Economics

Monetary Regime Transition in the Emerging World

Jan 7, 2013 Andrés Velasco

Many central banks in the developed world appear set to replace inflation targeting with nominal-GDP targeting as their monetary-policy anchor. But, while central banks in emerging-market economies have had problems with inflation targeting from the outset, moving to nominal-GDP targeting solves none of them.

SANTIAGO – Is inflation targeting – the rule that most of the world’s major central banks (though not the United States Federal Reserve) use to set interest rates – in its death throes? Many analysts seem to think so.

Mark Carney, currently Governor of the Bank of Canada, has not even taken over his new job at the helm of the Bank of England, yet he has already announced that he might change the BoE’s policy anchor. In Japan, the Liberal Democrats won December’s general election after having promised a more expansionary monetary policy. And in the US, the Fed has announced that it will keep interest rates low until unemployment reaches 6.5%.

None of this is as new as it seems. Among rich countries, inflation targeting has been on its way out since the 2008-2009 financial crisis. The large-scale asset purchases carried out by the European Central Bank, for example, have little to do with any definition of inflation targeting.

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Andrés Velasco

Writing for PS since 2001
136 Commentaries

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

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Jonathan Lam Jan 20, 2013

Gamesmith94134: Monetary Regime Transition in the Emerging World

As long as the central banks of the developed nations chose their targets either on the inflation, GNP, or unemployment, most emerging market nations may felt the chill because the heated economies are flooded with inflows of foreign investment.

Commodity exports typically continue to grow, but industrial and non-traditional exports suffer; “irrational exuberance” set in and a bubble developed in real-estate or equities markets, and lending in crisis situations implies using international reserves and providing foreign-currency liquidity. These are not only the problems to the standard target-inflation-and-float-the-currency regime; ” A comprehensive regime should encompass two rules – one for crisis situations and one for “the rest of the time” – plus explicit guidelines for moving from one to the other and back.” Therefore, cash inflow must be taxed uniformly in order to give the leverage to the local currencies to interact during the heated market; and to identify these inflow each continent like OAS or ASEAN must have a zone policy. So, as I would suggest that IMF could restore the more standardized multiple currencies exchange rate in due course that sovereignty rule must be respected and its own currencies must be honored through the zone policy just in order to trade. Perhaps, Euro-dollar, or yen are not just the answer to the inflationary emerging market through the hot cash.

The center of the problems issued on the competitiveness the developed nations lost from the labor cost and cheaper resources, but there is an advantage of the dominated currencies on valuation in the international trading in its settings. In the recent trading, yen and euro are devalued through the liquidity of the dollar, but dollar remains strong for its exchange and the emerging market nations restored dollar’s value in reversing their reserves to cut the heat on their inflation. In contrast, the dollar did not devalued through its liquidity motion or enhanced its competitiveness with other currencies. So, the problem on competitiveness based on its monetary regime may never be resolved; instead, it imported with value-added goods will continue to accelerate to its deficits. As usual, our government may execute a lower-profit profile on enterprise to cut inflation, but the process will further damage the profitability and creditability of the American Companies. Eventually, we are talking of the huge cash flow of these companies could be cut and their expansion as business as usual might turn negative to credit.
More of the monetary stimulation through the Bank of Japan, it suggested more merger and purchase in foreign soil. However, it may become a trigger on migration of funds or reserves to its native land on protectionism; then, the stock market would be more volatile than ever, with its see-saw motion till global recession comes. Dependency on dollar’s liquidity may harm the global economy and its competitiveness. If the giant falls, then no one can escape even for China which is not consummating with its consumption route to make Chinese to spend more with lesser exports.

In order to restore competitiveness in each economy and flexibility to growth, we must talk more on currencies exchange of its rate and system to revive the global economy. Liquidity is only buying time and advantage of arithmetic use can be delusional ; self efficiency is the key to prosper even for money printing nations.

May the Buddha Bless you?
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Darko Oracic Jan 11, 2013

"The boom-and-bust cycle of recent years" was a result of inflation targeting. For example, when inflation was above the target in 2008, the ECB raised the interest rates and that caused the Great Recession in 2009. Inflation was again above the target in 2011, the ECB raised the interest rates, and that caused another recession in 2012.
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Ken Presting Jan 11, 2013

Mr. Velasco brings together many valuable observations in a stimulating article. But I want to chime in on a topic he breezes past.

"The boom-and-bust cycle of recent years" was a purely economic phenomenon in many countries, but in the USA, Italy, and Greece there is substantial evidence of corruption in either government or financial institutions or both.

Most of us who think about economic issues simply assume that the laws of arithmetic and rules of accounting are never questioned. But once we start to apply economic reasoning to public policy, we need to remember that accounting is not physics - those rules can be broken.
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Procyon Mukherjee Jan 8, 2013

We are slowly and steadily moving towards lesser and lesser independence of the Central banks as monetary stances are being orchestrated that have broader mandates than just the stability of the monetary system; the BOJ example of increasing the inflation target after repeated dozes of stimuli, may be an extreme one, but surely every other Central Bank cannot afford to playing truant to the more fiscal role that needs to be taken up by the Government, any more.

For the emerging countries, in India for example, the Central banks continue to withstand immense political pressure on lowering of interest rates and India is still leading the pack on macro-prudential fiduciary responsibility that it has to deliver, not many examples of which exist in the rest of the emerging system.

Procyon Mukherjee
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Johnny (MoneyWonk) Jan 7, 2013

While I embrace the end of an inflation target and welcome a nominal regime change, I do not think QE deviates from an inflation targeting mandate. Ever since the Fed has expanded its balance sheet through LSAPs, inflation has stayed within the 2-3% mandate and avoided the serious deflation that inevitably would have followed the "Great Contraction."
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