced, under the leadership of Carol S. Carson. In parallel with the SDDS, during the past year we have begun using the IMF’s new Data Quality Assessment Framework (DQAF) as a systemic approach to assessing country practices and capabilities in the statistical area. While the DQAF was not designed with inflation-targeting countries specifically in mind, it is clear that data quality in the sense of the framework is precisely what underpins a well-functioning inflation-targeting regime.

The SDDS was designed for countries seeking access to international capital markets, regardless of their exchange rate regimes. But another one of our objectives here is to consider whether the SDDS might need to be enhanced to take account of special data needs of countries with inflation-targeting regimes. Whatever the outcome, it is noteworthy, and certainly welcome, that virtually all countries that have adopted an inflation-targeting regime are also among the 50 subscribers to the SDDS.

2 The Bank of Canada’s Approach to Inflation Targeting

MALCOLM KNIGHT, ROBERT FAY, and BRIAN O’REILLY^*

THE FUNDAMENTAL appeal of a monetary framework that directly targets inflation as the single monetary policy objective stems from its apparent simplicity and clarity. Surely the general level of prices is an easy thing to measure, and thus it must also be an easy matter—even for the person in the street—to have a clear view of whether the central bank is or is not achieving its objective. Unfortunately, as is the case in most areas of economics, an inflation-targeting framework is not quite as simple to understand or to operate as it seems at first glance.

This chapter deals with Canada’s experience with the informational and statistical requirements for operating a direct inflation-targeting regime. We will argue that, while the basic objective of the direct inflation-targeting approach is relatively simple and transparent, the informational, statistical, and econometric requirements for implementing such a regime are quite demanding. These demands turn out, however, to be a virtue of inflation targeting, since they impose a great deal of discipline on the process by which a central bank formulates its monetary policy and undertakes its monetary operations. Over time, this discipline can help both to improve the implementation of monetary policy and to strengthen the credibility of the inflation-control target itself.

In what follows, we will argue these propositions by building on Canada’s experience with inflation targeting. The chapter first outlines the reasons that lay behind Canada’s adoption of an inflation-targeting regime back in 1991 and sketches the basic statistical elements of an inflation-targeting regime. A subsequent section describes in detail the monetary transmission mechanism. The second half of the chapter then turns to statistical aspects that are particularly important to an inflation-targeting country, including the information required to assess policy developments, how to measure the policy stance, market expectations, the credibility of monetary policy, and accountability over the longer term. The final section provides some concluding thoughts.

3 Statistical Implications of Inflation Targeting in South Africa

PALI J. LEHOHLA and ANNETTE MYBURGH

INFLATION TARGETING provides a monetary policy framework within which policy actions are guided by expected future inflation relative to an announced inflation target (Green, 1996). Such a framework was implemented in South Africa when the South African government adopted an inflation target of 3 to 6 percent for the year 2002, as announced by the Minister of Finance in his budget speech on February 23, 2000.

This chapter briefly summarizes the rati...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Foreword
• Acknowledgments
• Abbreviations
• Part I. Information Requirements for Inflation Targeting
• Part II. Defining and Measuring the Target
• Part III. Deriving Measures of Inflation and Inflation Expectations from the Market Data
• Part IV. Implications for the IMF
• Part V. Conclusions
• References
• Seminar Participants and Authors
• Chapter Appendices
• Footnotes