Monetary Policy Decision Making at the NBU

NATIONAL BANK OF UKRAINE

Monetary Policy Decision Making at the NBU

KSE Open LectureKYIV, June 04, 2015

Sergiy NikolaychukDirector of Monetary Policy and Economic Analysis DepartmentNational Bank of Ukraine


Contents

2

Overview of monetary policy framework in Ukraine

Decision making bodies on monetary policy

• NBU Council

• NBU Board

• Monetary Policy Committee (MPC)

Monetary Policy Committee meetings (agenda, inputs, deliveries)

Forecasting process at the NBU

Modeling toolkit

• Quarterly Projection Model

• Satellite (econometric) models

• Further steps – DSGE model


Overview of monetary policy framework: theory

3

Main goal of Monetary Policy is ensuring the stability of the national

currency:

• that is necessary precondition for high and sustainable economic growth

Options:

• Discretion

• Rules (based on targets)

ER (currency board, hard peg etc.)

monetary aggregates

inflation

Impossible Trinity

Capital mobility

Independent MP

Fixed ER


Overview of monetary policy framework in Ukraine: evolution

4

Managed floating with no preannounced path for the ER

Other conventional fixed peg arrangements

Other managed arrangements (de jure - flexible ER)

Stabilized arrangements (de jure - flexible ER, de facto - ER anchor to U.S. dollar)

Floating

Exchange rate anchor Monetary aggregate target


Stabilization of FX market / Disinflation Successful implementation of IMF program Replenishment of international reserves Gradual elimination of administrative measures

CURRENT TARGETS TO ACHIEVE

Stage 1. Monetary targeting (framework of IMF program): accumulation of International reserves targets on NDA and NIR flexible exchange rate disinflation.

Stage 2. IT lite: price stability (1-digit target) accumulation of International reserves interest rate as a key instrument

Stage 3. Full-fledged IT: price stability (1-digit target) floating exchange rate

Future evolution of MP regime and goals

Establishment of Monetary Policy Committee which makes decisions:

• Clear and transparent• Forward-looking• Analytically supported

More transparent and market-friendly MP instruments framework

Introduction of Key policy rate and working o/n corridor

Liquidity providing / absorbing auctions Required reserves

Avoiding of multiple currency practices

Improvements that already done

Overview of monetary policy framework in Ukraine: next steps

5


Analysis of data, forecasts, policy

analysis

Monetary Policy decision making in the past: reactive policy

6

Collection of data and information about lower frequency economic events

Board/MPC

Policy Decision about the operational

targets

Decisions about the levels of individual

instruments

Operations in the money and FX

markets

MP Formulation and Implementation


Analysis of data, forecasts, policy

analysis

Monetary Policy decision making now and further: preemptive policy

7

Collection of data and information about lower frequency economic events

Board/MPC

Policy Decision about the operational

targets

Decisions about the levels of individual

instruments

Operations in the money and FX

markets

MP ImplementationMP Formulation


Decision-making bodies

8

responsible for developing the Monetary Policy Guidelines and supervision of monetary policy implementation

the decisions with regard to the Monetary Policy Guidelines are mandatory for the NBU Board

NBU Council

in accordance with the MP Guidelines implements the MP using appropriate monetary instruments

organizes execution of other functions and manages the activities of the NBU

NBU Board

an advisory body responsible for drafting proposals on formulating the monetary policy to be submitted to the Board of the National Bank for approval

MPC


Decision making bodies on monetary policy: NBU Council

9

NBU Council elaborates the Monetary Policy Guidelines, makes them public, submits them annually (till the 15th of September) to the Parliament of Ukraine, and exercises control over monetary policy implementation. NBU Council can submit recommendations for consideration by NBU Board.

Under Draft Law on NBU the Council will be reformed: optimized by size (9 members) more power and responsibilities stricter criteria's for candidates

NBU Council consists of 15 Members

Governor of the NBU

7 members appointed

by the President

7 members appointed

by the Parliament

experience (10 years) no representative mandate in other bodies no commercial interests in financial industry

Candidates for position in the Board need to fulfill certain criteria's:


Decision making bodies on monetary policy: NBU Board

10

NBU Board ensures implementation of monetary policy, organizes exercise of the other functions in accordance with Law and manages the activities of the National Bank.

experience (10 years); no representative mandate in other bodies; no commercial interests in financial industry.

Under Draft Law on NBU the Council will be reformed to Executive Committee: optimized by size (6 members – only Governor and Deputies) more independence for Board members

NBU Board consists of 11 persons

The Governor

Deputy GovernorsDirectors of the Departments involved in implementation of

main function of the NBU

Candidates for position in the Board need to fulfill certain criteria's:


Decision making bodies on monetary policy: members of MPC

11

NBU Council

Monetary Policy and Economic Analysis

Department

Statistics and Reporting Department

Financial Stability Department

Banking Supervision Department

Financial Monitoring Department

Registration and Licensing Department

Methodology Department

International Relations Department

Deputy Governor

Open Market Operations Department

Accounting Department

Office for Banking System Strategy and Reform

Financial Controlling Department

Cash Circulation Department

Payment Systems Department

Information Technologies Department

Internal Audit DepartmentLegal Department

PersonnelDepartment

Risk Management Department Corporate Services Department

NBU Governor

Deputy Governor Deputy Governor Deputy Governor

Operational Department

Regional Offices

Procurement and Logistics Department

Information Security Department

Retail Payments Department

First Deputy Governor

Banking Inspection Department

Loan Management Department

Division for Custodial Accounting of Government Securities

Organizational Chart of the National Bank of Ukraine

NBU Central Clearing House

Main Administration and Maintenance Office

Team for International Credit Line Management of NBU

University of Banking of NBU

Ukrainian Academy of Banking of NBU

NBU Council Office

Department of the Corporate Non-State Pension Fund of NBU

Security Department

Guard of NBUSites Located in Kyiv

Classified Records Division


MPC meetings

12

2-days long:

1 day - staff technical presentations and discussions

2 day – formulation of recommendations and NBU Board’s approval

Wednesday Thursday

Morning Macroeconomic Overview and Forecast

Presentation on Staff`s Policy recommendations

Policy discussion(Advisory Voting)

Afternoon

Markets Stance

Financial Stability IssuesBoard approval

Press release / Press conference


Forecasting Process at the NBU (1)

13

ParticipantsForecasting

groupMPC

members

Current situation assessment (1 week)

Current economic situation assessment +

Assumptions approving (1 week)

Update of forecasting methods and forecast assumptions +Presentation of assumptions to MPC members and approval +

Work on baseline scenario (2 weeks)

Baseline forecast development +Presentation of forecast and alternative scenarios assumptions to MPC members

+

Update of forecast +

Work on alternative scenarios (1.5 weeks)

Alternative forecast development +

Work on the Inflation Report (4 weeks)

Inflation Report finalization +Presentation of the report to MPC +Inflation Report publication and final meeting +


Forecasting Process at the NBU (2)

Near-term models and expert

forecastNTF Inflation, GDP, EURROL etc.

Assessment of initial

conditions and medium-term

trends

Exogenous variables forecasts (Assumptions)

Trends & Gaps

Medium-term(core)

model - QPM

Expert judgments/ additional

models

Finalmedium-

term forecast

Anticipated shocks, fiscal impulse, etc.

Near-term forecast

Tuning

Uncertainty

Data

Base


Modeling toolkit: general overview

15

Model’s suite toolkit

Middle-term projection model

Short-term regular

forecasting models

Additional (on-purpose) models (fiscal stance model,

REER equilibrium model etc.)

“The Bank’s use of economic models is pragmatic and pluralist. In an everchanging economy, no single model can possibly assimilate in a comprehensible way all the factors that matter for policy. Forming judgments about those factors, and their implications for policy, is the job of the Committee, not something that can be abdicated to models or even to modellers. But economic models are indispensable tools in that process”Eddie George (former Governor of the Bank of England), 1999.

“Essentially, all models are wrong, but some are useful”George Box, 1987

• a tool for current economic analysis and policy alternatives development

• a basis for forecasting process (combining empirical data, expert judgments and short-term forecasts into the common middle-term forecast).

• determining path of policy instruments• assessing forecast uncertainty (confidence

intervals and risks of scenarios)


Quarterly Projection Model: main features

16

QPM is a small semi-structural model with dynamic New Keynesian

theory in a nutshell

• ad-hoc structure (follows by microeconomic principles derived

equations but do not use such approach explicitly)

• forward looking variables, thus is not subject to Lucas critics The origins of the model came from QPM of the Bank of Canada and

Czech National Bank (similar models are used by central banks of

Serbia, Armenia, Slovak Republic and many others) Describes monetary policy transmission mechanism policy channels

and is not neutral to monetary shocks in short and middle run QPM reflects monetary policy neutrality and consistent with

inflation target in long run The model is calibrated (both - parameters and steady state values)


Quarterly Projection Models: trends and gaps

17

The concept of the model is the state space representation of

macroeconomic variables where trends and gaps are unobservable

components (state variables) State variables are linked together by putting to relationships the

same theory as in nutshell QPM model Advantages:

• allows to explain gaps in terms of other variables

• has a low sensitivity to sample length and number of parameters


Quarterly Projection Model: main equations

18

IS curve (output gap equation) Forward-looking expectation augmented Phillips curve

• core CPI inflation

• raw food inflation

• administratively regulated prices

• fuel prices UIP condition (nominal exchange rate and interest rate relationship) Monetary policy rule (hybrid rule - sets incomplete control of FX or

money market)• under fixed exchange rate• under flexible exchange rate (pure Taylor rule)• combination of rules under relaxing peg but incomplete control of

money market


Quarterly Projection Model: structure

19

Short-term interest

rate

UAH/USD

UIP

Risk premium

Foreign interest rate

Long-term interest rate

Real interest rate

Real interest rate gap

Trend of real interest rate

NEER REER REER gap

Output gap

Imported inflation

Core inflation

Food inflation

Admin. inflation

Changes of fuel prices

Inflation

USD/EUR

USD/RUR

Foreign inflation

Spread

Trend of REEROil prices

Metal prices

Terms of trade

GDP

Trend of GDP

Inflation expactations


Satellite (econometric) models

20

An automated system with a combination of forecasts from the unconditional average, random walk, autoregressive models, ordinary VAR

Small structural econometric models for components of inflation (including the connection between food inflation and the core inflation, producer and consumer inflation)

Bayesian VAR and FAVAR (for current quarter GDP estimation) VECM for external trade variables

Regular short-term forecasting models

Assessment of fiscal policy structural and cyclical component Assessment of equilibrium REER Models for financial stability needs (modeling the non-performing loans) Understanding the monetary policy stance with monetary aggregates

volumes Modeling the impact of harvest changes on the food prices

Additional (for special purposes) models


Further steps – transition to DSGE model

21

QPM is rather reliable and powerful tool for middle-term forecasting and policy

analysis

Still it lacks rigor and some very modern theoretic features

(financial accelerator etc.)

We develop new generation model (DSGE type) that should replace the QPM,

but the project hasn't been finished yet

Besides now traditional agents (households, firms) we are going to introduce

banking sector that will allow to model financial sector imbalances and its

consequences


Key messages to retain

22

NBU has a program to cope with the current turmoil, the program is

supported by IMF, WB and other IFIs;

We are serious in strengthening the institutional capacity of NBU

That are the crucial preconditions for transition to Inflation targeting and

maintenance of price stability

Enhancing the monetary policy decision making process is one of such

important preconditions

Significant progress is already achieved in different subareas (MPC

establishment, macroeconomic analysis and forecasting as the basis for MP

decisions, publication of macroeconomic forecast of the NBU in the Inflation

Report etc.)

But a lot of technical and policy work is ahead…

And the NBU needs the injection of the brilliant young economists,

analysts, researchers… so you are very welcome:

[email protected]

mailto:[email protected]

Presentations & Public Speaking

Monetary Policy Decision Making at the NBU