Targeting inflation in Asia and
the Pacific
Andrew Filardo*
Hans Genberg**
*Bank for International Settlements
**Hong Kong Monetary Authority
The views expressed are those of the authors and do not
necessarily represent those of the Bank for International
Settlements or the Hong Kong Monetary Authority.
Inflation targeting vs.
targeting inflation
• Inflation performance in the region has
been good
• True for inflation targeting central banks
but also for others
• Targeting inflation is important
• Inflation objective can be achieved in more
ways than one.
2
Agenda
• A review of policy objectives and strategies of
central banks in Asia and the Pacific
• Evolution of central bank independence and
other aspects of governance
• The inflation record in IT and non-IT economies
–
–
–
–
Inflation rates
Inflation persistence
Properties of inflation forecasts
Effects of the recent commodity price cycle
• Policy implications
3
Central bank policy objectives
Jurisdiction
Australia
Policy objective
Price stability
China
Value of the currency
Hong Kong SAR
Exchange rate
stability
India
Price stability and
adequate credit supply
Indonesia
Price stability and
exchange rate stability
Japan
Price stability
South Korea
Price stability
Malaysia
Price stability and
exchange rate stability
New Zealand
Price stability
Philippines
Price stability
Singapore
Price stability
Thailand
Price stability
4
Inflation targeting central banks
Starting year Targeting arrangement
Australia
1993
Target for headline CPI consumer price inflation
of 2-3 per cent per annum on average over the
business cycle
Indonesia
2000
Tnflation target for 2008, 2009, and 2010 is 5±1%,
4.5±1%, and 4±1% for y-o-y CPI inflation
Korea
1999
Target range of 3±0.5% in terms of 3-year
average of annual CPI inflation
New Zealand 1990
Target range of 1 to 3% on average, over the
medium term, defined in terms of the All
Groups Consumers Price Index (CPI)
Philippines
2002
Target range of 3.5±1% (2009), 4.5±1% (2010) for
the avg year-on-year change in the CPI over
the calendar year.
Thailand
2000
Target range of 0-3.5% for quarterly average of
5
core inflation.
Non-IT central banks
Targeting arrangement
China
Reference to money growth targets
Hong Kong
Currency board: target range centered on HKD 7.8 = USD 1
India
Multiple objectives: price stability understanding containing the perception of inflation in the range of
4.0-4.5% so that an inflation rate of 3.0% becomes the
medium term objective.
Japan
Medium- to long-term price stability expressed in terms of
year on year rate of change in the CPI (approximately
between 0 and 2%).
Malaysia
Multiple indicators and instruments
Singapore
As of mid-2009, zero percent appreciation of the
undisclosed S$NEER policy band
6
Improved governance structures
• Greater legal and political independence
• Greater ability to carry out independent
exchange rate policy
• Increased ability to carry out monetary
policy independently of fiscal policy
• Increased transparency and accountability
• For IT central banks: Greater emphasis on
price stability as the primary objective
7
Improved governance, 1996-2005
8
The inflation record
Average inflation rates
9.00
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
1996-00
2001-08
Old' IT
New-IT
Non-IT
9
Some more detail
• Inflation persistence
• Properties of inflation forecasts
• Impact of commodity price cycle
10
Inflation persistence
• Inflation is less persistent in IT economies
– Smaller AR coefficient
– Transitory shocks relatively more important
11
Changing AR(1) inflation persistence
 t  C   t 1   t
.
12
Changing IMA(1) inflation persistence
The greater |  | , the greater the proportion of the inflation variance accounted for by the transitory component.
13
Properties of inflation forecasts
• Use Consensus Forecasts to investigate
whether:
– Better central bank governance reduces the
dispersion of inflation forecasts
– Inflation forecasts are more homogeneous in
IT economies?
14
The Kullback-Leibler divergence measure
DK  L

p ( x)
  p( x) log
dx

u ( x)
100%
p(x)
q(x)
u(x)
Probability
80%
60%
40%
20%
0%
-2
0
2
4
6
Inflation
15
i
KLnt
C
i
i
  KLct  j
i
 CBGI CBGIt
i
 et
Table 4
The impact of the changes in CBGI
on the cross-sectional distribution of inflation forecasts in Asia-Pacific
Index
β
θCBIG
Nobs
R2
Overall
0.62
(5.3)
0.30
(1.2)
116
0.68
Monetary
policy
independence
0.62
(5.3)
0.30
(1.2)
116
0.67
Notes: 1) Using January sample for 1991 to 2005; 2) estimated using fixed effects and
t-statistics in parentheses based on robust standard errors.
16
KLnti
C
i
  KLcti j
  IT Iti
11
  AIT 
n 1
Itn

  IT Iti
 KLcti j
 
AIT
 11 n
i 
I

KLc
 eti
  t
t j 

 n1

The impact of the adoption of inflation targeting on the cross-sectional distribution of inflation
forecasts in Asia-Pacific
Using January sample
(1)
(2)
(3)
(4)
(5)
(6)
(7)
ΔKL
KL in levels
β
.62 (6.8)
γIT
.61 (6.8)
.59 (6.6)
.21 (4.2)
γAIT
.05 (3.4)
.57 (6.3)
.60 (5.2)
.60 (5.1)
-.31 (-2.4)
-.18 (-0.9)
.09 (.14)
.06 (.52)
.10 (4.4)
.12 (7.8)
.06 (.49)
.02 (3.3)
-.12 (-1.1)
-.26 (-1.0)
βIT
βAIT
Nobs
(8)
.03 (.52)
.54 (3.4)
.37 (1.8)
.53 (3.4)
.39 (1.8)
-.12 (-4.1) -.12 (-4.2)
163
163
163
163
163
163
149
0.66
0.66
0.66
0.66
0.66
.67
.32
149
17
.35
Impact of commodity price cycle
Asia
Mature economies
Headline
Excluding food and energy
18
19
Summary or empirical evidence
• Admirable inflation performance
• Difficult to document differences between
explicit IT economies and non-IT economies
Why?
• Common shocks → Common outcomes
• Social consensus about importance of
inflation control.
– Central bank objectives
– Governance structures
20
Policy challenges 1
• How to reconcile primary focus on inflation
with increasing concern in society about
other objectives?
– Volatility of capital flows/sudden stops
– Exchange rate misalignments
– Financial stability and economic growth
• Policy frameworks must be such as to
prevent these factors from undermining
the consensus in favour of inflation control.
21
Policy challenges 2
• Need as many independent instruments as you
have objectives.
– Impeccable logic in theory but:
• In some cases the trade-off between objectives may translate
into a trade-off between inflation in the near term vs. inflation
later
• What if other instruments are not used?
• There may still be a case for coordination.
• Lexicographic approach
– Assumes independence between objectives
– Not what central banks have been observed to do
recently
22
Policy challenges 3
• Practice
– Expanded perspectives. Pay attention to
emerging imbalances
• Two pillars (ECB), two perspectives (BoJ)
• Theory:
– State-dependent preferences?, escape
clauses?
• Work in progress
23
Forecast accuracy
• Forecast Accuracy = F(governance
indicator, IT dummy, controls)
• Preliminary results:
– Better governance → smaller forecast errors
– IT → smaller forecast errors
– Governance indicator drives out IT dummy
24