Diego Moccero

Do Latin American Central Bankers Behave Non-Linearly?: The Experiences of Brazil, Chile, Colombia and Mexico

Abstract This paper contributes to the empirical literature on inflation zone targeting by estimating monetary reaction functions in a non-linear cointegration framework for Brazil, Chile, Colombia and Mexico. Evidence shows that central banks respond linearly to deviations of expected inflation from the target (the inflation gap) in Brazil and Chile. As the inflation gap widens, policy responses become weaker in Colombia and Mexico, a finding that most probably reflects a history of adverse supply shocks rather than a lack of resolve from the monetary authorities. Non-linearity is also found in the central bank’s response to fluctuations in the exchange rate in Brazil and Colombia.

Is there a Case for Price-level Targeting?

There is a case, but there are also counter-arguments. With sufficient forward-looking behaviour among firms and households, price-level targeting can act as a powerful built-in stabiliser through automatic shifts in inflation expectations. This stabilisation mechanism reduces the need for large shifts in policy rates, alleviating the risk of hitting the zero lower bound of nominal interest rates and falling into a liquidity trap. Furthermore, credible price-level targeting can support capital accumulation by protecting the long-run purchasing power of money and reducing the inflation risk premium embedded in actual long-term real interest rates. However, price-level targeting can imply welfare-reducing policy-induced output volatility in situations where the degree of forward-looking behaviour is very low. The self-regulating capacity of price-level targeting can be undermined if central banks are not fully credible. Besides, aggressive inflation targeting can replicate some of (but not all) the benefits of price-level targeting. On balance, the case for adopting price-level targeting is not clear-cut, all the more so since transition costs are likely to be significant. Y a-t-il beaucoup a dire en faveur du ciblage du niveau des prix ? Oui, mais il y a aussi de serieux contre-arguments. Si une part suffisante des entreprises et des menages presente un comportement tourne vers l’avenir, le ciblage du niveau des prix peut fonctionner comme un puissant outil de stabilisation autonome grâce aux ajustements automatiques des anticipations des inflations. Ce mecanisme limite le besoin d’operer de larges mouvements des taux directeurs, ce qui reduit le risque de heurter la borne zero sur les taux d’interet et de tomber dans une trappe a liquidites. Qui plus est, grâce a la maniere dont elle protege le pouvoir d’achat de la monnaie, une politique credible de ciblage du niveau des prix peut encourager l’accumulation de capital en reduisant la prime contre le risque d’inflation qui est incorporee aux taux d’interets reels effectifs. Neanmoins, le ciblage du niveau des prix peut entrainer une volatilite de l’activite prejudiciable au bien-etre social si la part des menages et des entreprises qui sont tournes vers l’avenir est tres faible. La capacite de stabilisation automatique d’un regime de ciblage du niveau des prix peut aussi etre moindrie si la banque centrale manque de credibilite. Par ailleurs, une strategie de ciblage agressif du taux d’inflation peut reproduire une partie (mais non pas l’ensemble) des avantages du ciblage du niveau des prix. Tout bien pese, les arguments en faveur du ciblage du niveau des prix ne justifient pas de maniere nette un changement de strategie monetaire, d’autant plus que les couts de transition risquent d’etre eleves.

Improving the Business and Investment Climate in Indonesia

Indonesia’s business environment is discouraging entrepreneurship and holding back private-sector growth and development. Weaknesses in the regulatory framework, infrastructure bottlenecks and poor governance continue to weigh down on investment. Policies have been put in place to address these problems, but much remains to be done. An important recent initiative is the enactment of the Investment Law in 2007, which strengthened the foreign investment regime. This paper argues that options for reform could focus on making regulations more pro-business, including by removing red tape and onerous provisions at the local level of government, improving governance and relaxing remaining restrictions on foreign investment. Further financial deepening would facilitate access by enterprises to more abundant, cheaper sources of finance. This Working Paper relates to the 2008 OECD Economic Assessment of Indonesia (www.oecd.org/eco/surveys/indonesia). Ameliorer le cadre des affaires et des investissements en Indonesie En Indonesie, le cadre des affaires decourage la creation d’entreprises et freine la croissance du secteur prive. Les faiblesses de la reglementation, les goulets d’etranglement dans les infrastructures et la mediocrite de la gouvernance continuent a entraver les investissements. Des mesures ont ete prises pour remedier a ces problemes, mais beaucoup reste a faire. L’une des importantes initiatives prises recemment a ete l’adoption, en 2007, d’une loi sur les investissements qui a ameliore le regime des investissements etrangers. On soutient dans ce papier que la reforme pourrait viser surtout a rendre la reglementation plus favorable a l’activite privee, notamment en supprimant les tracasseries et les lourdeurs administratives aux echelons locaux des pouvoirs publics, en ameliorant la gouvernance et en assouplissant les restrictions qui subsistent a l’egard des investissements etrangers. En outre, la poursuite de l’approfondissement des marches financiers permettrait aux entreprises de se procurer davantage de fonds a moindre cout. Ce Document de travail se rapporte a l’Evaluation economique de l’OCDE de l’Indonesie, 2008 (www.oecd.org/eco/etudes/indonesie).

Interdependencies between Monetary Policy and Foreign Exchange Intervention under Inflation Targeting

The bulk of recent literature on foreign exchange interventions has overlooked the potential interdependencies that may exist between these operations and the conduct of monetary policy. This is the case even under inflation targeting and especially in emerging-market economies, because central banks often explicitly reserve the right to intervene to calm disorderly markets and to accumulate foreign reserves, and when the exchange rate is perceived as being out of step with fundamentals. This paper uses a friction model to estimate intervention reaction functions and the associated marginal effects for Brazil and the Czech Republic since the adoption of inflation targeting in these countries in 1999 and 1998, respectively. The main findings are that: (i) in both countries interventions occur predominantly to reduce exchange rate volatility, while in

Monetary Policy and Macroeconomic Stability in Latin America

In 1999, new monetary policy regimes were adopted in Brazil, Chile, Colombia and Mexico, combining inflation targeting with floating exchange rates. These regime changes have been accompanied by lower volatility in the monetary stance in Brazil, Colombia and Mexico, despite higher inflation volatility in Brazil and Colombia. This paper estimates a conventional New Keynesian model for these four countries and shows that: i) the post-1999 regime has been associated with greater responsiveness by the monetary authority to changes in expected inflation in Brazil and Chile, while in Colombia and Mexico monetary policy has become less counter-cyclical, ii) lower interest-rate volatility in the post-1999 period owes more to a benign economic environment than to a change in the policy setting, and iii) the change in the monetary regime has not yet resulted in a reduction in output volatility in these countries.

Do Latin American Central Bankers Behave Non-Linearly?

This papers estimates unrestricted monetary reaction functions for four Latin American countries (Brazil, Chile, Colombia and Mexico) and tests for the presence of non-linear effects in central bank behaviour. The analysis covers the post-1999 inflation-targeting period. We deal with the presence of unit roots in the data by estimating the policy rules in a co-integration setting. We test for linear and non-linear co-integration among the variables of interest. The results suggest that a non-linear specification is not rejected by the data for Brazil, Colombia and Mexico, but it is for Chile. Estimation of smooth-transition models by NLLS and EN-NLLS suggests that the central bank’s response to the inflation gap (i.e. deviations of expected inflation from the target) is invariant across policy regimes in Colombia. It becomes stronger in Mexico as expected inflation deviates from the target. Policy responses appear to weaken in Brazil as the inflation gap widens, a finding that most probably reflects a history of adverse supply shocks and upward adjustments in targets in the early years of inflation targeting. Non-linearity is also found in the central bank’s response to the exchange rate in Brazil and Colombia.