1. Art and Diseño

Monetary Policy Implementation During US Policy Normalization
Javier Guzmán Calafell, Deputy Governor, Banco de México
JP Morgan Investor Seminar
Washington, DC, 10 October 2014
1
Outline
1
Introduction
2
Monetary Policy in 2014-15
a. The External Environment
b. Domestic Conditions
3
Beyond 2015
Monetary Policy Implementation During US Policy Normalization
2
Since 2001, monetary policy in Mexico is implemented under an
inflation targeting regime.
In this context:

A permanent inflation target of 3 percent, with a variability
interval of +/- 1 percent, has been set.

A systematic analysis of inflation and its determinants is carried
out, on the basis of a wide range of indicators and tools.

The efficient convergence of inflation to the target (i.e. at the
lowest possible cost in terms of economic activity) is sought.
It is also worth noting that in the aftermath of the global financial
crisis, the Banco de México, in coordination with other authorities,
is attaching increasing relevance to financial stability.
Monetary Policy Implementation During US Policy Normalization
3
With the support of major efforts on the fiscal side, such a strategy
has allowed continued progress in the reduction of inflation…
Headline Inflation and Overnight Interbank Interest Rate
Annual %
Sep
Introduction
of inflation
targeting
60
9
Sep
8
50
7
Overnight interbank interest rate1/
40
6
5
30
4
20
3
Headline inflation
Headline inflation
2
10
1
2014
2013
2012
2011
2010
2009
0
2008
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
0
Source: Banco de México.
1/ Target for the overnight interbank interest rate adopted on 21 January 2008.
Monetary Policy Implementation During US Policy Normalization
4
…and to maintain stable medium and long term inflation
expectations even in the presence of substantial shocks.
Inflation Expectations and Inflation Shocks
Annual %
60
16
Sep
50
MXN/USD Exchange Rate
Fruits and Vegetables
40
14
Inflation Expectations:
12 months
2 years
4 years
12
2014
2013
2012
2011
2010
0
2009
-20
2008
2
2007
-10
2006
4
2005
0
2004
6
2003
10
2002
8
2001
20
2000
10
1999
30
Sources: Banco de México and INEGI.
Monetary Policy Implementation During US Policy Normalization
5
Outline
1
Introduction
2
Monetary Policy in 2014-15
a. The External Environment
b. Domestic Conditions
3
Beyond 2015
Monetary Policy Implementation During US Policy Normalization
6
Since Mexico´s economy is very open, the implementation of
monetary policy is heavily influenced by external developments.
Trade Openness
Exports and Imports as % of GDP, 2013
63.4
Financial Openness
Chinn-Ito Index1/, 2012
90
1.0
80
0.9
70
0.8
0.69
0.7
60
0.6
50
0.5
40
0.4
Source: Own calculations with data from World Economic Outlook and
Direction of Trade Statistics, IMF.
0.3
S. Africa
China
India
Colombia
Indonesia
Brazil
Poland
0.0
Turkey
0
Russia
0.1
Chile
10
Mexico
0.2
Korea
20
Peru
Brazil
Colombia
Russia
India
Indonesia
China
Peru
Turkey
Chile
Mexico
S. Africa
Poland
Korea
30
1/ Measures a country's degree of de jure capital account openness (0-1 scale),
based on the IMF's Annual Report on Exchange Arrangements and Exchange
Restrictions (AREAER).
Source: Chinn and Ito (2006) : "What Matters for Financial Development? Capital
Controls, Institutions, and Interactions“, JDE 81(1):163-192 (October).
Monetary Policy Implementation During US Policy Normalization
7
The recent behavior of the world economy and its projected evolution
for the rest of 2014 and in 2015 favors the expansion of Mexican exports.
Major Economies: Real GDP
Index 4Q-2007 = 100, s.a.
200
2Q 2014
109
Mexican Exports by Country of Destination
% of Total, 2013
Japan, 0.6
China, 1.7
U.K., 0.4
China
150
104
Eurozone,
4.4
United
States
Japan
Canada,
2.8
100
100
50
Other,
11.4
Eurozone
96
U.S., 78.8
United Kingdom
s.a./ Seasonally adjusted.
Source: Haver Analytics.
2014
2013
2012
2011
2010
2009
2008
2007
2006
91
2005
0
Source: INEGI.
Monetary Policy Implementation During US Policy Normalization
8
In particular, analysts estimate US GDP growth above potential.
US: Real Gross Domestic Product
Quarterly annualized rate, s.a.
Gross Domestic Product
Potential GDP1/
6
Forecast
4
2
0
-2
IV 2015
III 2015
II 2015
I 2015
IV 2014
III 2014
II 2014
I 2014
IV 2013
III 2013
II 2013
I 2013
-4
s.a./ Seasonally adjusted.
1/ Mid-point of the central tendency interval of FOMC participants’ projections for the long-run change in real GDP.
Sources: BEA , Federal Reserve and Blue Chip.
Monetary Policy Implementation During US Policy Normalization
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On the other hand, the expected increase in interest rates in the US will pose
additional challenges for monetary policy in Mexico and other emerging
market economies. Risks are enhanced by the continued search for yield…
Volatility indexes for selected
financial assets
Basis points
Yield to maturity of selected
fixed income securities
Percent
United States
300
18
80
23%
27%
16
70
200
14
60
12
50
2
0
0
Commodity
index 4/
Source: Banco de México with data from Bloomberg
1/ MOVE (Merrill Option Volatility Estimate).
2/ VIX(“CBOE Volatility Index”).
3/ CVIX: 3-month implicit volatility of the most operated currencies.
4/ Actual volatility of the CRB index (index composed of 19 commodity futures
contracts).
10-year range
Corporate
high yield*
10
Corporate
BBB
4
Corporate
AAA
20
Agencies
Currency
index 3/
10-year range
6
MBS
S&P 500 2/
30
ABS
0
8
Corporate
high yield*
50
40
Corporate
BBB
100
10
Corporate
AAA
150
Current (8-Oct-14)
Europe
90
250
Treasury notes 1/
Percent
Current (7-Oct-14)
Source: Bank of America - Merrill Lynch.
*Bonds with credit rating lower than BBB-.
Monetary Policy Implementation During US Policy Normalization
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… and the fact that markets seem to be overly optimistic
about the pace of interest rate adjustments in the US.
3.0
FFR Futures 30-Jun-14
FFR Futures 08-Oct-14
2.5
Source: Bloomberg and FOMC Economic Projections.
Dec-16
Sep-16
Jun-16
Mar-16
2.0
Dec-15
Sep-15
Jun-15
Mar-15
Dec-14
Sep-14
Median FOMC Dec-13
Median FOMC Mar-14
Median FOMC Jun-14
Median FOMC Sep-14
Federal Funds Rate Implicit in the OIS1/
Curve and FOMC Projections
%
3.0
FFR implicit in OIS curve
2.5
Median FOMC Dec-13
Median FOMC Mar-14
Median FOMC Jun-14
Median FOMC Sep-14
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
Jun-12
Sep-12
Dec-12
Mar-13
Jun-13
Sep-13
Dec-13
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15
Mar-16
Jun-16
Sep-16
Dec-16
Federal Funds Rate Futures
and FOMC Projections
%
Source: FOMC’s projections and own calculations with data from Bloomberg.
1/ Overnight Index Swap.
Monetary Policy Implementation During US Policy Normalization
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However, it is important to note that markets have
differentiated across countries.
Emerging Markets: Credit Default Swaps 1/
Index 01-Jan-2013 = 100
230
2014
Russia
Brazil
Oct
210
Turkey
190
170
150
S. Africa
130
Peru
Chile
110
90
Korea
Colombia
Poland
70
Mexico
Oct-14
Jul-14
Apr-14
Jan-14
Oct-13
Jul-13
Apr-13
Jan-13
50
1/ 5-year CDS.
Source: Bloomberg, with data through 8 October 2014.
Monetary Policy Implementation During US Policy Normalization
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Outline
1
Introduction
2
Monetary Policy in 2014-15
a. The External Environment
b. Domestic Conditions
3
Beyond 2015
Monetary Policy Implementation During US Policy Normalization
13
Economic activity showed clear signs of recovery during the
first half of 2014.
Real Gross Domestic Product
Annual % and Quarterly Annualized Rate, s.a.
6
5.2
5.0
3.9
4.0
4.2
3.2
3.1
1.4
1.4
1.8
4
2
0
-2
-4
-4.7
II-2014
I-2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
-6
s.a./ Seasonally adjusted.
Source: INEGI.
Monetary Policy Implementation During US Policy Normalization
14
Exports were the main factor behind the expansion of economic
activity, but a revival of domestic demand was also observed…
Aggregate Supply and Demand
Quarterly %, s.a.
6
2014-II
2014-I
3.9
1.7
1.4
1.0
4
2
0.2
0.1
0
-1.2
-2
-4
-6
-8
GDP
Imports
Private
Govt.
Private
Consumption Consumption Investment
Govt.
Investment
Exports
s.a./ Seasonally adjusted.
Source: Banco de México and INEGI.
Monetary Policy Implementation During US Policy Normalization
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…which has continued in more recent months.
1,400
Aug
Sep
1,300
1,100
130
1,000
120
900
110
Domestic
Sales of
Light
Vehicles
800
700
s.a. / Seasonally adjusted data.
Source: Banco de México with data from INEGI.
100
95
100
Construction
90
90
s.a. / Seasonally adjusted data.
1/ Excludes oil and automobile imports.
Source: Banco de México and AMIA (Mexican
Association of the Automobile Industry).
2014
2013
2012
85
2011
2014
2012
2011
2010
80
2009
600
2008
2014
2013
2012
2011
2010
2009
2008
110
Total
140
2013
114
110
105
Imports of
Consumption
Goods
1,200
118
Jul
150
126
122
160
2010
130
2009
Jul
Gross Fixed Investment
Index 2008 = 100, s.a.
2008
Retail Sales
Index 2003=100, s.a.
Imports of Consumption Goods 1/
and Domestic Sales of Light Vehicles
Index 2007 = 100 and Thousands of
annualized units, s.a.
s.a./ Seasonally adjusted data.
Source: INEGI.
Monetary Policy Implementation During US Policy Normalization
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Nonetheless, substantial slack persists.
National and Urban Unemployment Rates
% of EAP, s.a.
Aug
Urban
Output Gap
% of potential output, s.a.
8
2Q-14
July
8
6
4
7
GDP
2
0
6
-2
-4
IGAE
5
National
-6
-8
4
-10
-12
-14
EAP/ Economically Active Population.
s.a./ Seasonally adjusted.
Source: National Employment Survey (Encuesta Nacional de Ocupación y Empleo), INEGI.
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2014
2013
2012
2011
2010
2009
2008
2007
3
s.a./ Calculated with seasonally adjusted data.
Note: The shaded area is the 95% confidence interval of the output gap.
Source: Calculated by Banco de México with data from INEGI.
Monetary Policy Implementation During US Policy Normalization
17
In the case of inflation, some upward pressures have been
observed recently.
Consumer Price Index
Annual %
Sep
8
7
Headline
6
5
4
3
Core
2
1
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
0
Sources: Banco de México and INEGI.
Monetary Policy Implementation During US Policy Normalization
18
However, they result from factors of a temporary nature, and
are not demand-driven.
Core Inflation
Annual %
Non-Core Inflation
Annual %
25
20
Sep
Core
Food, Beverage and Tobacco
Air Transportation
Sep
Non-core
Livestock
20
15
15
10
5
10
0
-5
5
-10
-15
0
-20
Sources: Banco de México and INEGI.
2014
2013
2012
2011
2010
-5
2009
2014
2013
2012
2011
2010
2009
-25
Sources: Banco de México and INEGI.
Monetary Policy Implementation During US Policy Normalization
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Consequently, medium and long term inflation expectations
remain well anchored.
Headline Inflation Expectations
Median, %
End of 2014
Sep
Oct
Next 4 and 5-8 Years
End of 2015
4.5
Sep
Oct
4.5
Sep
4.5
Banco de México
4.0
4.0
4.0
Banco de México
Next 4 Years
Next 5-8 Years
Sep-14
Feb-14
Jul-13
Dec-12
May-12
Oct-11
Mar-11
Aug-10
Jan-10
Oct-14
2.5
Aug-14
2.5
Jun-14
2.5
Apr-14
3.0
Feb-14
3.0
Dec-13
3.0
Oct-13
Oct-14
Jul-14
Apr-14
Jan-14
Banamex
Oct-13
Jul-13
Apr-13
Jan-13
3.5
3.5
3.5
Banamex
Sources: Banco de México’s Survey, monthly. Last observation: September 2014. Banamex Survey, bi-weekly. Last observation: 7 October 2014.
Monetary Policy Implementation During US Policy Normalization
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Looking forward:
• Strong external demand;
• Expansionary monetary policy;
• Fiscal stimulus; and
• Increasing levels of confidence.
… give support to Banco de México’s expectation of 2-2.8%
GDP growth in 2014 and 3.2-4.2% in 2015, implying an
expansion above potential in 2H-2014 and in 2015.
Monetary Policy Implementation During US Policy Normalization
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A strong cyclical upturn during the rest of this year and the
next is expected to coincide with the convergence of inflation
to the 3% target in 2015 given:
1.
A negative although gradually closing
output gap.
2.
Gasoline price increases based on
inflation expectations.
3.
A favorable base effect after the tax
reform.
Monetary Policy Implementation During US Policy Normalization
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This scenario is subject to a number of risks:
1.
Uncertainty related to estimates of
the output gap.
2.
Faster closing of the output gap if the
recovery of economic activity is
stronger than currently foreseen.
3.
Additional shocks deriving from the
behavior of non-core inflation or
other factors.
Monetary Policy Implementation During US Policy Normalization
23
Monetary policy normalization in the US represents another
risk for the Mexican economy.
• Increased financial market volatility and uncertainty.
• Tighter external financing.
• Potential impact on peso exchange rate and inflation.
Risks have increased as the beginning of interest rate hikes
draws closer.
Monetary Policy Implementation During US Policy Normalization
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The Mexican economy has solid macroeconomic and financial
stability bases to resiliently sail through the process.
Strong macroeconomic position:
• Credible monetary and fiscal policies.
• Flexible exchange rate regime.
• Low current account deficit.
• Record high international reserves.
• FCL with the IMF.
• Relatively low public debt.
Financial stability in the context of enhanced policy framework.
Favorable growth prospects after a major structural reform effort:
• Labor markets: November 2012.
• Education: September 2013.
• Financial sector: January 2014.
• Competition: May 2014.
• Telecommunications: July 2014.
• Energy: August 2014.
Monetary Policy Implementation During US Policy Normalization
25
Outline
1
Introduction
2
Monetary Policy in 2014-15
a. The External Environment
b. Domestic Conditions
3
Beyond 2015
Monetary Policy Implementation During US Policy Normalization
26
Beyond 2015

Inflation targeting has proved its merits in Mexico and other
countries before, during and in the aftermath of the global
financial crisis.

However, the crisis has highlighted a number of issues whose
implications for inflation targeting regimes will have to be
carefully assessed.

One of them is the need to better understand the role of
monetary policy and other instruments in preserving financial
stability.

Nonetheless, this does not imply a substantial modification of the
fundamental structure of these regimes, nor does it raise question
marks on their usefulness to anchor inflation expectations.
Monetary Policy Implementation During US Policy Normalization
27
Beyond 2015, monetary policy is likely to operate in an
environment characterized by world economic growth below that
observed before the crisis...
GDP Growth Projections
Annual %
8
7
China
6
5
4
United States
3
United Kingdom
2
1
Japan
Eurozone
0
2019
2018
2017
2016
2015
2014
2013
-1
Source: IMF’s World Economic Outlook, October 2014.
Monetary Policy Implementation During US Policy Normalization
28
…and an upward trend in international interest rates, which underlines
the importance of strengthening the domestic sources of growth.
Federal Funds Rate
Annual %
4.0
3.5
Federal Funds Rate
FOMC
OIS-implied
Futures
Blue Chip
3.0
2.5
2.0
1.5
1.0
0.5
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
0.0
Sources: FOMC, Bloomberg and Blue Chip.
Monetary Policy Implementation During US Policy Normalization
29
Even before considering the key measures approved in 2014 (financial,
competition, telecommunications and energy), Mexico’s efforts of structural
reform were deemed to be among the most ambitious in the world. Contrary
to other experiences, this was not propelled by an economic crisis.
Economic Reform Responsiveness
Share of OECD reform recommendations with
significant action taken during 2012-2013
0.9
0.8
0.7
0.57
0.6
0.5
0.4
0.3
0.2
0.1
CHE
NOR
TUR
CZE
USA
FRA
KOR
AUS
AUT
BEL
CHL
DEU
NLD
SWE
POL
FIN
JPN
SVK
CAN
EST
LUX
SVN
NZL
ITA
GRC
HUN
IRL
ISR
MEX
PRT
DNK
GBR
ESP
0.0
Source: Own calculations based on results presented in OECD (2014), Going for Growth Interim Report, February.
Monetary Policy Implementation During US Policy Normalization
30
The latter should allow the economy to grow at faster rates
without pressures on prices.
 More flexible and competitive
product and input markets
 More efficient resource allocation
 More and better human and
physical capital
 More incentives for technological
change
 Stronger institutional framework
Productivity
gains
Higher
economic
growth
Lower
inflationary
pressures
Main challenges: adequate implementation of structural
reforms, tackling other major structural obstacles to growth,
continuous strengthening of economic fundamentals.
Monetary Policy Implementation During US Policy Normalization
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32