Monetary Policy Decision Making at the NBU

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Monetary Policy Decision Making at the NBUKSE Open LectureKYIV, June 04, 2015Sergiy NikolaychukDirector of Monetary Policy and Economic Analysis DepartmentNational Bank of Ukraine NATIONAL BANK OF UKRAINE Contents2Overview of monetary policy framework in UkraineDecision making bodies on monetary policyNBU CouncilNBU BoardMonetary Policy Committee (MPC)Monetary Policy Committee meetings (agenda, inputs, deliveries)Forecasting process at the NBUModeling toolkit Quarterly Projection ModelSatellite (econometric) models Further steps DSGE modelNATIONAL BANK OF UKRAINE Overview of monetary policy framework: theory3Main goal of Monetary Policy is ensuring the stability of the national currency:that is necessary precondition for high and sustainable economic growth

Options:Discretion Rules (based on targets)ER (currency board, hard peg etc.)monetary aggregates inflationImpossible TrinityCapital mobilityIndependent MPFixed ERNATIONAL BANK OF UKRAINE Overview of monetary policy framework in Ukraine: evolution4

Managed floating with no preannounced path for the EROther conventional fixed peg arrangements

Other managed arrangements (de jure - flexible ER)Stabilized arrangements (de jure - flexible ER, de facto - ER anchor to U.S. dollar)Floating

Exchange rate anchorMonetary aggregate targetNATIONAL BANK OF UKRAINE Stabilization of FX market / Disinflation Successful implementation of IMF programReplenishment of international reservesGradual elimination of administrative measuresCurrent TARGETS TO ACHIEVEStage 1. Monetary targeting (framework of IMF program):accumulation of International reservestargets on NDA and NIRflexible exchange ratedisinflation.

Stage 2. IT lite:price stability (1-digit target)accumulation of International reservesinterest rate as a key instrument

Stage 3. Full-fledged IT:price stability (1-digit target)floating exchange rate

Future evolution of MP regime and goals Establishment of Monetary Policy Committee which makes decisions:Clear and transparentForward-lookingAnalytically supported

More transparent and market-friendly MP instruments frameworkIntroduction of Key policy rate and working o/n corridorLiquidity providing / absorbing auctionsRequired reserves

Avoiding of multiple currency practicesImprovements that already doneOverview of monetary policy framework in Ukraine: next steps5NATIONAL BANK OF UKRAINE Analysis of data, forecasts, policy analysisMonetary Policy decision making in the past: reactive policy 6Collection of data and information about lower frequency economic eventsBoard/MPCPolicy Decision about the operational targetsDecisions about the levels of individual instrumentsOperations in the money and FX marketsMP Formulation and ImplementationNATIONAL BANK OF UKRAINE 6Analysis of data, forecasts, policy analysisMonetary Policy decision making now and further: preemptive policy 7Collection of data and information about lower frequency economic eventsBoard/MPCPolicy Decision about the operational targetsDecisions about the levels of individual instrumentsOperations in the money and FX marketsMP ImplementationMP FormulationNATIONAL BANK OF UKRAINE 7Decision-making bodies8

responsible for developing the Monetary Policy Guidelines and supervision of monetary policy implementationthe decisions with regard to the Monetary Policy Guidelines are mandatory for the NBU BoardNBU Councilin accordance with the MP Guidelines implements the MP using appropriate monetary instrumentsorganizes execution of other functions and manages the activities of the NBUNBU Boardan advisory body responsible for drafting proposals on formulating the monetary policy to be submitted to the Board of the National Bank for approvalMPCNATIONAL BANK OF UKRAINE Decision making bodies on monetary policy: NBU Council 9NBU Council elaborates the Monetary Policy Guidelines, makes them public, submits them annually (till the 15th of September) to the Parliament of Ukraine, and exercises control over monetary policy implementation. NBU Council can submit recommendations for consideration by NBU Board.Under Draft Law on NBU the Council will be reformed: optimized by size (9 members) more power and responsibilities stricter criteria's for candidatesNBU Council consists of 15 MembersGovernor of the NBU7 members appointed by the President7 members appointed by the Parliament experience (10 years) no representative mandate in other bodies no commercial interests in financial industry Candidates for position in the Board need to fulfill certain criteria's:NATIONAL BANK OF UKRAINE Decision making bodies on monetary policy: NBU Board 10NBU Board ensures implementation of monetary policy, organizes exercise of the other functions in accordance with Law and manages the activities of the National Bank.

experience (10 years);no representative mandate in other bodies;no commercial interests in financial industry.Under Draft Law on NBU the Council will be reformed to Executive Committee: optimized by size (6 members only Governor and Deputies) more independence for Board membersNBU Board consists of 11 personsThe GovernorDeputy GovernorsDirectors of the Departments involved in implementation of main function of the NBUCandidates for position in the Board need to fulfill certain criteria's:NATIONAL BANK OF UKRAINE Decision making bodies on monetary policy: members of MPC 11NBU CouncilMonetary Policy and Economic Analysis DepartmentStatistics and Reporting DepartmentFinancial Stability Department Banking Supervision DepartmentFinancial Monitoring DepartmentRegistration and Licensing Department Methodology DepartmentInternational Relations DepartmentDeputy GovernorOpen Market Operations Department Accounting DepartmentOffice for Banking System Strategy and ReformFinancial Controlling DepartmentCash Circulation Department Payment Systems DepartmentInformation Technologies DepartmentInternal Audit DepartmentLegal DepartmentPersonnelDepartmentRisk Management DepartmentCorporate Services DepartmentNBU GovernorDeputy GovernorDeputy GovernorDeputy GovernorOperational DepartmentRegional OfficesProcurement and Logistics Department Information Security DepartmentRetail Payments DepartmentFirst Deputy GovernorBanking Inspection DepartmentLoan Management DepartmentDivision for Custodial Accounting of Government SecuritiesOrganizational Chart of the National Bank of UkraineNBU Central Clearing HouseMain Administration and Maintenance OfficeTeam for International Credit Line Management of NBUUniversity of Banking of NBUUkrainian Academy of Banking of NBUNBU Council OfficeDepartment of the Corporate Non-State Pension Fund of NBUSecurity DepartmentGuard of NBUSites Located in KyivClassified Records DivisionNATIONAL BANK OF UKRAINE MPC meetings122-days long:1 day - staff technical presentations and discussions2 day formulation of recommendations and NBU Boards approval

WednesdayThursdayMorningMacroeconomic Overview and ForecastPresentation on Staff`s Policy recommendations

Policy discussion(Advisory Voting)AfternoonMarkets Stance

Financial Stability IssuesBoard approvalPress release / Press conferenceNATIONAL BANK OF UKRAINE Forecasting Process at the NBU (1)13ParticipantsForecasting groupMPC membersCurrent situation assessment (1 week)Current economic situation assessment+Assumptions approving (1 week)Update of forecasting methods and forecast assumptions+Presentation of assumptions to MPC members and approval+Work on baseline scenario (2 weeks)Baseline forecast development+Presentation of forecast and alternative scenarios assumptions to MPC members+Update of forecast+Work on alternative scenarios (1.5 weeks)Alternative forecast development+Work on the Inflation Report (4 weeks)Inflation Report finalization+Presentation of the report to MPC+Inflation Report publication and final meeting+NATIONAL BANK OF UKRAINE Forecasting Process at the NBU (2)Near-term models and expert forecastNTF Inflation, GDP, EURROL etc.Assessment of initial conditions and medium-term trends Exogenous variables forecasts (Assumptions) Trends & GapsMedium-term(core)model - QPMExpert judgments/ additional models Finalmedium-term forecastAnticipated shocks, fiscal impulse, etc.Near-term forecastTuningUncertainty Data BaseNATIONAL BANK OF UKRAINE Modeling toolkit: general overview15The Banks use of economic models is pragmatic and pluralist. In an everchanging economy, no single model can possibly assimilate in a comprehensible way all the factors that matter for policy. Forming judgments about those factors, and their implications for policy, is the job of the Committee, not something that can be abdicated to models or even to modellers. But economic models are indispensable tools in that processEddie George (former Governor of the Bank of England), 1999.Essentially, all models are wrong, but some are usefulGeorge Box, 1987a tool for current economic analysis and policy alternatives developmenta basis for forecasting process (combining empirical data, expert judgments and short-term forecasts into the common middle-term forecast).determining path of policy instrumentsassessing forecast uncertainty (confidence intervals and risks of scenarios)NATIONAL BANK OF UKRAINE Quarterly Projection Model: main features16QPM is a small semi-structural model with dynamic New Keynesian theory in a nutshellad-hoc structure (follows by microeconomic principles derived equations but do not use such approach explicitly)forward looking variables, thus is not subject to Lucas criticsThe origins of the model came from QPM of the Bank of Canada and Czech National Bank (similar models are used by central banks of Serbia, Armenia, Slovak Republic and many others)Describes monetary policy transmission mechanism policy channels and is not neutral to monetary shocks in short and middle runQPM reflects monetary policy neutrality and consistent with inflation target in long runThe model is calibrated (both - parameters and steady state values)NATIONAL BANK OF UKRAINE Quarterly Projection Models: trends and gaps17The concept of the model is the state space representation of macroeconomic variables where trends and gaps are unobservable components (state variables)State variables are linked together by putting to relationships the same theory as in nutshell QPM modelAdvantages:allows to explain gaps in terms of other variables has a low sensitivity to sample length and number of parameters NATIONAL BANK OF UKRAINE 17Quarterly Projection Model: main equations18IS curve (output gap equation)Forward-looking expectation augmented Phillips curvecore CPI inflation raw food inflationadministratively regulated pricesfuel pricesUIP condition (nominal exchange rate and interest rate relationship)Monetary policy rule (hybrid rule - sets incomplete control of FX or money market)under fixed exchange rateunder flexible exchange rate (pure Taylor rule)combination of rules under relaxing peg but incomplete control of money marketNATIONAL BANK OF UKRAINE 18Quarterly Projection Model: structure19

NATIONAL BANK OF UKRAINE 19Satellite (econometric) models20

An automated system with a combination of forecasts from the unconditional average, random walk, autoregressive models, ordinary VARSmall structural econometric models for components of inflation (including the connection between food inflation and the core inflation, producer and consumer inflation)Bayesian VAR and FAVAR (for current quarter GDP estimation)VECM for external trade variablesRegular short-term forecasting modelsAssessment of fiscal policy structural and cyclical componentAssessment of equilibrium REERModels for financial stability needs (modeling the non-performing loans)Understanding the monetary policy stance with monetary aggregates volumesModeling the impact of harvest changes on the food pricesAdditional (for special purposes) modelsNATIONAL BANK OF UKRAINE Further steps transition to DSGE model21QPM is rather reliable and powerful tool for middle-term forecasting and policy analysisStill it lacks rigor and some very modern theoretic features(financial accelerator etc.) We develop new generation model (DSGE type) that should replace the QPM, but the project hasn't been finished yetBesides now traditional agents (households, firms) we are going to introduce banking sector that will allow to model financial sector imbalances and its consequencesNATIONAL BANK OF UKRAINE Key messages to retain22NBU has a program to cope with the current turmoil, the program is supported by IMF, WB and other IFIs;We are serious in strengthening the institutional capacity of NBUThat are the crucial preconditions for transition to Inflation targeting and maintenance of price stabilityEnhancing the monetary policy decision making process is one of such important preconditionsSignificant progress is already achieved in different subareas (MPC establishment, macroeconomic analysis and forecasting as the basis for MP decisions, publication of macroeconomic forecast of the NBU in the Inflation Report etc.)But a lot of technical and policy work is ahead And the NBU needs the injection of the brilliant young economists, analysts, researchers so you are very welcome:Serhii.Nikolaichuk@bank.gov.ua NATIONAL BANK OF UKRAINE Short-term interest rate

UAH/USD

UIP

Risk premium

Foreign interest rate

Long-term interest rate

Real interest rate

Real interest rate gap

Trend of real interest rate

NEER

REER

REER gap

Output gap

Imported inflation

Core inflation

Food inflation

Admin. inflation

Changes of fuel prices

Inflation

USD/EUR

USD/RUR

Foreign inflation

Spread

Trend of REER

Oil prices

Metal prices

Terms of trade

GDP

Trend of GDP

Inflation expactations