1. Monetary and exchange rate policy in Peru Adrián Armas (BCR) “XXI Meeting of the Latin American Network of Central Banks and Finance Ministries“ May, 2005

2. 2 Motivation  Which are the optimal monetary and exchange rate regimes in a dollarised economy?  How can dollarisation risks, in terms of both the central bank’s reaction function and regulatory issues, be dealt with?  How can confidence in the domestic currency be restored?  The Peruvian experience: inflation targeting in a partially dollarised economy (IT + dollarisation risks control)

3. 3 Agenda  Financial dollarisation and its effects on monetary policy design  Financial dollarisation and its effects on monetary policy implementation  The BCR’s strategy for controlling financial dollarisation risks

4. 4 Financial dollarisation and MP design

5. 5 a. The inflation target

6. 6 Financial dollarisation and MP design b. The operational target Interbank interest rate volatility has reduced

7. 7 Peru: Interbank interest rate in domestic currency Apr.04-Apr.05

8. 8 Agenda  Financial dollarisation and its effects on monetary policy design  Financial dollarisation and its effects on monetary policy implementation  The BCR’s strategy for controlling financial dollarisation risks

9. 9 Financial dollarisation and MP implementation

10. 10 Financial dollarisation and MP implementation The inflation forecasting system Combines judgement and model-based projections Main inflation forecasting model: QPM. Semi-structural, calibrated model. Captures main monetary policy transmission mechanisms Assumes that financial markets are not under stress

11. 11 Agenda  Financial dollarisation and its effects on monetary policy design  Financial dollarisation and its effects on monetary policy implementation  The BCR’s strategy for controlling financial dollarisation risks

12. 12 Peru: Dollarisation Ratio 2000: 70% 2005: 54%

13. 13 Financial dollarisation risks control Financial dollarisation is decreasing, but still remains high With high financial dollarisation, the economy is vulnerable to large domestic currency depreciations The BCR implements policies to mitigate the risks posed by financial dollarisation IT plus financial dollarisation risks control

14. 14 Financial dollarisation risks control

15. 15 Financial dollarisation risks control Dedollarisation policies: building credibility in the target

16. 16 Financial dollarisation risks control Dedollarisation policies: long term financial instruments in soles

17. 17 Financial dollarisation risks control

18. 18 Financial dollarisation risks control Exchange intervention to reduce exchange rate variability has let a process of NIR accumulation.

19. 19 Financial dollarisation risks control NIR accumulation has implied an increase of the CDBCRP’s stock.

20. 20 Peru: Nominal Exchange Rate Jan.99-Apr.05

21. 21 Financial dollarisation risks control While interest rate variability has been reduced in recent years (2002-2004), exchange rate variability maintains a similar level.

22. 22 Peru: Interbank Interest Rate Jan.02-Apr.05 Escape Clause

23. 23 Concluding remarks Peru is a financially dollarised ITer IT + financial dollarisation risks control: Inflation target Interbank interest rate as operational target Financial dollarisation considerations in the QPM Dollarisation risks control Financial dollarisation does not preclude independent monetary policy oriented at maintaining low and stable inflation

24. 24 Concluding remarks Inflation target fulfilment: 2002 to 2004 Gradual financial dedollarisation process