Banco Central do Brasil Inflation Targeting in Brazil
Banco Central do Brasil Inflation Targeting in Brazil Ilan Goldfajn February 2002 1
Brazilian IT Framework • Implementation in July 1 st, 1999 • Headline IPCA was chosen • Targets were 8%, 6% and 4% for 1999, 2000 and 2001, with a ± 2% tolerance interval • Targets are 3. 5% for 2002 and 3. 25% for 2003, with a ± 2% tolerance interval • Absence of escape clauses 2
Inflation in Brazil - IT Regime Annual IPCA X Targets 8. 94 8. 00 7. 67 6. 00 5. 97 4. 00 1999 2000 3. 50 2001 Target 2002 3. 25 2003 IPCA 3
12 -month IPCA X Targets Inflation Rate - IPCA (% over year ago) 10% 8% 6% 8. 00 6. 00 4% 2% 7. 62 4. 00 Inflation Targeting 3. 50 0% Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Dotted lines represent the inflation targets for 1999, 2000, 2001 and 2002 4
IPCA and Exchange Rate 100 16 80 14 12 60 10 40 8 20 6 0 4 Jan-02 Nov-01 Sep-01 Jul-01 May-01 Mar-01 Jan-01 Nov-00 Sep-00 Jul-00 May-00 Mar-00 0 Jan-00 -40 Nov-99 2 Sep-99 -20 Exchange Rate t-3 (3 -month annualized accumulated variation; left scale) IPCA t (3 -month annualized accumulated variation; right scale ) 5
Interest Rate Over-Selic Rate (daily figures: January 4, 1999 to February 26, 2002) 50 45% % p. y. 40 30 18. 80 20 10 Jan 99 May Sep Jan 00 May Sep Jan 01 May Sep Jan 02 6
Inflation Targeting Regime: Practical Issues – To Core or not to Core – Supply versus Demand Shocks (expected supply effect? ) – Transparency Issues – Different expectations from market’s 7
Macroeconomic Models • Instrumental for managing monetary policy under IT • Powerful tool for communicating monetary policy (inflation fan charts) 8
Monetary Policy Decision Process • Use the broadest information set as possible. • Judgmental analysis is very important. • Use macro models to discipline and make discussion more rigorous. • Use several models to check consistency, but choose the main one. 10
Forecasting Process • Scenarios – Model specification • The Copom defines which relations are relevant for the monetary policy decision. – Exogenous variables • The most likely path for the exogenous variables are set by the Copom after interacting with the staff. – Shocks • The timing, magnitude, variance and skewness are set by the Copom after interacting with the staff. 11
Forecasting Tools • Small-scale macroeconomic models • VARs models • Leading Indicators • Core inflation 12
VAR Models for Short-run Inflation Forecasting • Objective: provide short-run forecasts for the structural model • Endogenous variables: interest rate, exchange rate, money, GDP, industrial production, unemployment and construction price index • Sample: post Real Plan • Frequency: monthly and quarterly 13
Leading Inflation Indicators • Composite index built as a combination of economic variables that show leading relation to inflation. • The methodology used to combine the economic series extracts their common movements related to inflation process. • The main objective is to predict turning points of inflation in real time. • Also provides linear forecast using a VAR system combining the index with inflation. • Components follow a general pattern: monetary, real sector, financial and external shocks variables. 14
Leading Indicators 0. 015 3 2 0. 010 1 0. 005 0 0. 000 -1 -0. 005 -0. 010 98: 01 -2 -3 98: 07 Inflation 99: 01 99: 07 Indicator 1 00: 01 Indicator 2 15
Core Inflation • Broad consumer price index (IPCA) - 52 components (items) • Trimmed-mean with smoothing items • Trim 20% of each tail to minimize the difference with a 13 -month centered moving average of inflation 16
IPCA and Core Measure IPCA and core measure - monthly changes 1. 3 0. 9 0. 5 0. 1 -0. 3 IPCA Core Jul 00 Apr 00 Jan 00 Oct 99 Jul 99 Apr 99 Jan 99 Oct 98 Jul 98 -0. 7 Apr 98 0. 31 0. 61 0. 42 0. 43 0. 24 0. 31 0. 43 0. 40 0. 68 0. 46 0. 58 0. 44 0. 37 0. 45 0. 35 0. 42 0. 58 0. 60 0. 42 Jan 98 0. 70 1. 05 1. 10 0. 56 0. 30 0. 19 1. 09 0. 56 0. 31 1. 19 0. 95 0. 60 0. 62 0. 13 0. 22 0. 42 0. 01 0. 23 1. 61 1. 31 0. 23 Oct 97 Jan 99 Feb 99 Mar 99 Apr 99 May 99 Jun 99 Jul 99 Aug 99 Sep 99 Oct 99 Nov 99 Dec 99 Jan 00 Feb 00 Mar 00 Apr 00 May 00 Jun 00 Jul 00 Aug 00 Sep 00 Jul 97 Core Apr 97 IPCA Jan 97 Period 17
IPCA and Core Measure IPCA and core measure - 12 -month changes Period IPCA Core 10. 0 9. 0 8. 0 7. 0 6. 0 5. 0 4. 0 3. 0 2. 0 1. 0 IPCA Jul 00 Apr 00 Jan 00 Oct 99 Jul 99 Apr 99 Jan 99 Oct 98 0. 0 Jul 98 1. 97 2. 19 2. 20 2. 45 2. 46 2. 56 2. 69 3. 19 3. 55 4. 19 4. 67 5. 22 5. 40 5. 21 5. 16 5. 18 5. 29 5. 49 5. 77 5. 96 5. 98 Apr 98 1. 65 2. 24 3. 02 3. 35 3. 14 3. 32 4. 57 5. 69 6. 25 7. 50 8. 65 8. 94 8. 85 7. 86 6. 92 6. 77 6. 47 6. 51 7. 06 7. 85 7. 77 Jan 98 Jan 99 Feb 99 Mar 99 Apr 99 May 99 Jun 99 Jul 99 Aug 99 Sep 99 Oct 99 Nov 99 Dec 99 Jan 00 Feb 00 Mar 00 Apr 00 May 00 Jun 00 Jul 00 Aug 00 Sep 00 Core 18
General Structure of Models Other determinants Fiscal Variables Risk Premium UIP IS Aggregate Demand Exchange Rate IS Phillips UIP Inflation Interest Rate Rules / Exogenous Path Interest Rates 19
Building Blocks • Demand (IS Curve) • Supply (Phillips Curve) • exchange rate passthrough • forward x backward looking • inflation expectation • Exchange-rate • exogenous • endogenous x exogenous 20
Modeling the Pass Through a 4 =constant a 4 = (a 41 + a 42 D( pt. F-1 + et -1 )) a 4 = a 41 + a 42 et -1 Et 2 -1 - a 42 a 4 = a 41 2 Et -1 + a 42 where: p. F log of foreign producer price index e log of exchange rate E exchange rate 21
Treatment of Inflation Expectations • Forward-looking Phillips curve • Alternatives – Institutional approach ì pt*+i ï * Et ( pt +i ) = í pt +i +1 , ïp* + 2 î t +i where pt*+i is the inflation target for t +i 22
Treatment of Inflation Expectations • Alternatives – Model Consistent (recursive solution)* {Et ( pt +i )}( 0) = {initial guess} Solve the model Do {Et ( pt +1 )}( n +1) = {pt +1 }( n) and solve the model until {Et ( pt +1 )}( n +1) {pt +1 }( n +1) where a b means that b is in a neighborhood of a. *The convergence is usually achieved in less than 20 iterations. 23
Exchange Rate Determination • Exchange rate follows the equation below, based on a UIP: Et et +1 - et = it - it. F - xt Det = Dit. F + Dxt - Dit + ht where: e log of exchange rate i. F log of foreign interest rate x log of risk premium residual including the expectation variations assumed white noise 24
Exchange Rate Determination • Modeling the risk premium – exogenous path – endogenous determination • depends on PSBR/GDP ratio (primary) and other risk premium determinants. N DXt = g 1 Xt -1 + g 2 DPRt -3 + åg j DZ j , t -t j j =3 where: X risk premium (SOT) in basis points PR PSBR/GDP ratio (primary) Zj other risk premium determinants 25
Forecasting • Fan Chart – Measure of central tendency • median: the model estimate the mean, median is obtained using the variance and skewness of a two-piece normal distribution. – Shocks stylization • The magnitudes are obtained from out of model estimation. The assessment of variance and skewness are subjective. – Variance • It is calculated using the historical forecast error as benchmark. However, it can be adjusted by subjective assessment. 26
Inflation Forecasted IPCA - Inflation with interest rate fixed at 19. 00% p. y. (accumulated inflation in 12 months) 27
Forecast: IPCA with 19. 00% p. y. fixed interest rate Confidence Interval Central 50% Projection 30% Year Q 10% 2001 4 7. 0 7. 2 7. 3 7. 5 7. 6 7. 7 7. 4 2002 1 6. 4 6. 6 6. 9 7. 2 7. 5 6. 8 2002 2 5. 1 5. 5 6. 0 6. 3 6. 8 7. 2 6. 1 2002 3 3. 4 4. 0 4. 6 5. 1 5. 6 6. 3 4. 8 2002 4 2. 0 2. 7 3. 3 4. 0 4. 6 5. 4 3. 7 2003 1 1. 4 2. 2 3. 0 3. 7 4. 4 5. 2 3. 3 2003 2 0. 9 1. 7 2. 5 3. 3 4. 0 4. 9 2003 3 0. 5 1. 4 2. 2 3. 0 3. 8 4. 7 2. 6 2003 4 0. 3 1. 3 2. 1 2. 9 3. 7 4. 7 2. 5 Note: Accumulated inflation in 12 month, in % p. y. The values correspond to the ones shown in inflation fan chart. 28
Inflation Market Expectations median of IPCA for 1999, 2000, 2001, 2002 and 2003 (daily figures: June 24, 1999 to February 22, 2002 10 1999 9 8 2000 6 2002 5 4. 85 2001 4 2003 3 4. 00 Source: Investor Relations Group / Banco Central Jan 31 Dec 26 Nov 20 Oct 10 Sep 04 Jul 31 Jun 26 May 18 Apr 11 Mar 07 Jan 29 Dec 21 Nov 16 Oct 09 Sep 01 Jul 28 Jun 23 May 18 Apr 11 Mar 03 Jan 28 Dec 22 Nov 17 Oct 08 Sep 02 Jul 29 2 Jun 24 (%) 7 29
Interest Rate Market Expectations Over-Selic Rate Market Expectations Median of Over-Selic Rate for 2001, 2002 and 2003 (daily figures: August 1 st, 2001 to February 22, 2002) 20 2001 19 2002 17 17 16 2003 15 14. 1 14 13 12 8/1/01 8/8/01 8/15/01 8/22/01 8/29/01 9/5/01 9/13/01 9/20/01 9/27/01 10/4/01 10/11/01 10/19/01 10/26/01 11/13/01 11/21/01 11/28/01 12/5/01 12/12/01 12/19/01 12/27/01 1/4/02 1/11/02 1/18/02 1/25/02 2/1/02 2/8/02 % p. y. 18 Source: Investor Relations Group / Banco Central 30
Exchange Rate Market Expectations Exchange Rate (R$/US$) Market Expectations Me d i a n o f R $ / U S $ fo r 2 0 0 1 , 2 0 0 2 a n d 2 0 0 3 (daily figures: August 1 st, 2001 to February 22, 2002) 3. 10 2003 2. 70 2. 7 2002 2. 55 2. 50 2001 2. 30 Source: Investor Relations Group/Banco Central 2/14/02 2/4/02 1/24/02 1/15/02 1/4/02 12/24/01 12/13/01 12/4/01 11/23/01 11/13/01 10/31/01 10/22/01 10/10/01 10/1/01 9/20/01 9/11/01 8/30/01 8/21/01 1. 90 8/10/01 2. 10 8/1/01 R$/US$ 2. 90 31
GDP Market Expectations GDP Growth Market Expectations Me d i a n o f G D P g r o w th fo r 2 0 0 1 , 2 0 0 2 a n d 2 0 0 3 (daily figures: August 1 st, 2001 to February 22, 2002) 4. 5 4. 0 2003 3. 0 2. 4 2002 2. 5 2. 0 2001 1. 5 1. 8 1. 0 Source: Investor Relations Group/Banco Central 2/13/02 1/25/02 2/4/02 1/9/02 1/17/02 12/20/01 12/31/01 11/26/01 12/4/01 12/12/01 11/16/01 10/26/01 11/7/01 10/9/01 10/18/01 9/21/01 10/1/01 9/4/01 9/13/01 0. 0 8/17/01 8/27/01 0. 5 8/1/01 8/9/01 % p. y. 3. 5 32
Recent Challenges R e c e n t C h a l l e n g e s i n a n I n fl a ti o n T a r g e ti n g R e g i m e – Nominal (and real) exchange rate changes – Prices administered by contracts – Quarterly targets within IMF program – Fiscal dominance? 33
Exchange Rate Changes – How to deal with large RER adjustments – Pass through and repressed pass through – Future exchange rate Bonus 34
Nominal Exchange Rate E v o l u ti o n o f th e N o m i n a l E x c h a n g e R a te 3. 00 2. 80 R$/US$ 2. 60 2. 40 2. 39 2. 20 2. 00 1. 80 1. 60 1. 40 1. 20 Jan 99 May Sep Jan 00 May Figures updated up to Feb 26 th, 2002 Sep Jan 01 May Sep Jan 02 35
Exchange Rate: January 1998 - February 2002 (R$/US$) 2. 80 2. 60 2. 3947 2. 40 2. 20 2. 00 1. 80 1. 60 1. 40 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 May-99 Jan-99 Sep-98 May-98 Jan-98 1. 20 1. 00 Sep-99 Inflation Targeting 36
Real Exchange Rate Evolution of the Real Exchange Rate (R$/US$) at Jan u ary 2002 w h o l esal e p ri ces 3. 00 (J a n u a r y 2 0 0 2 = 1 0 0 ) 2. 80 2. 60 Average in the period 2. 40 2. 20 2. 42 2. 27 2. 00 1. 80 1. 60 Jan Jan Jan Jan 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Real Exchange Rate at Jan 2002 prices (WPI) 37
Real Exchange Rate Evolution of the Real Exchange Rate (R$/US$) at Jan u ary 2002 co n su mer p ri ces 3. 00 (J a n u a r y 2 0 0 2 = 1 0 0 ) 2. 80 2. 60 2. 42 2. 40 2. 20 2. 00 Average in the period 1. 80 1. 71 1. 60 1. 40 1. 20 Jan Jan Jan Jan 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Real Exchange Rate at Jan 2002 prices (CPI-Fipe) 38
Two Interesting Issues – Is inflation targeting inconsistent with an IMF program? – Inflation targeting and prices administered by contracts. 39
Inflation and Prices Administered by Contracts 12 -Month 22 20 18 Prices administered by contracts (%) 16 14 12 10 IPCA 8 6 4 2 0 Free prices Jan May Sep Jan 99 99 99 00 00 00 01 01 01 02 IPCA Admin. Livres 40
Transition Table - Fixed Interest 2002 2003 Observations Copom January 3. 83 2. 88 p January * 4. 01 2. 93 Gasoline and Diesel ** 3. 75 2. 68 Gasoline 2002 (-10. 2 -> -11. 9) Bottled Gas ** 3. 75 2. 63 2002 (9. 0 -> 17. 9) Administered by contracts (Total) ** 3. 77 2. 95 2002 (5. 44 -> 5. 72) 2003 (3. 47 -> 3. 85) Dollar 4. 01 3. 06 (2. 37 -> 2. 42) E(p) 4. 05 3. 07 (2002: 4. 68 => 4. 80; 2003: 4. 0 => 4. 0) Basic Scenario 4. 05 3. 07 Oil-by products (constant since Feb 9) 3. 82 3. 01 (0. 40 -> 0. 52) Considers a updating for the prices administered by contracts in January Gasoline 2002 (-13. 95) Diesel 2002 (-1. 93) Bottled Gas (14. 80) * Includes the January inflation effect. ** Reflects the effect of the updated projection of the prices only from February to December 2002. 41
IMF Inflation Targets I MF I n fl a ti o n T a r g e ts 10 9 8 7 6 5 IPCA 12 -month Inner band Sep-02 Jun-02 Mar-02 Dec-01 Sep-01 Jun-01 Mar-01 Dec-00 Sep-00 Jun-00 Mar-00 Dec-99 Sep-99 Jun-99 Mar-99 Jan-99 4 3 2 1 0 Central target Outer band 42
IMF Agreement - IPCA Targets Interval 43
Fiscal Targets - Primary Surplus Fiscal Targets - IMF Primary Surplus 43. 7 45 40. 2 30 Target 15 Year cumulative data Sep-02 Jun-02 Mar-02 Dec-01 Sep-01 Jun-01 Mar-01 Dec-00 Sep-00 Jun-00 Mar-00 Dec-99 Sep-99 Jun-99 0 Mar-99 R$ billion Occurred 44
Net Public Sector Debt Dynamics Up to Dec 2001: occurred 50 36. 9 40 30 Forecasted from December 2002 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 20 1991 % of GDP 60 45
A Few Important Questions – Why has monetary policy been credible in Brazil? – What is the sustainable growth rate in Brazil? – What is the current pass through coefficient? 46
GDP Growth (% real variation) 5 4. 36 4 3 2. 00 2. 50 2001 * 2002 * 2 0. 81 1 0. 13 0 1998 1999 /* 2001 and 2002 projections 2000 47
Potential GDP and Potencial GDP In R$ millions of 1999 1, 100 1, 000 Potencial GDP 900 800 GDP 700 GDP 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 600 Potencial GDP 48
Potential GDP Total Factor Productivity Annual and HP Smoothed 1. 00 0. 98 0. 96 0. 94 0. 92 0. 90 0. 88 0. 86 0. 84 Annual 2000 1998 1996 1994 1992 1990 1988 1986 1984 1982 1980 0. 82 HP 49
Potential GDP 2001 -05 Potencial GDP: Scenarios and Forecasts TFP INVESTMENT * Hip. 1 Hip. 2 Hip. 3 0. 77% 3. 30% 3. 55% 3. 62% 1. 00% 3. 60% 3. 78% 3. 85% 1. 20% 3. 81% 3. 99% 4. 06% 1. 50% 4. 11% 4. 30% 4. 37% (*) In 1999 prices Hip. 1 - Investment equals to 19, 5% - 20%-20, 5%-21, 5% in 2001 -04, respectively. Hip. 2 - Investment equals to 20%-21%-22%-23% -24% in 2001 -04, respectively. Hip. 3 - Investment equals to 20%-21, 2%-22, 4%-23, 6%-2, 84% in 2001 -04, respectively. 50
0. 06 2001: 3 2001: 2 2001: 1 2000: 4 2000: 3 2000: 2 2000: 1 1999: 4 1999: 3 1999: 2 1999: 1 1998: 4 1998: 3 1998: 2 1998: 1 0. 20 1997: 4 1997: 3 1997: 2 1997: 1 Pass Through E v o l u ti o n o f th e P a s s T h r o u g h C o e ffi c i e n t 0. 18 0. 16 0. 14 0. 12 0. 10 0. 08 51
Pass Through Comparison Months Short Long G&W w/for /2 America (2) (4) 3 months 0. 123 0. 117 0. 20 6 months 0. 131 0. 228 0. 53 after 1 year 0. 134 0. 441 0. 69 18 months 0. 134 0. 642 1. 24 52
Assessments – Credibility is a moving average concept. Fiscal is important. – Growth rate in Brazil depends on external financing restriction and reforms. – Pass through from exchange rate has been moderate. Future? – Two issues: IMF and IT and prices administered by contracts. 53
Relative Success, Why? – Strong fiscal performance. – GDP did not collapse. Long-awaited crisis allowed private sector hedging. – Low pass through: output gap, overvaluation, and initial inflation. – Credibility of the IT Regime. 54
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