National Bank of Romania NATIONAL BANK OF ROMANIA 1

National Bank of RomaniaNational Bank of RomaniaNATIONAL BANK OF ROMANIANATIONAL BANK OF ROMANIA1


A) Inflation Targeting in Romania

I. Rationale Behind the Adoption of Inflation Targeting

II. Key Features

III. International Experience

IV. Prerequisites

V. Advantages

VI. Features of NBR’s Inflation Targeting Strategy

VII. Exchange Rate Policy

VIII. Quarterly Forecasting & Decision-Making Process

IX. Forecast Horizons

X. Forecasting Cycle

XI. The Core Model

XII. The New Inflation Report

XIII. Communication

SUMMARYSUMMARY


B) Charts

1. Inflation Rate (annual data)

2. Inflation Rate (monthly data)

3. Inflation Forecast

4. NBR Policy Rate

5. Financial Intermediation

6. General Government Deficit/GDP

7. Reserves and Debt Indicators

8. Total External Debt

9. M&LT External Debt

10. Public Debt Stock

11. Inflation Rate and Interest Rates

12a. Non-Government Credit

12b. Total Credit and Non-Government Credit


Necessary commitment to disinflationcommitment to disinflation due to forthcoming European accession

Weakening relationship between money aggregates and inflation

Needed focus on inflationfocus on inflation rather than on intermediary targets

With capital account liberalization, capital account liberalization, exchange rate pegging is not a viable alternative: inflation still high, Balassa-Samuelson effect would slow down disinflation

I. Rationale Behind the Adoption I. Rationale Behind the Adoption of Inflation Targetingof Inflation Targeting


Primary objective of monetary policy: to ensure and maintain the aggregate price stability

Use of the whole range of monetary policy tools for reaching the inflation target

Proactive monetary policy stance (forward-looking behaviour)

II. Key FeaturesII. Key Features


Transparency of the monetary policy strategy

by communicating to the general public the

objectives, the decisions adopted, the rationale behind

monetary policy decisions and the associated risks and

uncertainties

Increased efficiency of monetary policy on medium-term

Key Features (2)Key Features (2)


Central banks of 21 countries adopted inflation targeting strategy

Initially, inflation targeting strategy was adopted only by some developed countries

Subsequently, the strategy proved to be an attractive alternative to emerging countries

Large economic imbalances had been solved prior to the adoption of inflation targeting strategy

III. International ExperienceIII. International Experience


The annual inflation rate is in the single-digit range

The NBR has full operational independence (by its legal Statute)

The financial sector is stable and sound, although financial intermediation is needed to increase

Fiscal dominance is no longer a threat

IV. PrerequisitesIV. Prerequisites


Inflation targets for the coming years have been agreed on together with the government

The central bank has improved its inflation-forecasting capacity

Disinflation progress over the past few years has led to the strengthening of NBR credibility

Prerequisites (2)Prerequisites (2)


Reducing time inconsistency by increasing the responsibility of the central bank for achieving its primary objective, i.e. price stability

Flexible and transparent regime that is operational even under an unstable relation between monetary aggregates and inflation

Disinflation with relative minimisation of costs, a more direct impact on inflation expectations

V. AdvantagesV. Advantages


CPI-based inflation target

Target set as a midpoint within a target band of ±1 percentage point

Annual targets set for a longer time horizon (initially 2 years)

VI. Features of NBR’s VI. Features of NBR’s Inflation Targeting StrategyInflation Targeting Strategy


Features of NBR’s Features of NBR’s Inflation Targeting Strategy (2)Inflation Targeting Strategy (2)

Flexible interpretation of inflation targeting (mainly its co-existence with the managed floating regime)

Ex ante definition of a narrow set of circumstances which are independent from the monetary policy influence and restrict the NBR’s responsibility for reaching the inflation target (escape clauses)

Joint announcement of inflation targets by the NBR and the government


Further managed floating regime, with market playing an increasing role in determining the exchange rate

Less frequent interventions by the NBR

Exchange rate unpredictability in the short run, in order to discourage speculative capital inflows following capital account liberalization

VII. Exchange Rate PolicyVII. Exchange Rate Policy


VIII. Quarterly Forecasting VIII. Quarterly Forecasting && Decision-Making Process Decision-Making Process

Task Force – interdepartmental working group: Prepares near- and medium-term forecasts on economic growth

and inflation rate Monitors the main economic and monetary indicators on a monthly basis Draws up the Inflation Report

Monetary Policy Committee: Examines the initial conditions for the core model Assesses the forecasts and recommendations on the monetary policy

measures Analyses the Inflation Report and makes recommendations

NBR Board: Makes the monetary policy decision taking account of the formulated

risks and uncertainties Analyses and adopts the Inflation Report


Quarterly Forecasting Quarterly Forecasting && Decision-Making Process (2) Decision-Making Process (2)

Near-term models (ARMAX)

and Expert forecastNTF Inflation, GDP, EUR/RON etc.

Assessment of initial conditions

and medium-term trends

Exogenous variables forecasts

Trends & Gaps

Medium-term(core)model

Expert judgement

Finalmedium-term

forecast

Anticipated shocks, fiscal impulse etc.

Near-term forecast

Tuning

Uncertainty

Flow of information in the forecasting process Flow of information in the forecasting process at the National Bank of Romaniaat the National Bank of Romania


IX. Forecast HorizonsIX. Forecast Horizons

Near-term forecast (2 quarters)

ARMAX model for the main CPI components (food, non-food, services)

Expert judgement forecast for CPI components

Useful for determining the starting point of medium-term forecast and for monitoring in between two forecasting cycles


Forecast Horizons (2)Forecast Horizons (2)

Medium-term forecast (8 quarters) Based on a quarterly projection model (QPM) that provides

a description of dynamics of the main macroeconomic variables and their interaction

QPM is used for generating macroeconomic development scenarios, assessing the risks of potential shocks and analysing alternative monetary policy measures

QPM is based on economic theory, assuming modelling of economic agents’ expectations and the convergence of the economy towards long-term equilibrium

QPM is a flexible model allowing the use of additional information and expert opinions provided by specialists of the NBR and of other institutions


X. Forecasting CycleX. Forecasting Cycle

Quarterly cycle relying on frequency of data on GDP

Forecasting process, formulation of monetary policy decisions and drafting of Inflation Report last for about one month

Forecasting cycle does not require quarterly frequency of monetary policy decisions

monetary decisions may also be taken between two forecast meetings based on the developments identified during monitoring


Assessing the current position of the economy:Assessing the current position of the economy:

Initial conditionsInitial conditions for the core model: GDP trend, neutral real interest rate, equilibrium real exchange rate, their medium-term profiles and current gaps

Providing a consistent view on recent economic developments, current inflationary pressures, and real monetary conditions stance

Role:Role:

Integrates information from history, near-term forecasting and expert judgement

Generates endogenous interest rate path which can serve as policy guideline

Used to generate risk scenarios and policy analysis

XI. The Core ModelXI. The Core Model


Characteristics:Characteristics:

Small semi-structural calibrated model

New-Keynesian core (short-term and medium-term non-

neutrality)

Well behaved steady-state

Consistent with achieving multi-period inflation targets

The Core Model (2)The Core Model (2)


Structure:Structure:

Core inflation determined by own persistence, agents’ expectations, output gap, and import price inflation

Output gap determined by own persistence and real monetary conditions

Exchange rate determined according to uncovered interest parity including risk premium

Forward-looking policy interest rate rule reacts to deviations of inflation from target, the output gap and smoothes out interest rate volatility

Agents’ expectations modelled as hybrids of backward-looking (inertial) and forward-looking (“model-consistent”) expectations



Features of the transmission mechanism:Features of the transmission mechanism:

Expectations channel quite significant for monetary policy direct influence on inflation

Exchange rate channel also important

direct channel, via pass-through – strongest

indirect channel, through influences on real sector – relatively weaker at present

Interest rate channel relatively weak in the past, steadily strengthening

monetary policy impulses intermediated by relatively sluggish bank deposit and lending rates



XII. The New Inflation ReportXII. The New Inflation Report

Main communication tool with the public in order to anchor inflation expectations

Since August 2005 – quarterly Inflation Report

Sections: assessment of current economic developments

rationale behind the monetary policy decisions in the reviewed period

NBR projection on inflation rate developments on eight-quarter time horizon

uncertainties and risks associated with the projection

implications of the context on the monetary policy future stance


More transparent policyMore transparent policy

Formal announcement of adoption of full-fledged inflation full-fledged inflation targeting regime,targeting regime, with detailsdetails on bandwidth, formalized exceptions etc.

Formal announcement of calendarcalendar for policy-related Board meetings

External communication based on publishing the new quarterly new quarterly Inflation Report Inflation Report and on regular press conferences press conferences occasioned by its releaseoccasioned by its release

Press releasesPress releases on contents of between-forecastbetween-forecast meetingsmeetings and on the monetary policy decisions

XIII. CommunicationXIII. Communication


CHARTSCHARTS


*) based on CPI (60% EUR+40% USD)Source: National Bank of Romania, National Institute of Statistics (NBR calculations)

Inflation Rate

35 27 25 22 14 9 7.5 5

54.8

40.7

30.3

17.8

14.1

9.3

0

10

20

30

40

50

60

1999 2000 2001 2002 2003 2004 2005t 2006t

Source: National Institute of Statistics, Pre-Accession Economic Programme

Dec./Dec.

0

10

20

30

40

50

60

target actual

August ’05 12-month CPI inflation: 8.9%

1.


Inflation Rate

0

5

10

15

20

25

30

35D

ec.0

1

Feb

.02

Apr

.02

Jun.

02

Aug

.02

Oct

.02

Dec

.02

Feb

.03

Apr

.03

Jun.

03

Aug

.03

Oct

.03

Dec

.03

Feb

.04

Apr

.04

Jun.

04

Aug

.04

Oct

.04

Dec

.04

Feb

.05

Apr

.05

Jun.

05

Aug

.05

Source: National Institute of Statistics

CPI; percentage change against the same period of previous year

actual

trend

CPI inflation Jan.- Aug. 2005: 5.2% (7.9% annualized figure)

2.


Inflation Forecast

2

4

6

8

10

12

14

2004II III IV

2005I II III IV

2006I II III IV

Source: National Institute of Statistics, National Bank of Romania calculations

annual inflation rate (end of period)

target band*

annual inflation target

annual percentage change

Inflation targets (Dec./Dec.) 2005: 7.5% 2006: 5%

*) Note: ±1 percentage point on either side of targeted inflation path

3.


NBR Policy Rate

17.75

21.2520.00

18.75

12.50

8.507.50

16.50

14.50

0

5

10

15

20

25

30

Jan.04 Apr.04 Jul.04 Oct.04 Jan.05 Apr.05 Jul.05

Source: National Bank of Romania

percent per annum

4.

22 Sep. 05


Financial Intermediation*

10.1

11.8

15.9

17.5

21.0

9.3

0

5

10

15

20

25

2000 2001 2002 2003 2004 2005f

Source: National Institute of Statistics, National Bank of Romania

end of period, share of GDP

*) Non-government Credit/GDP

5.


-4.0

-3.2

-2.6-2.3

-1.1 -1.05

2000 2001 2002 2003 2004 2005t

Source: Ministry of Public Finance, National Institute of Statistics

General Government Deficit /GDP

percent(IMF methodology)

6.


Reserves and Debt Indicators

2.1

2.93.5 3.4

2.9

3.64.1

5.2

6.8 7.06.4 6.4

4.8

6.16.6

4.2

5.5 5.4

0

2

4

6

8

10

12

2000 2001 2002 2003 2004 200528 Sep.

Source: National Bank of Romania, Ministry of Public Finance

official foreign exchange reserves - months of goods-and-services imports

official reserves - months of goods-and-services imports

public and publicly guaranteed debt - months of goods-and-services exports

months

Note: For 2005, calculations based on prospective imports/exports of goods and services

July

7.


Source: National Bank of Romania, Ministry of Public Finance

M&LT External Debt

4 5 6 68

11

7

99 10

10

11

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

2000

2001

2002

2003

2004

Jul.

05

public and publicly guaranteed debt

private debt

EUR billion

11

18

1615

14

22

Total External Debt

1114

15 1618

221

11

2

4

4

0

2

4

6

8

10

12

14

16

18

20

22

24

26

282000

2001

2002

2003

2004

Jul.

05

*) majority private debt

M&LT debt ST debt*

EUR billion

12

1516

18

22

26

8. 9.


Public Debt Stock

22.4 20.9 21.2 20.916.7

14.0

9.27.9 7.8

6.0

6.1

5.0

0

5

10

15

20

25

30

35

40

2000 2001 2002 2003 2004 2005f

Source: Ministry of Public Finance, National Bank of Romania, National Institute of Statistics

0

5

10

15

20

25

30

35

40

domestic public debt / GDP

foreign public and publicly guaranteed debt / GDP

percent (IMF methodology) percent

19

22.8

26.92928.8

31.6

10.


Inflation Rate and Interest Rates

0

10

20

30

40

50Ja

n.0

2

Jul.0

2

Jan.0

3

Jul.0

3

Jan.0

4

Jul.0

4

Jan.0

5

Jul.0

5

Source: National Bank of Romania, National Institute of Statistics

percent

inflation rate (percentage change against the same year-earlier period)

average interest rate on RON-denominated loans of non-gov't, non-bank clients (% p.a.)

deposit rate (time deposits; % p.a.)

NBR's policy rate: 7.5% starting with 22 September 2005

11.


12a. Non-Government Credit

3.8 4.1 4.4 3.9

7.15.0

6.9 7.08.8

5.59.4

10.4

7.4

12.0

8.8 12.510.6

14.012.5

1.40.70.5

8.5

6.0

0

5

10

15

20

25

2000 2001 2002 2003 2004 2005f

percent of GDP

companies

households

foreign currency

ROL

Source: National Bank of Romania

9.3 10.1

11.8

15.917.5

21.0


Total Credit and Non-Government Credit (2)

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Jan.0

0

Jul.0

0

Jan.0

1

Jul.0

1

Jan.0

2

Jul.0

2

Jan.0

3

Jul.0

3

Jan.0

4

Jul.0

4

Jan.0

5

Jul.0

5

Source: National Bank of Romania, National Institute of Statistics

foreign exchange-denominated creditRON-denominated credittotal credit, net

defla

ted b

y C

PI,

Dec.

'99=100

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

Jan.0

0

Jul.0

0

Jan.0

1

Jul.0

1

Jan.0

2

Jul.0

2

Jan.0

3

Jul.0

3

Jan.0

4

Jul.0

4

Jan.0

5

Jul.0

5

RON million

to private companiesto householdsto state-owned companies

(in real terms)RON million

12b.

Documents

National Bank of Romania NATIONAL BANK OF ROMANIA 1