1 Monetary Policy in East Asia: Does Targeting Inflation Require ‘Inflation Targeting’? Hans Genberg Professor, Graduate Institute of International Studies, Geneva Research Fellow, HKIMR

2 Outline Inflation and monetary policy in East Asia:‘If it isn’t broken, don’t fix it’ Inflation targeting must not be a one-size- fit-all strategy Target inflation, yes - ‘inflation targeting’, maybe Some suggestions for research

3 East Asia does not have an ‘inflation problem’

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7 Is there a need to change strategy? Fear of pegging What are the objectives of monetary policy Need for a nominal anchor

8 What will countries do? New Zealand and Australia - No, but there is some talk of a monetary union Hong Kong - A basket peg? Korea and Thailand - have adopted inflation targeting. How will it be implemented? Malaysia and Singapore - exchange-rate based strategies Philippines - inflation targeting as well?

9 Inflation Targeting Fundamentally about the objectives of monetary policy and How to achieve these objectives Countries differ - the implementation of inflation targeting in industrialized countries does not necessarily fit elsewhere

10 Targeting inflation vs. Inflation Targeting The need for a nominal anchor Monetary policy can not do it alone Inflation targeting can not mean targeting only inflation Implementation must be country specific

11 Alternative nominal anchors The exchange rate Monetary or credit aggregates An inflation target

12 The importance of policy consistency Large fiscal imbalances complicate inflation targeting –Deficit financing –Changes in the equilibrium real interest rate Agreement of what monetary policy can and cannot accomplish Central Bank independence is not enough –‘The government giveth and the government taketh away’

13 Objectives of monetary policy Strict inflation targeting (‘inflation nutters’) –Inflation – to provide a nominal anchor Flexible inflation targeting (inflation targeting does not mean targeting only inflation) –Inflation –Output variability –What about the exchange rate?

14 The exchange rate among the targets? Exchange-rate volatility and trade –Theory (ambiguous but presumption that higher uncertainty would reduce trade). –Empirical evidence Time-series evidence does not show much effect Recent cross-section evidence finds stronger relationship Trade promotes welfare through increased incomes and growth

15 Implementation must be country specific The choice of goals The choice of intermediate target What should be the operating target? Inflation reports, communication with the public, central bank independence and all that

16 Some important areas for research Fixed rules are relatively easy to carry out Targeting inflation implies more discretion and responsibility for the central bank This requires more knowledge

17 The transmission mechanism The central bank must choose an operating procedure that allows it to control inflation while at the same time getting as close as possible to other subsidiary goals The transmission mechanism of monetary policy defines the policy strategy

18 Inflation Output gap Exchange rate Interest rate Monetary policy instrument ? ‘Noise’ Alternative transmission mechanisms

19 Inflation Output gap Interest rate Exchange rate Monetary policy instrument ? ‘Noise’ Alternative transmission mechanisms

20 Inflation Output gap Interest rate Exchange rate Monetary policy instrument ? ‘Noise’ Alternative transmission mechanisms

21 Should the interest rate or the exchange rate be the residual? What constitutes a neutral monetary policy? Vulnerability of the economy to interest rate vs exchange rate volatility Sources of chocks and nature of financial relationships in the economy

22 Is there a need for international policy co-ordination? Independent inflation targeting means greater exchange rate volatility The risk of competitive depreciations/appreciations

23 Three parting reminders Inflation targeting is about goals of monetary policy –It does not imply that there is only one goal Implementation of monetary policy has to be country specific –IT is consistent with many different approaches Knowledge of the transmission of monetary policy will become more important

24 Your comments are welcome