Monetary Policy


Monetary Policy Decision-Making in an Environment of Uncertainty

Monetary policy decision-making requires that two fundamental questions be answered: (1) How is the economy doing? and (2) Where is the economy headed?  The need to assess the status of the economy both in the present and prospectively is due to the fact that the instruments of monetary policy act slowly on the economy. This is known as the transmission mechanism, through which changes in the benchmark interest rate affect other market interest rates with a variable lag that may take up to  six quarters.

Good Practices - Transparency
Transparency is fundamental for the accountability of independent central banks. Inasmuch as they have been given greater independence, transparency in these institutions is considered as a mechanism to provide society with the ability to evaluate if a central bank's actions are consistent with its constitutional or legal mandate. Also, it is well known that greater transparency in the formulation and implementation of monetary policy strengthens the credibility of the central bank, improves the efficiency of its policies, and contributes to the better operation of markets. 
Why is it important to keep Inflation low and stable?

A low and stable inflation improves the well-being of the population. This takes place in several ways: 

 

How is the Monetary Policy implemented in Colombia?

In order to implement the monetary policy, it is necessary to determine the desired inflation target and the policy instruments to be used. Starting in 2010, the Board of Directors of Banco de la República adopted the long-term inflation target that had been proposed since the beginning of the Inflation Targeting Strategy. This target corresponds to an inflation range of 3.0% ± 1 percentage point, measured through the annual variation in the Consumer Price Index prepared by DANE.

Why is it essential to have a low and stable inflation rate?

 

A low and stable inflation rate improves the well being of the population. This is manifested in various ways:

 

The purpose of the monetary policy

 

The primary objective of monetary policy is to reach and maintain a low and stable inflation rate, and to achieve a long-term GDP growth trend.

 

This is the only way to achieve sustained growth rates that will generate employment and improve the population’s quality of life. Otherwise, if the economy does not grow on a sustained basis, sooner or later a crisis will occur with serious consequences for the economy, leading to worsening social indicators, loss of public confidence, lowered investment and higher unemployment.

 
How does Monetary Policy affect the Economy?

Whenever the Central Bank changes the interest rate for REPO operations (also known as the benchmark intervention rate)  it sets into motion a series of forces which, with a certain lag, affect market interest rates, the exchange rate, and inflation expectations, which in turn influence:

 

Monetary policy in an uncertain environment

 

Monetary policy should continuously assess the state of the economy, as well as its future developments and prospects over the next four to eight quarterly terms. It is during this time span that changes in interest-rate intervention rates have their effect on other interest rates and have impact on the economy. Therefore, monetary policy necessarily operates in an environment of uncertainty. The following factors contribute to this:

 

Monetary Policy: The Inflation-Targeting Strategy in Colombia

Monetary policy in Colombia is governed by an Inflation Targeting strategy, thats purpose is to maintain a low and stable inflation rate and to reach output growth in line with the potential capacity of the economy. This means that the objectives of monetary policy combine price stability with maximum sustainable growth of output and employment. These objectives are compatible as long as the inflation targets are credible. Thus, monetary policy complies with the Constitutional mandate and contributes to improve the well-being of the population.

Foreign Exchange Intervention Policy

The Central Bank's policy seeks to maintain a low and stable inflation rate, as well as to reach output levels close to the economy’s potential. Besides, the Bank’s policy contributes to the preservation of financial stability and the payment system. The flexibility of the exchange rate is considered a fundamental element for the achievement of these objectives. In the first place, in a flexible exchange-rate regime, the exchange rate operates as an adjustment variable when facing shocks to the economy, by reducing the volatility of the economic activity.

This content has been translated into English for informational purposes. Upon any query regarding its interpretation or enforceability, the Spanish version shall be deemed official, and will prevail over the English version. The authors of specific texts such as working papers or articles select the language of publication; therefore, there might be cases in which the content may only be available in English.