Monetary Policy in Emerging Markets:
Key Current IT Themes
Leonardo Leiderman
Tel-Aviv University
E-mail:lleiderman@leoleiderman.com
OECD and CCBS/Bank of England Conference, Paris, Feb. 28, 2007
1
Current Global Conditions Provide Strong
Support for IT in Emerging Markets
 Globalization has resulted in lower inflation
rates
 World interest rates have remained low
 Rapid growth and reforms have improved EM’s
fiscal stance
 EM external accounts have improved
 Capital mobility has contributed to
monetary/fiscal policy discipline
 A diminishing role of political uncertainties for
market movements?
2
A Marked Decline in EM Budget Deficits
(% of GDP)
4%
3%
2%
1%
0%
1999
2007
Source: WEO 9/2006, IMF. The figures correspond to the central government budget
deficit of “other emerging market and developing countries.” The figure for 2007 is
an IMF forecast..
3
Rapid GDP Growth Helped Reduce
Public Debt to GDP Ratios
(% of GDP change from end 2001 to end 2005)
6%
4%
2%
0%
-2%
-4%
-6%
-8%
Total change
Primary balance
GDP growth
Other
Source: WEO 9/2006, IMF. “Other” includes: exchange rate and interest rate
effects, the stock-flow adjustment and statistical discrepancy
4
Changes in Global Risk Aversion Have
Been Key for EEM Volatility in 2006
140
130
120
110
100
90
80
30/12/2005
30/06/2006
Note: index for the EEM ETF (end of 2005=100).
30/12/2006
5
Currency depreciation 10.5.06-22.6.06
The Current Account/Monetary Policy Link:
Larger Currency Depreciation Under Weaker
External Accounts
(Mid ’06 Episode of Global Risk Aversion)
25%
TUR
20%
15%
10%
5%
HUN
PLN
ROM
BRL
CZE
THA
0%
-5%
-10%
-5%
0%
ARG
ISR
5%
Current account/GDP
RUS
10%
15%
6
The Main Risk Ahead
Slower economic growth and weaker
fundamentals could make monetary policy
in emerging-market economies more
vulnerable to adverse shocks.
7
An Illustration of Current IT Themes
Based on Israel’s Experience
8
Inflation Volatility has Resulted in Deviations
from IT…
7%
5%
3%
1%
-1%
-3%
1.00
0
1.01
CPI YoY
1.02
1.03
1.04
Official inflation targets
1.05
1.06
1.07
9
…Yet Inflation Expectations Have
Remained Within Targets
7%
5%
3%
1%
-1%
-3%
1.00
1.01
1.02
1.03
0
CPI YoY
Official inflation targets
12-month break-even inflation
1.04
1.05
1.06
1.07
10
Inflation Expectations Appear Now
Less Adaptive than in the Past
11%
9%
7%
5%
3%
1%
-1%
-3%
-5%
1.97
1.98
1.99
1.00
1.01
1.02
0
CPI YoY
Official inflation targets
12-month break-even inflation
1.03
1.04
1.05
1.06
1.07
11
Although the Pass-through has Diminished,
The Nominal Exchange Rate Still has a
Dominant Role in the Transmission Mechanism
20%
15%
10%
5%
0%
-5%
-10%
-15%
1.00
1.01
CPI YoY
1.02
1.03
1.04
$/NIS - YoY
1.05
1.06
12
ILS Recent Strength Resulted from
Improved Current Account Performance…
(Israel’s current account surplus)
$ millions
% of GDP
5.2%
5,000
5%
2.6% 2.9%
3,000
1.4%
1,000
3%
1%
-0.6%
-1,000
-1.2%
-3.2%
-3,000
-1.6%
-1.1%
-1%
-1.3%
-5,000
-3%
-5%
-5.1%
-5.2%
-7%
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
-7,000
13
…as well as from USD weakness
USD/ILS
USD/EUR
4.8
0.86
4.7
0.84
4.6
0.82
4.5
4.4
0.80
4.3
0.78
4.2
0.76
4.1
0.74
4.0
3.9
0.72
3.8
0.70
02/01/2006
27/03/2006
19/06/2006
11/09/2006
04/12/2006
14
Should the IT Rely on Core Inflation?
5%
3%
1%
-1%
-3%
1.04
1.05
CPI
Core inflation (excl. housing and energy)
3 ‫קו‬
4 ‫קו‬
1.06
15
Entering New Territory for Monetary Policy: The
BoI Rate is Lower than the FedFunds Rate…
10%
9%
8%
7%
BoI
6%
5%
4%
3%
Fed
2%
1%
0%
1.02
1.03
1.04
Bank of Israel and Federal Reserve policy rates.
1.05
1.06
1.07
16
10%
…Yet Ex-Ante Real Interest Rates
Remain Reasonable
BoI interest rate
12 months break-even inflation
Real - ex-ante interest rate
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
2002
2003
Source: Bank of Israel.
2004
2005
2006
2007
17
Looking Back at the 2002
Monetary/Fiscal Policy Mistake
Inflation target: 2-3%
Actual inflation: 6.5%
18
Policy Rate: A Surprise Move to Easy
Money in 12.2001
(central bank interest rates)
12%
Expected Real
Nominal
10%
8%
6%
4%
2%
0%
2000.01
2001.01
2002.01
2003.01
2004.01
2005.01
2006.01
2007.01
19
The Budget Deficit in 2002:
Revising the Target Frequently
(Ratios of Budget Deficit to GDP)
5%
4%
3%
2%
1%
0%
Target 1 4.2001
Target 2
12.2001
Target 3 5.2002
Actual
20
Fiscal and Monetary Expansion Resulted in
Rapid ILS Depreciation Against the USD
USD/ILS
5.0
4.8
4.6
4.4
4.2
4.0
1/1/01
1/7/01
1/1/02
1/7/02
1/1/03
1/7/03
21
Concluding Remarks
 The need for flexibility in implementing
IT in emerging-market economies…
 …yet credibility is especially needed in a
‘flexible’ IT regime
 The need for defining the IT horizon “over
the medium term”
 Less benign global conditions and weaker
fundamentals could pose more difficult
tradeoffs for EM monetary policies ahead
22