Transcript Coping with Volatility: Monetary & Exchange Rate Policies for Commodity-Exporting Countries like Kazakhstan Jeffrey Frankel Harpel Professor of Capital Formation & Growth July 15, 2013

Coping with Volatility:
Monetary & Exchange Rate Policies
for Commodity-Exporting Countries
like Kazakhstan
Jeffrey Frankel
Harpel Professor of Capital Formation & Growth
July 15, 2013
Oil prices & minerals prices have been especially
volatile over the last decade – and correlated.
Source: UNCTAD
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Commodity exporters face extra volatility
in their terms of trade

Choices of macroeconomic policies &
institutions can help manage the volatility.

Too often, historically, they have exacerbated it:

Pro-cyclical macroeconomics
(i) capital flows, money, credit;
 (ii) currency policy; relative price of nontraded goods;
 and (iii) fiscal policy.

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(i) Pro-cyclical capital flows

According to inter-temporal optimization theory,
capital flows should be counter-cyclical:



flowing in when exports do badly
and flowing out when exports do well.
In practice, it does not always work this way.
Capital flows are more pro-cyclical than counter-cyclical.

Gavin, Hausmann, Perotti & Talvi (1996);
Kaminsky, Reinhart & Vegh (2005);
Reinhart & Reinhart (2009);
and Mendoza & Terrones (2008).
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(ii) Pro-cyclical monetary policy

If the exchange rate is fixed,

surpluses during commodity booms can lead to:
Rising reserves
 Excessive money & credit
 Excess demand for goods; overheating
 Inflation
 Asset bubbles, incl. land.

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Macro effects of commodity boom

Inflation shows up especially
in non-traded goods & services,
like construction.
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Pro-cyclical real exchange rate
Countries undergoing a commodity boom
experience real appreciation of their currency

The resulting shift of land, labor & capital
out of manufacturing, and into the booming
commodity sector might be
appropriate & inevitable,



to the extent it is expandable,
especially if the commodity boom is permanent.
But the shift out of manufacturing into NTGs is
often an undesirable macroeconomic side effect –

the “disease” part of Dutch Disease.
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Two questions for the monetary regime

1. How can a country avoid pro-cyclical money:



excessive credit creation & inflation in a commodity boom,
deflation & balance of payments crisis in a bust ?
Allow some currency flexibility

though not a free float.


2. Nominal anchor for monetary policy:
What is it to be, if not the exchange rate? CPI?
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1) Pros & cons of exchange rate flexibility
for oil-exporters, in particular

Advantages of more stable exchange rate:

Lower forex risk & transactions costs
facilitate international trade & capital flows -

especially important if country is small & open to trade.
Exchange rate provides a nominal anchor for
monetary policy, reducing inflation expectations -
especially important if country has history of high inflation


e.g., Kazakhstan (1991-95)
or even hyperinflation (1992-93).
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Pros & cons of exchange rate flexibility, continued

Advantages of more flexible exchange rate

Autonomy of monetary policy -

especially important if country has idiosyncratic shocks
& low labor mobility.
Automatic accommodation of trade shocks -
especially important for commodity-exporting countries.
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Other factors to be considered in conjunction
with fixed versus floating exchange rate choice

Intermediate exchange rate regimes


Band-basket-crawl
Managed float

Intervention and sterilization

Capital controls

Denomination of foreign debt



Currency mismatch from foreign denomination (original sin)
The move away from foreign-denominated debt.
Bank accounts denominated in foreign currency.
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The challenge of designing a monetary regime
when terms of trade shocks dominate the cycle

Fixing the exchange rate
leads to pro-cyclical monetary policy:

Money flows in during commodity booms.



Excessive credit creation can lead to inflation.
Example: Saudi Arabia & UAE during the 2003-08 oil boom.
Money flows out during commodity busts.


Credit squeeze can lead to excess supply,
recession & balance of payments crisis.
Example: Oil exporters in 1980s (Mexico) or 1997-98 (Russia).
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Currency regime,

continued
Floating accommodates terms of trade shocks:

If terms of trade improve,
currency automatically appreciates,


reducing excessive money inflows, credit, overheating,
inflation, and real estate bubbles.
If terms of trade worsen,
currency automatically depreciates,

preventing recession & balance of payments crisis.
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Demand vs. supply shocks

An old wisdom regarding the source of shocks:



One set of supply shocks:
natural disasters


Fixed rates work best if shocks are mostly
internal demand shocks (especially monetary);
floating rates work best if shocks tend to be
real shocks (especially external terms of trade).
R.Ramcharan (2007) finds floating works better.
A common source
of real shocks: trade.
Terms-of-trade variability

Prices of crude oil & mineral commodities hit record
highs in 2008 & 2011.

=> Favorable terms of trade shocks for some
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=> Unfavorable terms of trade shock for others


(oil producers, Africa, Latin America, etc.);
(oil importers such as Japan, Korea).
Textbook theory says a country where trade shocks
dominate should accommodate by floating.
Confirmed empirically:


Developing countries facing terms of trade shocks do better
with flexible exchange rates than fixed exchange rates.
Broda (2004), Edwards & L.Yeyati (2005),
Rafiq (2011), and Céspedes & Velasco (2012)…
Céspedes & Velasco (Nov. 2012)
NBER WP 18569
“Macroeconomic Performance During Commodity Price Booms & Busts”
** Statistically
significant
at 5% level.
Constant term
not reported.
(t-statistics in
parentheses.)
Across 107 major commodity boom-bust cycles,
output loss is bigger the bigger is the commodity
price change & the smaller is exchange rate flexibility.
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The IMF recommends a more flexible
exchange rate for the tenge.

“Looking ahead, there is scope
to allow greater exchange rate flexibility…”

-- Article IV Consultation Concluding Statement
of the IMF Mission to Republic of Kazakhstan—
2013, June 4, para. 7.

But, if the exchange rate were no longer
the nominal anchor for Kazakh monetary policy,
the IMF would then ask what is to take its place.
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Monetary regime
2) If the exchange rate is not to be
the monetary anchor, what is?

The popular choice
of the last decade:
Inflation Targeting.

But CPI targeting can react perversely
to supply shocks
 & terms of trade shocks.

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Needed:
Nominal anchors that accommodate the shocks
that are common in developing countries


Supply shocks,

e.g., droughts, floods, hurricanes:

=> Target Nominal GDP.
Terms of trade shocks

e.g., fall in price of commodity export.

=> Target GDP deflator.
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Nominal GDP target
cancels out velocity shocks (vs. M target)
& moderates effects of supply shocks (vs. IT)
P
Nom.
GDP
target
IT
•
Adverse
AS shock
AS
•
•
AD
Real
GDP 20
Does Nominal GDP target give best output/inflation trade-off?
Adverse AS shock
P
Nom.
GDP
target
IT
•
•
It gives exactly the right answer
if the simple Taylor Rule’s equal
weights accurately capture what
discretion would do.
Even if not exact, the “true”
objective function would have
to put far more weight on P than
output, or AS would have to be
very steep, for the P rule to give
a better outcome.
AD
Real GDP
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The revival of proposals
for Nominal GDP Targeting in 2011-13

heard mostly in the context of advanced economies




UK, US, Japan…
E.g. the new Bank of England Governor,
Mark Carney, is a fan.
But Nominal GDP Targeting in fact makes more sense
for developing & commodity-exporting countries.
To clarify: set a target range at a 1-2-year horizon;

not inconsistent with “Flexible Inflation Targeting,”

setting a longer-term target for inflation.
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Why does Nominal GDP Targeting make more
sense for developing & commodity-exporting
countries than for advanced countries?

More supply shocks,


such as adverse weather events.
More terms of trade shocks,


such as rises in the price of imports, &
declines in the commodity export price.
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Comparison of 3 alternative monetary regimes
Supply shock,
e.g. weather
disaster
Monetary
regime
Terms of trade shocks
Fall in export
price, e.g., oil
Rise in import
price, e.g., cars
Exchange Trade balance ↓
rate target Output Y ↓
Trade balance ↓
Output Y ↓
Trade balance ↓
CPI target Money must
Depreciation is limited
because it would raise
import prices, which
have more weight
than oil in the CPI.
Currency
appreciates to
prevent consumer
prices from rising.
=> Worse TB ↓ & Y ↓
Inflation ↑.
=> Exchange
rate moves
in wrong
direction.
tighten enough
to appreciate
currency.
=>
Worse TB ↓ &Y ↓
Currency
Nominal
GDP target depreciates.
Helps TB &Y.
=> Exchange
Adverse effects
rate moves in
shared between P &
right direction. Y, rather than all Y.
Inflation ↑
Currency depreciates. No appreciation.
Helps TB &Y ,
prevents recession.
Exchange rate here accommodates terms
of trade, the opposite of under a CPI target.
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Steps in an evaluation
of Nominal GDP Targeting (vs. IT)
1.
2.
3.
How wide would announced band have to be
so that the outcome usually fell within it?
What about subsequent revisions
in Nominal GDP statistics?
Are supply shocks big enough, and is the AS
curve steep enough, for Nominal GDP
targeting to be better than price targeting?
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What Kazakh data are needed for the analysis?
1.
I have historical data, for Kazakhstan


Nominal GDP, real GDP, deflator, & CPI,
and some year-ahead forecasts of each:


2.
estimated from the time series by an ARIMA process, or
Private forecasts from Consensus Economics (for real GDP & CPI).
Ideally I would get real-time revisions for each -
3.
1991-2012,
preliminary estimates, revised, & final;
And data on exogenous supply shocks,

if possible:
adverse weather events?
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year
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Actual Kazakhstan
Consensus Economics
RGDP growth rates (WDI) Kazakhstan RGDP forecast
-1.9
3
2.7
3.7
9.8
1.8
13.5
3.7
9.8
5.1
9.3
6.6
9.6
7
9.7
8.6
10.7
8.3
8.9
8.1
3.3
9
1.2
7.3
7.3
3.4
7.5
4.5
6.2
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How wide would 1-standard-deviation band have to be,
encompassing 2/3 of nominal GDP realizations around target?
Variable
(growth Variance
rates p.a.)
St dev
NGDP
RGDP
Deflator
CPI
15.12%
4.43%
13.58%
4.59%
2.29%
0.20%
1.85%
0.21%
Mean of
actual
rate
19.10%
6.46%
12.64%
8.65%
68% Confidence
Interval
Lower
Upper
3.98%
2.03%
-0.95%
4.06%
34.22%
10.89%
26.22%
13.24%
Covar (RGDP,Deflator) = 0.114 %
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How wide would 1-standard-deviation band have to be?
Nominal GDP growth rates
68% CI Band for Actual NGDP rate Vs Forecast rates
ARIMA-Forecast vs actual
with 68% CI Band around ARIMA Forecast
0.6
0.5
0.6
0.4
0.5
0.4
0.3
0.3
0.2
0.2
0.1
0.1
0
2010
2011
2012
2009
2011
2008
2010
2007
2009
2008
2006
2007
2005
2006
2004
2005
2003
2004
2002
2003
2001
2002
2000
2001
1999
2000
1998
1999
1997
1998
1997
-0.1
-0.1
2012
-0.2
-0.2
-0.3
ln_ngdprate
ln_ngdprate
lnf_ngdprate
lnf_ngdprate
lowerci_ngdp
upperci_ngdp
lowercif_ngdp
uppercif_ngdp
The confidence interval would be narrower if the central bank
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can influence demand (within one-year horizon).
References by the author

Project Syndicate,



http://www.hks.harvard.edu/fs/jfrankel/
“Escaping the Oil Curse,” Dec.9, 2011.
"Barrels, Bushels & Bonds: How Commodity Exporters Can Hedge Volatility," Oct.17, 2011.
“The Natural Resource Curse: A Survey of Diagnoses and Some
Prescriptions,” 2012, Commodity Price Volatility and Inclusive Growth in Low-Income
Countries , R.Arezki et al., eds. (IMF); HKS RWP12-014.


“How Can Commodity Exporters Make Fiscal and Monetary Policy Less
Procyclical?” 2011, in Natural Resources, Finance & Development. R.Arezki, T.Gylfason & A.Sy, eds. (IMF).
"Product Price Targeting -- A New Improved Way of Inflation Targeting,"
in MAS Monetary Review XI, 1, 2012 (Monetary Authority of Singapore).

“A Comparison of Product Price Targeting and Other Monetary Anchor
Options, for Commodity-Exporters in Latin America," Economia, 2011. NBER WP 16362.

"UAE & Other Gulf Countries Urged to Switch Currency Peg from the Dollar to a
Basket That Includes Oil,“ Vox, 9 July, 2008.

“On the Tenge: Monetary and Exchange Rate Policy for Kazakhstan,” Short-term
Consultancy, Republic of Kazakhstan, 2005. (Russian translation, ADB, 2009.)
In Growth & Competitiveness in Kazakhstan (Center for International Development): 23-42.

"Experience of and Lessons from Exchange Rate Regimes in Emerging Economies,"
in Monetary and Financial Integration in East Asia: The Way Ahead, edited by Asian
Development Bank, 2004 (Palgrave Macmillan), v91-138.
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Appendix: Nominal GDP statistics
Kazakhstan Nominal GDP, quarterly
GDP 2000-2012 quarterly (at current prices, mln. tenge)
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
1
quarter
524,139.10
634,620.20
746,291.90
2
quarter
590,711.60
798,324.00
919,581.30 1,060,280.90 1,380,820.50 1,783,707.40 2,363,805.00 3,059,192.60 3,988,726.10 3,654,517.10 4,691,265.70 5,623,135.60 6,559,138.30
3
quarter
778,203.10
975,151.40 1,094,634.70 1,331,640.40 1,646,303.20 2,009,652.10 2,648,602.60 3,400,454.50 4,607,610.40 4,511,118.60 5,423,084.00 7,243,951.70 7,842,365.80
4
quarter
706,847.80
842,497.70 1,015,769.30 1,270,477.30 1,572,268.80 2,147,085.40 3,160,375.70 3,853,912.00 4,249,338.30 5,786,747.50 7,680,288.90 9,398,551.50 9,840,317.70
annual
949,576.70 1,270,741.80 1,650,148.60 2,040,947.90 2,536,234.90 3,207,244.40 3,055,263.80 4,020,878.40 5,306,250.20 5,976,722.50
2,599,901.60 3,250,593.30 3,776,277.20 4,611,975.30 5,870,134.30 7,590,593.50
10,213,731.
12,849,794.
16,052,919.
17,007,647.
21,815,517.
27,571,889.
30,218,544.
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Year GDP (constant 2005 US$, m GDP (current US$, m GDP deflator (2000 = 100) CPI index (2005 = 100)
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
50,243
44,716
42,346
38,450
33,605
30,850
31,004
31,531
30,932
31,767
34,880
39,589
43,469
47,512
52,073
57,124
63,236
68,864
71,136
71,990
77,245
83,039
87,191
26,933
24,881
24,907
23,409
21,251
20,374
21,035
22,166
22,135
16,871
18,292
22,153
24,637
30,834
43,152
57,124
81,004
104,850
133,442
115,309
148,052
188,050
201,680
0.00
0.00
0.08
1.03
16.91
44.11
61.26
71.15
75.18
85.16
100.00
110.16
116.55
130.23
151.24
178.27
216.69
250.34
302.75
316.95
378.89
445.46
462.73
0.61
12.02
33.20
46.21
54.25
58.13
62.95
71.25
77.20
81.71
86.97
92.95
100.00
108.59
120.28
140.92
151.21
161.97
175.49
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184.47
How wide would 1-standard-deviation band
for real GDP growth have to be?
Forecast Vs Actual of RGDP rates
68% CI Band around ARIMA Forecast
0.2
0.15
0.1
0.05
0
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
-0.05
-0.1
ln_rgdprate
lnf_rgdprate
lowercif_rgdp
uppercif_rgdp
33
How wide would 1-standard-deviation band
for real GDP growth have to be?
ARIMA Forecast Vs Actual Deflator rates
with 68% CI Band around Forecast
0.5
0.4
0.3
0.2
0.1
0
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
-0.1
-0.2
-0.3
ln_deflrate
lnf_deflrate
lowercif_defl
uppercif_defl
34
How wide would 1-standard-deviation band
for CPI inflation have to be?
ARIMA Forecast Vs Actual CPI Inflation
68% CI Band around Forecast
0.3
0.25
0.2
0.15
0.1
0.05
0
2012
2011
2010
lowercif_cpi
2009
2008
2007
2006
2005
lnf_cpirate
2004
2003
2002
2001
2000
1999
1998
1997
ln_cpirate
uppercif_cpi
35
How wide would 1-standard-deviation band
for nominal GDP have to be?
Consensus Forecast Vs Actual Nominal GDP
68% CI Band around 2-year-ahead forecast
0.3
0.25
0.2
0.15
0.1
0.05
0
2012
2011
2010
lowerci_ngdp
2009
2008
2007
2006
lnf_ngdprate
2005
2004
2003
2002
2001
2000
1999
1998
ln_ngdprate
upperci_ngdp
36
How wide would 1-standard-deviation band
for nominal GDP have to be?
Consensus Forecast Vs Actual Nominal GDP
68% CI Band around 1-year-ahead forecast
0.30
0.25
0.20
0.15
0.10
0.05
0.00
2012
2011
2010
lowercif_ngdp
2009
2008
2007
2006
lnf_ngdprate
2005
2004
2003
2002
2001
2000
1999
1998
ln_ngdprate
uppercif_ngdp
37
How wide would 1-standard-deviation band
for real GDP growth have to be?
Consensus Forecast Vs Actual RGDP growth
68% CI Band around 1-year ahead forecast
0.15
0.1
0.05
0
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
-0.05
-0.1
ln_rgdprate
lnf_rgdprate
lowercif_rgdp
uppercif_rgdp
38
How wide would 1-standard-deviation band
for GDP deflator have to be?
Consensus Forecast Vs Actual GDP Deflator
with 68% CI Band around 1-year ahead forecast
0.2
0.18
0.16
0.14
0.12
0.1
0.08
0.06
0.04
0.02
0
2012
2011
2010
lowercif_defl
2009
2008
2007
2006
lnf_deflrate
2005
2004
2003
2002
2001
2000
1999
1998
ln_deflrate
uppercif_defl
39