Outline

Does ‘globalisation’ affect monetary policy?

Unconventional monetary policy (UMP) – small open economy perspective

What do we know about deflation?

A few thoughts on the ‘new’ central banking paradigm

How much does increasing globalisation affect monetary policy?

Global economy has become increasingly interconnected

Evidence of a global financial cycle? (H. Rey)

Global pool of liquidity through interconnected financial sector

leads to monetary policy spill-overs

Avenues for shock propagation and amplification are more open

than ever before – in CEE also thru banking system integration

Financial fragility leakages

To what extent has globalisation moderated inflation pressures?

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Great moderation of inflation?

Globalization and increased trade integration have reduced barriers to market access

Globalization has led to the relocation of production → the relative price of tradable goods declines → their fall has contributed to lower overall inflation

More intense global competition prevents firms from raising

prices and puts downward pressures on wages in many sectors;

Broad productivity gains, or

Cyclical conditions?

3

Last 15 years have seen broad productivity gains in EM

Source: The Conference Board.4

..monetary conditions are becoming more influenced by non-dometic

factors..

Globalization may have reduced the strength of the cyclical response of inflation to output fluctuations

prices of many items that are produced or consumed at home are increasingly determined by foreign demand and supply factors rather than local factors.

financial integration allows for larger trade balance deficits or surpluses and, thereby, weakens the relationship between domestic output and demand

International capital flows transmit monetary conditions globally, even under floating exchange-rate regimes

More of an issue for small open economies, than for a few big ones

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UMP – Small Open Economy Perspective

Is it possible to run countercyclical monetary policy in a small open economy with stable exchange rate regime? According to conventional wisdom – NO! But, in real life – YES – financial market imperfections limit

perfect capital mobility, so can CBs, behaviour of economic agents is path dependent...

central banks can widen their space for maneuver with the use of unconventional monetary policy and/or macroprudential measures

What have we learned from the crisis It is absolutely critical to act in time It is impossible to make-up for a delay, but better to act at

any time than not to act at all In order to act in time, one should often try to think out of

the box (reading from history helps)

(Unconventional) Monetary Policy- pre-crisis -

U(M)P in the pre-crisis period CNB – one of those central banks that

acted early to take care about financial stability and external vulnerabilities build-up

use of UMP and macroprudential measures to fight against excessive capital inflows (capital inflow tax, high fx liquidity requirements,tax on credit growth, increasing risk-weights for lending to unhedged borrowers...)

success in moderating banks’ credit growth

success in curbing banks’ foreign indebtness

creation of sizeable f/x liquidity buffers

doubling of banks’ Tier 1 capital

significant, although limited, impact on curbing overall external vulnerabilities

0,000

2,000

4,000

6,000

8,000

10,000

12,000

0,0

10,0

20,0

30,0

40,0

50,0

60,0

XII.2001 XII.2002 XII.2003 XII.2004 XII.2005 XII.2006 XII.2007 XII.2008 XII.2009

mio

EUR

bln

HRK

Regulatory capital and international reserves

Regulatory capital International reserves (rhs) Net usable international reserves (rhs)

Source: HNB

10

12

14

16

18

20

22

2008 2009 2010 2011 2012 2013*

%

Croatia Eurozone CEE

Bank (regulatory) capital adequacy ratio (CAR)

(Unconventional) Monetary Policy- post crisis -

U(M)P in the post-crisis period At the strike of the crisis, critical

objectives were: to preserve confidence (exchange rate

stability) to facilitate refinancing of all domestic

sectors, since foreign markets were effectively temporary closed (LOLR)

huge relaxation of domestic currency and f/x liquidity (approx. 13 percent of GDP)

possible thanks to the pre-crisis creation of buffers

After initial strike, objective turned to facilitate credit activity

creation of structural excess liquidity corporate lending programs to banks

syndicated with HBOR – 2010-14 (the early Croatian version of Funding for Lending)

incorporates risk sharing element corporate lending programme to banks

without HBOR – from November-2013

0

2

4

6

8

0

2

4

6

8

10

12

14

16

18

20

1/0

6

7/0

6

1/0

7

7/0

7

1/0

8

7/0

8

1/0

9

7/0

9

1/1

0

7/1

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1/1

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7/1

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1/1

2

7/1

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1/1

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7/1

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1/1

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bil

lio

n H

RK

%

Liquidity surplus and overnight interest rate

Liquidity surplus (including overnight deposits with the HNB) - rightOvernight interbank interest rate - left1-year T-bills (HRK) - left

Source: HNB

0

10

20

30

40

50

60

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

%

Reserve requirements and minimum f/c liquidity

Reserve requirementMarginal reserve requirementMinimum foreign currency liquiditySource: HNB

Pre and post crisis

-10,0

0,0

10,0

20,0

30,0

40,0

50,0

XII.2001 XII.2002 XII.2003 XII.2004 XII.2005 XII.2006 XII.2007 XII.2008 XII.2009 XII.2010 XII.2011 XII.2012 XII.2013

Banks' credit to private sector

Banks' credit to private sector, % growth Banks' credit to enterprises, % growth Banks' credit to households, % growth

Marginal reserve requirements

New decision on capital adequacy

HNB's Compulsory treasury bills

HNB lending programmes (incl. HBOR)

HNB lending programme (excl. HBOR)

Source: HNB

HNB's Compulsory treasury bills

Countercyclical monetary policy post crisis - high(est)

cumulative growth of corporate lending...

Changes of loans to enterprises, in % (8/2008 – 3/2014)

 

Note: EU15 = Finland, Ireland, Sweden and United Kingdom (north), Austria, Belgium, France, Germany and Netherlands,

(continental), Greeece, Italy, Portugal and Spain (south). EU 12 = Estonia, Latvia(north) Czech Republic, Hungary, Poland,

Slovakia and Slovenia(continental), Bulgaria and Romania (south)Source: ECB and national central banks 10

19,8 19,1

-29,4

-54,5

12,1 11,2

-1,8-4,7

5,2

25,8

-2,4 -3,4

-12,8

-36,0

3,2 3,1

-5,5

-30,9 -31,9

-14,7

-26,1

20,5

-0,3

-60

-50

-40

-30

-20

-10

0

10

20

30

40

FIN SWE GBR IRL NLD AUT DEU BEL FRA CRO ITA GRC PRT ESP SVK POL CZE SVN HUN EST LTU BGR ROMChan

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, in

% (

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EU 15south

EU 15continental

EU 12south

EU 12north

EU 12continental

EU 15north

...and the second strongest GDP decline

Real gross domestic product,(GDP change, average 2009-2013)

Note : EU15 = Denmark, Finland, Ireland, Sweden and United Kingdom (north), Austria, Belgium, France, Germany and Netherlands, (continental), Greece, Italy, Portugal and Spain (south). EU 12 = Estonija, Lithuania, Latvia (north), Czech Republic, Hungary, Poland, Slovakia and Slovenia(continental), Bulgaria and Romania (south)

Source:Eurostat11

-1,1 -0,9-0,6

-0,1

1,4

-0,7

0,2 0,3 0,40,7

-5,2

-2,5

-1,5 -1,4 -1,3

-1,9

-0,9

-0,4

1,0

2,7

-0,9

0,0

0,6

-0,4 -0,3

-6

-5

-4

-3

-2

-1

0

1

2

3

IRL FIN DNK GBR SWE NLD FRA BEL AUT DEU GRC CRO ITA PRT ESP SVN HUN CZE SVK POL LVA LTU EST BGR ROM

Rea

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-20

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EU15 north

EU15continental

EU15south

EU12continental

EU12north

EU12south

Broadening of Central Banks’ Mandate – Lessons Based on CNB’s

Pre-Crisis Experience

Taking care about financial stability and external vulnerabilities hardly possible to make clear separation among policy instruments in

relation to goals synergy among various policy tools (monetary / macroprudential /

microprudential) banks’ supervision at the central bank helps

before the crisis CNB was heavily criticized for its measures intrinsic problem – financial stability is difficult to measure, but crises are

evident without crises defending unpopular measures may become increasingly difficult in a way the global financial crisis helped CNB to prove its success on financial

stability front

important to resist pressures and stick to long-term policy goals

however, neither monetary nor macroprudential policy can resolve key problems

CNB’s success in reducing external vulnerabilities was limited only if all policies (fiscal, institutional, structural) play together it will

be possible to create sustainable growth

CNB’s success on financial stability front and in countercyclical monetary policy made other policy makers more lenient to push forward strong structural and fiscal reforms after the strike of the crisis

...current issue - CNB’s main objective is mainly externaly driven..

Inflation decomposition into baseline projection and domestic and external shocks in a small open economy (Croatia)

Strong negative external shocks of prices of food raw materials and oil are primary causes of recent low inflation rates

Unfavourable trends in the external real sector and domestic negative GDP gap contribute to deflationary pressures to a much smaller extent 13

What do we know about deflation in Croatia?

Deflation pressure is coming from a fall of food and energy prices

If the food and energy prices were at their five year average (2008-2013), inflation would have been at 2 per cent in 2014

Inflation diffusion index shows that 20-30 per cent of the prices decline monthly - in line with the average of the last five years

No deflationary expectations in real sector – no indication that consumers are postponing purchases of durable consumer goods due to expectations

Indebtedness and debt service ratio for the household sector are declining in spite of the mild increase of real interest rates

Decline in commodity, primarily energy prices, produces a significant positive terms of trade shock for the Croatian economy

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What do we know about deflation in general?

Not much, too few episodes, almost no recent ones

Historical example of a ‘good’ deflation: deflation associated with broad productivity increases during the classical gold standard and industrial revolution in the late 19th century

Study by Atkenson, A. and Kehoe P.J. (2004) finds that deflation and depression do seem to have been linked only during the 1930s (Great Depression), but in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link

They find many more periods of deflation with reasonable growth than with depression and many more periods of depression with inflation than with deflation

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Is there any parallel between late 19th c. and early 21st?

All through the late 19 century, deflation co-existed with growth due to:

Rapid productivity growth

Deep workforce pool

Realocation of productive resources away from agriculture during the industrial revolution

Until productivity gains were exhausted and workforce became scarce and inflation and wage pressures reappeared without any outside interventions

Over the last 15 years broad productivity gains in emerging economies transmited globally

World is closed economy – unexploited pools of workforce and potential productivity increases were unlocked over the last 25 years

When that gets depleted, will inflation and wage pressures similarly reappear?

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What do we know about “bad” deflation?

Theory

Declining long-term inflation expectations are indicator of the ‘bad’ deflation

A prolonged period of low inflation rates might destabilise inflation expectations

The monetary policy should response if a temporary shock is spreading through the economy and inducing downward shift in the long-term inflation expectations

More indebted you are, more likely deflation will be ‘bad’ for you

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However, in the monetary union, due to the lack of exchange rate instrument, some deflation is necessary to adjust – ‘internal devaluation’

Debt-deflation paradox?

More indebted you are, more likely you’ll need to deflate in order to increase competitiveness, while, at the same time, you’ll need more inflation to keep debt sustainable

Deflation could be relative, but can you rely on others to inflate as much as you need to have a positive inflation rate (say between 1-2%)?

That’s more of a structural/institutional issue. Therefore, unlikely. 18

Financial stability issue – storm under the calm surface

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New paradigm – CB’s should look after financial stability

Low inflation did not insure financial stability

Predictors of financial crises: lending boom (historicaly good

one), asset prices boom?

Global monetary policy stance was inappropriate, and

supervision was in many cases inadequate

Lesson from the crisis: Imbalances can build up with seemingly

low inflation and neutral output gap calculated by standard

methodology, as asset prices were not included in the

calculation of the output gap20

However, still more questions than answers

How to reconcile financial stability with ‘classic’ monetary policy goals? Who “plays the second fiddle”? (Eg. Bank of England Financial Stability Committee can suspend MPC decisions in Funding for Lending Program)

Monetary policy still mainly concerned with price stability, asset prices not explicitly included, however they get closely monitored

Some important, still open, questions:

how much should central banks worry about the asset price inflation? It seems that CB policies have more direct impact on asset prices than on CPIs?

could unconventional monetary policy do more harm than good by trying to push thru the closed door (structural conditions in the economy that limit productivity/GDP growth)?

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It might have little effect on sustainable GDP growth, while, on the other hand, much more effect on pricing and risk assesment in financial markets. If risks get overly mis-priced, that might create difficult conditions for exit strategy.

Is monetary policy already overstretched?

Could that endanger central bank independence?

Do we properly measure inflation and output gaps?

Is there a case for new monetary policy targets, i.e. ‘path dependent’ ones?

Is it time for some old medicine like capital controls, particularly for small open economies exposed to global monetary cycles?

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So, is there a New Paradigm appearing?

Except when it comes to financial stabilty, which is now widely accepted as a new goal of central banking policies, there are still too many open questions that need answers before one can build a New Paradigm.

Actualy, given all uncertainities, it seems that today’s monetary policy is even more an art than a science, than was the case before.

And, as usual, when it comes to the art – the beauty is in the eye of beholder...

...until we get better evidence 23

Thank you!

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