Inflation Targeting and the Pass‐through Rate in East Asian Economies

There has been serious debate regarding whether the inflation targeting (IT) framework for the emerging market economies has been an effective nominal anchor. Focusing on Korea, Thailand and the Philippines, this article aims to contribute to the debate by providing empirical evidence on a decline in the ‘pass‐through’ effect with IT adoption. Our main findings are as follows. First, under the IT framework, Korea has followed an inflation responsive rule in a forward‐looking manner, while Thailand has adopted the rule in a backward‐looking manner. Second, only Korea experiences a reduction in the pass‐through effect under IT adoption, thereby showing a linkage between the forward‐looking inflation responsive rule and the pass‐through effect. Finally, a test of the sensitivity of inflation expectations to external price shocks in Korea supports this linkage.     

Post-crisis monetary and exchange rate policies in Indonesia,Malaysia and Thailands

This paper surveys the post-crisis monetary and exchange rate policies of Indonesia, Thailand and Malaysia. Malaysia has pegged the ringgit while Indonesia and Thailand have adopted heavily managed exchange rates. Under their IMF programs, Thailand and Indonesia set base money targets, but Thailand has moved, and Indonesia is now moving, to inflation targeting, using interest rates as the short-term instrument. Malaysia also sets interest rates. The ability of the three central banks to set interest rates and also pursue an exchange rate target with an interest rate target has been bolstered by restrictions on the internationalisation of the domestic currency. The three central banks have also had to sterilise the monetary effects of their foreign exchange interventions. It is argued that inflation targeting is now a good policy choice, but that a more freely floating exchange rate would be better than sterilisation of balance of payments surpluses or deficits.     

What Drives Monetary Policy in Post-Crisis East Asia? Interest Rate or Exchange Rate Monetary Policy Rules

This paper estimates a simple small open macroeconomic model to analyse the effectiveness of monetary policy rules (MPRs) where either the nominal interest rate or the nominal exchange rate is the policy instrument. The aim is to ascertain which of those MPRs are best suited for a selection of inflation targeting economies of Asia. Normally, one would associate inflation targeting with interest rate rules but it is thought that, due to fear of floating, exchange rate rules may well be more effective given the openness of these economies. It is found that interest rate rules seem to better reflect the prevailing policy regime than exchange rate rules. It is also found that stronger relationships pertaining to the interest rate rules are found in the case of Korea and Thailand than for Indonesia and the Philippines. Exchange rates appear to be very influential in determining the value of the nominal interest rate but not in a policy sense.     

Exchange rates,price levels,and inflation targeting: Evidence from Asian countries

This study examines how the adoption of inflation-targeting influenced exchange rate pass-through and volatility in four Asian countries –Indonesia, South Korea, the Philippines, and Thailand – over the sample period of January 1990 to June 2007. We find that adopting inflation targeting helped reduce pass-through in South Korea, and Thailand, while the results are less clear for Indonesia and the Philippines. Nevertheless, the findings indicate that inflation targeting caused a decline in exchange rate volatility in all four countries. The important lesson from the experiences of these Asian countries is that the adoption of inflation targeting contributes to achieving the ultimate goal of inflation stability through reducing exchange rate pass-through or variability.     

Capital Inflows Problem in Selected Asian Economies in the 1990s Revisited: The Role of Monetary Sterilization*

This paper develops a simple model to examine the reasons behind the capital inflow surges into selected Asian economies in the 1990s prior to the financial crisis of 1997–98. The analytical model shows that persistent uncovered interest differentials and consequent capital inflows may be a result of complete monetary sterilization, perfect capital mobility, sluggish response of interest rates to domestic monetary disequilibrium, or some combination of all three. Using the model as an organizing framework, the paper undertakes a series of related simple empirical tests of the dynamic links between international capital flows, the extent to which they are sterilized and uncovered interest rate differentials in the five crisis‐hit economies (Indonesia, Korea, Malaysia, the Philippines and Thailand) over the period 1990:1–1997:5.     

Monetary autonomy in selected Asian economies: The role of international reserves

With the increased financial integration of Asian countries, monetary policy takes on the additional role of maintaining the stability of the financial system along with the traditional objectives of promoting growth and employment with price stability. Given the importance and relevance of monetary policy in Asian countries, we examine monetary autonomy and its interaction with financial integration, currency regimes and international reserves for the past two decades in the following Asian countries: Thailand, Korea, Indonesia, the Philippines, and India. The empirical analysis reveals two significant and interesting findings that have policy implications. First, Thailand, Korea and Indonesia, countries that have moved towards a floating currency regime, experienced simultaneous declines in the sensitivity of their interest rates (thereby increasing monetary autonomy), while India continues to increase the sensitivity of its interest rates with a pegged exchange rate and increased financial integration. Second, in all of the studied economies, the accumulation of international reserves has contributed, to some extent, to the retention of monetary autonomy in terms of preventing the sensitivity of the interest rates from rising. We speculate that the accumulation of reserves plays the role of an anchor for monetary autonomy in emerging market economies facing a “fear of floating”.     

Reactions to Shocks and Monetary Policy Regimes: Inflation Targeting Versus Flexible Currency Board in Sub‐Saharan Africa

The paper examines the monetary policy actions through which central banks in sub‐Saharan Africa have tried to eliminate the negative impacts of the shocks facing their economies. We compare two different monetary policy regimes: a currency board regime (in the CFA zone) and an inflation targeting policy regime (Ghana and South Africa) when central banks respond to demand, supply, and fiscal shocks. We extend the usual forecasting and policy analysis system models to replicate the economic features of these economies during the period 2002–12 and to evaluate the impact of several policies in response to these shocks. We find that both policies are inappropriate in helping the economies escape from the effects of negative demand shocks, both are essential when negative shocks to primary balance occur, while inflation targeting dominates the currency board regime as a strategy to cope with positive shocks to inflation.     

Exchange Rates and Economic Recovery in the 1930s: An Extension to Asia

Scholars have found a positive relationship between the magnitude of currency depreciation and the extent of recovery from the Great Depression for Europe and Latin America. The relationship between currency depreciation and economic activity during the Great Depression for Asian economies has not yet been explored. This paper examines this topic using data from 13 Asian economies: China, India, Indonesia, Iran, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand, Turkey, and Vietnam. We find that Asian economies responded in a similar way to currency depreciation during the Great Depression as did European and Latin American countries.     

Effectiveness and commitment to inflation targeting policy: Evidence from Indonesia and Thailand

The chief objective of our paper is to highlight basic features of the Information Technology (IT) policies adopted by Indonesia and Thailand, and to evaluate the commitment of the monetary authorities and the overall performances of the IT regime. The results demonstrate that the IT regime in these two economies has had some success, but not during the immediate aftermath of the Lehman Brothers’ collapse in the last quarter of 2008. Furthermore, the implementation IT policy in these economies has largely been “flexible” during the stable period, seeking the balance between narrowing the output gap, managing exchange rate volatility, and anchoring inflationary pressure. However during the turbulent period, there had been a heightened focus on anchoring inflationary expectations.     

Monetary policy shocks and exchange rates in Asian countries

In this paper, we empirically investigate the effects of monetary policy shocks on exchange rates in Asian countries. To do so, we use VAR models which impose sign restrictions on impulse responses to identify monetary policy shocks. We find that contractionary monetary policy shocks lead to significant exchange rate appreciation in Malaysia, the People’s Republic of China, and the Republic of Korea. However, in India, Indonesia, the Philippines and Thailand, we find either a significant depreciation or no significant effect. These results suggest that an interest rate increase (or decrease) may not necessarily shield Asian countries from exchange rate depreciation (or appreciation) pressure following a U.S. interest rate increase (or decrease).     

The Relationship Between Price Stability and Financial Stability: Evidence From Major Emerging Economies

We examine the relationship between price stability and financial stability for major emerging economies using a Markov regime-switching model. Empirical results suggest that monetary policy is consistent with the Taylor rule in all countries except for India and all countries followed both low and high inflation targeting monetary policy regimes. Low inflation targeting regime seems to be more persistent and has higher duration than high inflation targeting regimes except for Indonesia and South Africa. All countries seem to have had financial stability concerns when they formulated their monetary policy as the coefficient of the financial stress index is statistically significant at least in one regime. Overall the results suggest that Taylor rule-based monetary policies have been implemented to various degrees in major emerging economies to achieve economic stability, price stability, and financial stability.     

Terms of Trade Shocks and Inflation Targeting in Emerging Market Economies

Emerging market economies (EMEs) have persistently experienced different waves of commodity terms of trade disturbances, generating macroeconomic instabilities. The adoption of inflation targeting (IT) by many EMEs has raised questions about its relative suitability in dealing with these shocks compared with other monetary policy regimes. This paper tests the robustness of IT compared with monetary targeting and exchange rate targeting regimes in coping with commodity terms of trade shocks using the panel vector autoregressive technique. The results show that in general, IT countries respond better to commodity terms of trade shocks especially with respect to inflation and output gap. However, exchange rates are more volatile in IT countries than in exchange rate targeting countries. The results suggest that EME countries can reduce the adverse effects of commodity terms of trade fluctuations when they adopt IT, but they also need to pay attention to exchange rate movements.     

Is monetary policy non‐linear in Indonesia,Korea, Malaysia,and Thailand? A quantile regression analysis

There is a growing literature on the linearity or otherwise of monetary policy in industrialised countries. The investigations have revealed that the reactions of central banks to economic variables depend on the level of the variables, confirming the non‐linearity of monetary policy in these countries. However, research into whether monetary policy is non‐linear in emerging markets has been hampered by the lack of data, as a stable, ‘modern’ monetary regime has existed in emerging markets for only a relatively short time. Employing quantile regression, which is not as constrained as other regression methods by the shortness of time series, we investigate the non‐linearity of monetary policy in four emerging Asian nations: Indonesia, Korea, Malaysia, and Thailand. Our results indicate that monetary policy in all four is non‐linear. All display a ‘hump‐shaped’ response to inflation across the quantiles—policy becomes tighter, going from lower to higher quantiles, reaches a peak, and then becomes looser. These results are similar to those found previously in Japan, and likely arise from a desire to limit exchange rate appreciation, as all four countries depend heavily on exports.     

Monetary Policy Implementation and Volatility Transmission Along the Yield Curve: The Case of Kenya

This paper analyses the degree to which volatility in interbank interest rates leads to volatility in financial instruments with longer maturities (e.g. T‐bills) in Kenya since 2012, year in which the monetary policy framework switched to a forward‐looking approach, relative to seven other inflation targeting (IT) countries (Ghana, Hungary, Poland, South Africa, Sweden, Thailand and Uganda). Kenya shows strong volatility transmission and high persistence similar to other countries in transition to a more forwardlooking monetary policy framework. These results emphasize the importance of a strong commitment to an interbank rate as an operational target and suggest that the central bank could reduce uncertainty in short‐term yields significantly by smoothing out the overnight interest rates around the policy rate.     

An evaluation of the saving,investment, and current account balances of five ASEAN economies

This paper evaluates the saving, investment and current account balances (CABs) of five ASEAN economies: Thailand, Singapore, Indonesia, Malaysia and the Philippines over the period 1976 to 1997. The method is to apply a calibrated representative agent model of optimal saving and investment to each of these economies. The model generates optimal saving, investment and CABs for each year from 1976 to 1997 and these are compared with the actual balances. The results suggest that three of the ASEAN countries—Malaysia, the Philippines and Thailand—had below-optimal current account ratios (to GDP) on average over the period 1976 to 1997, for most reasonable values of parameters. This was the result of over-investment for Malaysia and Thailand and under-saving by the Philippines. For Singapore and, to a lesser extent Indonesia, the reverse applies—their current account ratios were above-optimal on average due to over-saving.     

The impact of financial development on the effectiveness of inflation targeting in developing economies

An ever-increasing number of developing economies with varied levels of financial development have adopted Inflation Targeting (IT) frameworks to guide monetary policy. Using a panel dataset of 54 developing economies over the period 1980 to 2015 (30 of which have IT frameworks), we re-visit the rather controversial issue of whether adoption of an IT framework leads to superior outcomes in terms of reducing inflation and its variability. After controlling for potential endogeneity and self-selection concerns of policy adoption, our main empirical finding is that IT frameworks appear to reduce inflation rates in developing economies regardless of the level of financial development, while it reduces variability of inflation rates only when we control for levels of financial market development. We further find that the effectiveness of IT framework on inflation is highly dependent on financial inclusion and bank characteristics, while the effect on inflation variability is more associated with components of capital market development.     

TOWARDS IMPLEMENTATION OF INFLATION TARGETING IN INDONESIA

The experience of high inflation accompanying the economic crisis in 1998 has brought back painful memories of hyperinflation in the 1960s. Success with inflation targeting (IT) in other countries has prompted Indonesia to consider this framework as the basis for monetary policy,a response that seems justified on at least two grounds. First, monetary policy needs a new anchor after the abandonment in 1997 of the previous regime of managed floating. Second, the central bank law enacted in 1999 prescribes stability of the value of the rupiah as Bank Indonesia's sole objective. This paper explores the future framework of monetary policy under a formal IT approach and highlights the constraints Bank Indonesia faces in implementing such an approach. It discusses the monetary policy framework before and during the crisis, and in the post-crisis period. It then goes on to outline a preliminary design for a suitable IT framework for Indonesia.     

Inflation targeting in Indonesia, 1999–2012: an ex-post review

Around the end of 1999, Bank Indonesia (BI) adopted inflation targeting as part of its approach to monetary policy. This article reviews the experience up to 2012, examines BI's performance in hitting its inflation targets and considers certain broader indicators of success. Overall, inflation targeting in Indonesia has been a messy, evolutionary process, and BI's implementation record compares unfavourably with that of its peers. Yet Indonesia recorded a significant downward trend in inflation during this period and maintained strong economic growth. Also, almost all of its inflation-targeting arrangements are now in line with common international practice. Looking ahead, this article offers suggestions for sustaining progress in inflation targeting, such as setting more ambitious targets in the outer years and implementing strong policies to reduce inflation further, including after large administrative price shocks.     

IS EAST ASIA FIT FOR AN OPTIMUM CURRENCY AREA? AN ASSESSMENT OF THE ECONOMIC FEASIBILITY OF A HIGHER DEGREE OF MONETARY COOPERATION IN EAST ASIA

This paper attempts to make a contribution to the recent search for a suitable assessment of the economic feasibility of a higher degree of monetary cooperation in East Asia. By using a structural vector autoregression approach as well as a generalized purchasing power parity approach, we find that a larger group of appropriately selected East Asian economies does satisfy the macroeconomic conditions for forming an Optimum Currency Area (OCA). The East Asian group consists of four ASEAN countries (Indonesia, Malaysia, Singapore, and Thailand) and four Northeast Asian economies (Hong Kong SAR, Japan, Republic of Korea, and Taiwan). This finding presents a striking contrast to the existing research results whose policy recommendation has generally been that countries in East Asia should start with a smaller subgroup currency area. It is time that many East Asian economies as a region made a serious effort to pursue a higher degree of monetary cooperation among themselves for forming an OCA.     

Unemployment hysteresis in the East Asia‐Pacific region: new evidence from MADF and SURADF tests

This study re‐examined the unemployment hysteresis hypothesis in the context of twelve countries in the East Asia‐Pacific region, namely Australia, China, Guam, Hong Kong, Indonesia, Japan, Malaysia, New Zealand, the Philippines, Singapore, South Korea, and Thailand. It employed the multivariate augmented Dickey–Fuller test and the seemingly unrelated regression augmented Dickey–Fuller test for this purpose. The empirical results confirmed the presence of unemployment hysteresis in these countries, except in South Korea and New Zealand. The findings indicated that the equilibrium rate of unemployment in the East Asia‐Pacific region tended to be path dependent and that cyclical fluctuations in these countries' economies could have permanent effects on the level of unemployment. These results provide additional empirical proof of the validity of the hysteresis hypothesis.