Monetary Policy in Colombia - World...

Monetary Policy in Colombia

Trade offs and policy dilemmas

Jorge Toro

Head of the Economics Studies Department

Banco de la República, Colombia

Lima, June 16, 2008

Source: DANE, Banco de la República.

Annual Inflation - Headline (%)

3,03,54,04,55,05,56,06,57,07,58,0

May

-03

Aug

-03

Nov

-03

Feb-

04M

ay-0

4A

ug-0

4N

ov-0

4Fe

b-05

May

-05

Aug

-05

Nov

-05

Feb-

06M

ay-0

6A

ug-0

6N

ov-0

6Fe

b-07

May

-07

Aug

-07

Nov

-07

Feb-

08M

ay-0

8

By the last quarter of 2006 inflationary pressures started to show up. The inflation target was missed in 2007 and current inflation continues well above the target range.

Source: DANE, Banco de la República.

Most of inflationary pressures are explained by an increase in food prices, with contribution to total inflation in 2007 of

46%. Oil prices, has also put pressure on inflation

Regulated InflationAnnual %

0,02,04,06,08,0

10,012,014,016,018,0

may

-03

sep-

03

ene-

04

may

-04

sep-

04

ene-

05

may

-05

sep-

05

ene-

06

may

-06

sep-

06

ene-

07

may

-07

sep-

07

ene-

08

may

-08

Regulated Fuel and transport Remainder

Headline Inflation and Food Inflation (%)

6,39

9,73

4

6

8

10

12

May-02 May-03 May-04 May-05 May-06 May-07 May-08

Headline Food

Measures of core inflation

3,0

4,0

5,0

6,0

7,0

8,0

9,0

may

-03

ago-

03

nov-

03

feb-

04

may

-04

ago-

04

nov-

04

feb-

05

may

-05

ago-

05

nov-

05

feb-

06

may

-06

ago-

06

nov-

06

feb-

07

may

-07

ago-

07

nov-

07

feb-

08

may

-08

Core 20 Excluding food

Excluding: perishable foods, fuel and utilities Excluding food and regulated

Copy USA

Source: DANE and Banco de la República.

Nonetheless, there are more than supply shocks in the explanation of inflation. In fact, different measures of core inflation show an upward trend. Hence, excess demand

has also played an important role.

Inflation of tradable goods (excluding food and regulated) remains positive, hovering around 2%, despite the sharp appreciation of the peso (11.8% in the last 12 months).

Non-tradable goods inflation is stagnant above 5%Inflation Tradable and Non-Tradable

Excluding Food and Regulated (Annual %)

1,0

2,0

3,0

4,0

5,0

6,0

7,0

May

-04

Aug

-04

Nov

-04

Feb-

05

May

-05

Aug

-05

Nov

-05

Feb-

06

May

-06

Aug

-06

Nov

-06

Feb-

07

May

-07

Aug

-07

Nov

-07

Feb-

08

May

-08

Tradables Non-tradables

Source: DANE and Banco de la República.

Source: DANE, Banco de la República.

Difussion Indicator

0%10%

20%30%40%

50%60%

70%80%

Apr

-03

Jul-0

3

Oct

-03

Jan-

04

Apr

-04

Jul-0

4

Oct

-04

Jan-

05

Apr

-05

Jul-0

5

Oct

-05

Jan-

06

Apr

-06

Jul-0

6

Oct

-06

Jan-

07

Apr

-07

Jul-0

7

Oct

-07

Jan-

08

Apr

-08

The diffusion indicator, that is, the weighted percentage of items of the consumer’s basket whose annual inflation

is above the mid-point target range, reaches 70 percent

Inflation Expectations 12 Months Ahead

The rise in inflation an its diffusion to many goods, have increased inflation expectations and have reduced the

credibility on the inflation target

5,33

3,8

4

4,2

4,4

4,6

4,8

5

5,2

5,4

May

-05

Aug

-05

Nov

-05

Feb-

06

May

-06

Aug

-06

Nov

-06

Feb-

07

May

-07

Aug

-07

Nov

-07

Feb-

08

May

-08

Source: Banco de la República.

GDP vs Aggregate Demand

8,1

10

1

3

5

7

9

11

Mar

-04

Jun-

04

Sep-

04

Dec

-04

Mar

-05

Jun-

05

Sep-

05

Dec

-05

Mar

-06

Jun-

06

Sep-

06

Dec

-06

Mar

-07

Jun-

07

Sep-

07

Dec

-07

Demand

GDP

Source: DANE, Banco de la República.

%

Inflation accelerated in a context of rapid economic growth, supported by a vigorous demand.

Source: DANE, Banco de la República.

Expansion of aggregate demand is explained by a strong investment and consumption growth, associated with a rise

of market confidence

Investment Growth (%)

15,8

28,2

-10

0

10

20

30

40

2000 2001 2002 2003 2004 2005 2006 2007

Private Public

Consumption Growth (%)

5,0

6,67,3

2,1

4,32,9

-2

0

2

4

6

8

2000 2001 2002 2003 2004 2005 2006 2007

Private Public

In addition, favorable terms of trade induced a rapid exports growth

Source: DANE

Terms of Trade 1994 = 100

70

80

90

100

110

120

130

140

150

abr-

80

abr-

82

abr-

84

abr-

86

abr-

88

abr-

90

abr-

92

abr-

94

abr-

96

abr-

98

abr-

00

abr-

02

abr-

04

abr-

06

abr-

08

Exports Growth - Annual Variation (12 Months Cumulative)

-20%

-10%

0%

10%

20%

30%

40%

50%

Dic

-95

Dic

-96

Dic

-97

Dic

-98

Dic

-99

Dic

-00

Dic

-01

Dic

-02

Dic

-03

Dic

-04

Dic

-05

Dic

-06

Dic

-07

Strong demand resulted in an increasingly positive output gap, despite a rise of potential GDP. Output gap is currently estimated in a range of [2.0 - 2.5] percent.

GDP and Potential GDP

-6%

-4%

-2%

0%

2%

4%

6%

8%

Dic

-79

Dic

-81

Dic

-83

Dic

-85

Dic

-87

Dic

-89

Dic

-91

Dic

-93

Dic

-95

Dic

-97

Dic

-99

Dic

-01

Dic

-03

Dic

-05

Dic

-07

GDP Potential GDP

Output Gap

-6%-5%-4%-3%-2%-1%0%1%2%3%4%

Dic

-79

Dic

-81

Dic

-83

Dic

-85

Dic

-87

Dic

-89

Dic

-91

Dic

-93

Dic

-95

Dic

-97

Dic

-99

Dic

-01

Dic

-03

Dic

-05

Dic

-07

HPP

Source: Banco de la República.

Interbank rate and Central Bank Rate

5,0%

6,0%

7,0%

8,0%

9,0%

10,0%

May

-03

Nov-

03

May

-04

Nov-

04

May

-05

Nov-

05

May

-06

Nov-

06

May

-07

Nov-

07

May

-08

Interbank rate Repo-rate

In a context of rapid growth and inflationary pressures, the central bank decided in April 2006, to start a gradual raise of interest rates. From an initial level of 6%, interest rates

have been increased to 9.75%.

j3

Slide 12

j3 faltajechavso, 12/03/2007

The rise in the central bank rate was eventually reflected in higher of market rates and in a slowdown of credit growth

Credit Growth(Annual %)

-20%

0%

20%

40%

Apr-02 Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08Total Mortgage Consumption Commercial

Nominal Rates (%)

5

7

9

11

13

15

17

19

May

-00

May

-01

May

-02

May

-03

May

-04

May

-05

May

-06

May

-07

May

-08

10

12

14

16

18

20

22

Deposit RateBanrep RateCredit Rate

At the same time, higher interest rates widened the interest rate differential. Nonetheless, portfolio flows were discouraged

by capital controls. Most capital inflows are FDI.

Central Bank Interest Rates

0

2

4

6

8

10

12

14

16

18

20

May

-99

Feb-

00

Nov

-00

Ago

-01

May

-02

Feb-

03

Nov

-03

Ago

-04

May

-05

Feb-

06

Nov

-06

Ago

-07

May

-08

FED RateBanrep Rate

Net Capital Flows - ColombiaMonthly Flows (US$ millions)

-500

-200

100

400

700

1000

1300

1600

Ene

06

Abr

06

Jul 0

6

Oct

06

Ene

07

Abr

07

Jul 0

7

Oct

07

Ene

08

Abr

08

FDIPortfolioTotal

Source : Banco de la República

Despite active intervention in the foreign exchange market, appreciation of the Colombian peso has turned

unstoppable.

Nominal Exchange Rate

LATAMLast Month Year to Date Year to Year Last 3 Years

Colombia -4,27% -15,52% -11,80% -27,24%Brasil -1,48% -7,86% -16,73% -32,93%

México -0,92% -4,79% -5,71% -4,28%Argentina -3,62% -3,10% -0,69% 6,03%

Perú 5,28% -2,84% -8,15% -10,42%Uruguay -2,43% -9,64% -18,14% -18,53%

Chile 6,43% -0,28% -6,32% -15,80%

Changes in Exchange Rates Against the US$

Ineffectiveness of Forex intervention was partly due to conflicting signals provided by a contractionary monetary

policy and an expansionary intervention policy. The weakening dollar added pressure on the peso.

-900

-600

-300

-

300

600

900

1,200

1,500

1,800

2,100

ene-

00ab

r-00

jul-0

0oc

t-00

ene-

01ab

r-01

jul-0

1oc

t-01

ene-

02ab

r-02

jul-0

2oc

t-02

ene-

03ab

r-03

jul-0

3oc

t-03

ene-

04ab

r-04

jul-0

4oc

t-04

ene-

05ab

r-05

jul-0

5oc

t-05

ene-

06ab

r-06

jul-0

6oc

t-06

ene-

07ab

r-07

jul-0

7oc

t-07

ene-

08ab

r-08

5

6

7

8

9

10

11

12

13

Intervención Neta Mensual sin GNC

Tasa Repo de Expansión Mensual Prom.

TIB Promedio Mensual Metodologia BR

Intervention in the Exchange Market Central Bank Rate and Interbank rate

Rapid economic growth and appreciation of the peso have resulted in an increasingly current account deficit.

Source: Banco de la República

( j )

-6

-5

-4

-3

-2

-1

0

1

2

319

92

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

e

Current Account as a Percentage of GDP

-3.7%

Despite a firm contractionary monetary policy, inflationary pressures remains strong

Core Inflation Indicators

3,0

3,5

4,0

4,5

5,0

5,5

6,0

May

-06

Jul-0

6

Sep-

06

Nov

-06

Ene-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Ene-

08

Mar

-08

May

-08

Núcleo 20With Out FoodWith Out Perishable Food, Fuel and Public ServicesWith Out Food and EnergyCore USA

Source: Banco de la República

Headline Inflation and Food Inflation (%)

6,39

9,73

4

6

8

10

May

-06

Jul-0

6

Sep-

06

Nov

-06

Ene-

07

Mar

-07

May

-07

Jul-0

7

Sep-

07

Nov

-07

Ene-

08

Mar

-08

May

-08

Headline Food

UC1

Slide 18

UC1 Dr. Toro, en esta gráfica usé los dos últimos años, en lugar del último año, porque en este último casi no se observa variación.Usuario Computacional, 06/12/2008

At the same time, there are clear symptoms of a recent slowdown of economic activity, while appreciation of

the peso is turning more acute

Uncertainty on the evolution of the world economy, and on its impact on emerging economies, makes particularly difficult at this juncture to assess the right direction of

monetary policy.

Commodities With Out Oil - Price Index

7090

110130150170190210

Dic

-95

Dic

-96

Dic

-97

Dic

-98

Dic

-99

Dic

-00

Dic

-01

Dic

-02

Dic

-03

Dic

-04

Dic

-05

Dic

-06

Dic

-07

Dic

-08

Dic

-09

Source: EIU

April Projections

International Risk Aversion

8

12

16

20

24

28

32

19/0

2/06

19/0

4/06

19/0

6/06

19/0

8/06

19/1

0/06

19/1

2/06

19/0

2/07

19/0

4/07

19/0

6/07

19/0

8/07

19/1

0/07

19/1

2/07

19/0

2/08

19/0

4/08

95

100

105

110

115

120

125

VIX JPY/USD

Source Bloomberg

In these circumstances, monetary authorities, both in Colombia, an in many other emerging economies, face challenging dilemmas:

1. Rising interest rates could exacerbate appreciation, but might also be required to tame inflationary pressures

2. Rising interest rates might be deemed indispensable to contain inflationary pressures, but entails the risk of inducing an excessive contraction of economic activity

The dilemma between relaxing or continue tightening could only be solved with more

information, as time goes by, but postponing necessary decisions could threaten economic

stability.

This is a hard time for policymakers