Limitations to Achieving Low Inflation with the Help of the Exchange Rate Anchor

The anchor role of the exchange rate, for which we appear to have found some evidence in the Hungarian case, obviously does not mean that any desirable low inflation rate or, ad absurdurn, the decreasing of the price level can be achieved by an appropriate choice of the rate of currency devaluation. There is no such rule for any anchor variable.

On the contrary, international experience suggests that bringing inflation down to low levels frequently involves macroeconomic and social costs that policy-makers find not worth incurring. Given backward looking expectations, as assumed in the Hungarian case, bringing inflation down from moderate to low rates may be costly in terns of foreign exchange reserves and employment. Once authorities decide that a given moderate rate of inflation is low enough to exclude the danger of hyperinflation but simultaneously high enough to avoid the costs associated with getting inflation down to low levels, they still have the task to provide ways for economic agents to live with moderate inflation and to avoid costly forecast errors in predicting future price level and exchange rate changes.

For this part of exchange rate policy, it is an explicit or implicit crawling peg type regime that may most appropriately serve those purposes (Dornbusch and Fischer,

1993).

Obviously, the crawling adjustment of the exchange rate must, from time to time, almost necessarily be supplemented by more sizeable adjustments for the following reasons. Any external shock that adversely affects the foreign currency earning capacity of the domestic economy will probably require an exchange rate adjustment in addition to the crawl.

Exchange Rate as Nominal Anchor in the Hungarian Case 11 1 Nonetheless, it may not be advisable to set the pace of the crawl so that it fully offsets unfavorable price differentials between home and abroad. Such a real exchange rate rule is likely to be built in inflation expectations and, thus, may be conducive to inflation getting out of control. (Montiel and Ostry, 1992). On the other hand, the allowance for some real appreciation when setting the pace of the crawl will induce companies in the vulnerable sectors to strengthen the non-price factors of their competitiveness in case the policy of (relative) exchange rate stability is credible (Marin, 1985). Also, the support of the labor unions is required so that there will be no wage increases that are not justified by a gain in productivity (Hochreiter and Knobl, 1991). However, if productivity is not improved or a consensus with the unions is absent, an adjustment of the exchange rate supplementary to the crawl can not be avoided. Of course, in case a sizeable exchange rate adjustment becomes inevitable, restrictive monetary and fiscal policies must be in place if the inflationary impact of the exchange rate adjustment is to be alleviated and the competitiveness effect is to be maintained.

An adjustable peg type system like the one outlined above can not be called a nominal anchor if the term is reserved for exchange rates fixed in the Austrian way. But it is a nominal anchor in the sense that once appropriately chosen and credibly maintained, it is capable of stabilizing exchange rate expectations and thus, as Hungarian experience suggests, may help control inflation.

6.5 Conclusion

In this paper, the possibility for using the exchange rate of the forint as a nominal anchor for the price level was examined. OLS was used to find that the exchange rate can and, in the period of observation, probably did serve as nominal anchor though not in the most commonly used sense of the term.

Notes

[I] As of 1 August, 1993, the basket contains 50% DEM and 50% USD.

[2] The discussion regarding the type of deflator most appropriate for the real effective exchange rate index of the Forint is beyond the scope of this paper.

[3] The explanatory variables were selected with the help of tests for Wiener-Granger causality between the dependent variable and a number of plausible explanatory variables including broad money. For different possibilities concerning the choice of price level anchors see Calvo and VCgh (1992). The lag structure of the explanatory variables was chosen on the basis of t-statistics.

[4] See previous footnote for explanation.

Table 6.1 Nominal and Real Effective Exchange Rate Index of the Forint, 1988-1993 (annual average for 1991 = 100) Jan. Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. Nominal effective exchange rate index Real effective exchange rate 1988 108.82 107.28 109.23 109.15 108.58 107.27 107.72 110.45 110.32 112.78 111.91 111.65 1989 107.04 106.19 106.81 113.15 113.92 112.91 112.84 110.18 109.32 110.35 110.47 121.16 1990 114.40 116.22 115.63 113.71 113.33 112.80 113.11 113.31 113.35 113.52 104.91 102.28 1991 104.69 104.20 99.36 97.76 97.20 95.18 95.60 95.36 96.75 97.52 102.97 104.28 1992 102.51 101.23 99.75 99.60 99.29 100.14 102.84 102.29 101.25 98.27 95.74 95.74 1993 92.23 92.09 92.77 95.76

Exchange Rate as Nominal Anchor in the Hungarian Case 113 Table 6.2 An OLS-Model of Producer Price Inflation in Industry

Sample period Explanatory variable Estimated coefficient T-statistic

Jan 90-Dec 92 INFLP. 1 0.364 2.961

Jan 90-Dec 92 PMOIL.3 0.085 4.298

Jan 90-Dec 92 PMMANUF.4 0.163 2.034

Jan 90-Dec 92 DEVEXP 0.28 1 3.214

'

Dependent variable: INFL (Producer prices)

DW(1) 1.983 DW(12) 1.784 F 4,31 10.098 R Bar Sq 0.51

Table 6.3 An OLS-model of Consumer Price Inflation

Sample period Explanatory variable Estimated coefficient T-statistic

Jan 90-Dec 92 INFLC. 1 0.333 3.021

Jan 90-Dec 92 INFLP 0.230 3.849

Jan 90-Dec 92 P M M ~ U F . ~ 0.089 2.443

Jan 90-Dec 92 CREDIT.7 0.501 2.758

Jan 90-Dec 92 R E P 0.01 2.38

'

Dependent variable: INFLC (Producer prices)

DW(1) 2.095 DW(12) 1.437 F 5,30 12.449 R Bar Sq 0.621

Table 6.4 List of Variables

INFLP producer prices, industry PMOIL prices of imported energy PMMANUF prices of imported manufactures

DEVEXP constructed variable for devaluation expectations INFLC consumer prices

CREDIT credit extended by the banking system to domestic agents

R E P dummy variable for price liberalization and fiscal reform measures that have a direct inflationary impact

Note: Figures after the names of variables, separated by dots, indicate the number of lags. All variables are first one-month differences of twelve-month differences in logarithmic form.

114 A. Szentgyorgy va'ri Table 6.5 Real Effective Exchange Rate Indices of the Forint

(previous year = 100)

Years Domestic Industrial Consumer GDP

industrial unit prices deflator

sales labor

price cost

Figure 6.1 The Real Effective Exchange Rate Index of the Forint, 1970-1991 (1973=100)

Exchange Rate as Nominal Anchor in the Hungarian Case

l-

Nominal effective exchange rote index ' ' ' Real effective exchange rote index

Figure 6.2 Nominal and Real Effective Exchange Rate Indices of the Forint, 1988-93

l-

Expectanon

- -

^'

-

Discrepancy

Figure 6.3 Indices of Expected Exchange Rate Changes (current month=100) and the Discrepancy between Official (=loo) and Black Market Exchange Rate of the Forint

A. Szentgyorgyvdri

1 - - - -

Mustrlal producer prices

-

Consumer prlces

1

Figure 6.4 Changes in Consumer and Industrial Producer Prices (same month of previous year = 100)

Observed

- - - -

Trend (&month rnovlng overage)

Figure 6.5 Actual Changes in the Exchange Rate of the Forint Relative to the Foreign Currency Basket

Exchange Rate as Nominal Anchor in the Hungarian Case

Figure 6.6 Simulation Results of Expected Changes in the Exchange Rate Relative to the Foreign Currency Basket of the Forint (same month of previous year = 100)

References

Calvo, G. and C. VCgh (1992): Inflation Stabilization and Nominal Anchors. Unpublished, Research Department, IMF.

Dornbusch, R. and S. Fischer (1993): Moderate Inflation. In: The World Bank Economic Review, Vo1.7., No. 1.

Hochreiter, E. and A. Knob1 (1991): Exchange Rate Policy in Austria and Finland - Two Examples of a Peg. Bank of Finland Discussion Papers, 191, No. 12.

Marin, D. (1985): Structural Change through Exchange Rate Policy. Welrwirtschaftliches Archiv, 198513.

Montiel, P. and J. Ostry (1992): Real Exchange Rate Targeting Under Capital Controls.

IMF Staff Papers, Vol. 39., No. 1.

Takagi, S. (1991): Exchange Rate Expectations. IMF Staff Papers, Vol. 38., No. 1.

Chapter 7

Im Dokument Stabilization Policies at Crossroads? An Interim Report From Central and Eastern Europe (Seite 126-135)