| 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.
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:
- A low inflation rate promotes the efficient use of productive resources. When inflation is high, a substantial quantity of individual people's time and resources from the economy are invested in searching for mechanisms to defend themselves from inflation. Thus, for example, when inflation is high, businesses have to channel more resources into portfolio management in order to avoid financial losses. This is an inefficient use of productive resources that do not generate wealth to society.
- A low inflation rate reduces uncertainty. It has been observed that economies with high inflation also suffer from a more variable type of inflation. Uncertainty can have negative effects on expected profits from investment and, therefore, negative effects on long-term growth. Greater uncertainty also implies uncertainty with regard to relative prices, to the extent that there is a loss in price informative content for future prices and increase in trade margins. All of this affects the efficient allocation of resources and lowers economic growth.
- Low inflation fosters investment. The most important decisions taken by individuals and businesses alike are usually long-term decisions: a decision to build a factory, to start a business, to pursue an education, to own one's home. These decisions crucially depend on the degree of uncertainty regarding the future. Low and stable inflation is a macroeconomic indicator for stability that contributes greatly to the confidence of people and businesses for making investment decisions.
- A low inflation rate also prevents arbitrary redistribution of income and wealth, which particularly affect the poorest sectors of society, with the result that wage earners and retired people have fewer mechanisms to protect themselves against the inflationary erosion of their income. Contract clauses on wages indexed to inflation are scarce or practically non-existent. For example, in Colombia, wages and pensions are adjusted once a year. Furthermore, the lower the income, the fewer mechanisms that will be used to offset inflation, such as savings or real estate acquisitions. Therefor, rising inflation means a redistribution of income that is detrimental for the poorest sector of the population.
 |
 |
| How is monetary policy implemented in Colombia? |
The Board of Directors of the Banco de la República, Colombia’s Central Bank, defines the quantitative inflation targets. The latter are defined as the yearly variation of the Consumer Price Index (CPI) given by the DANE (Departamento Administrativo Nacional de Estadística – The National Department for Statistics).
.
What are the current inflation targets?
- The inflation target range for 2007 was set at between 3.5% and 4.5%.
- The inflation target range for 2008 was set at between 3.5% and 4.5%.
- The long-term inflation target range to be defined in 2009 should be between 3.0% and 3.5%
- The inflation target range to be defined in the long term should be between 2.0% and 4.0.
The Banco de la República implements monetary policy by changing interest rates, which either provide or withdraw liquidity from the economy. Thus, these intervention rates are the Central Bank’s monetary policy tool and, through them, the Bank affects the market’s interest rates.
| How does monetary policy affect the economy? |
When the Banco de la República alters its intervention rates, it affects the market’s interest rates, the exchange rate and the cost of credit, thereby activating mechanisms that affect the following:
- Financial markets.
- Decisions by economic agents on expenditure, production and employment.
- Expectations of economic agents, based on of policy announcements.
- The inflation rate, after a long and variable period of time.
These mechanisms are known as Transmission Mechanisms. They refer to the processes or channels, through which monetary policy decisions influence the product (GDP) and inflation.
When projected inflation lies below the target range:
When project inflation lies above the target range:
|
| 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. Therefor, monetary policy necessarily operates in an environment of uncertainty. The following factors contribute to this:
- There is a delay concerning the information available in relation to a number of economic variables,(e.g., GDP) and, in many cases, this information is subject to important revisions and errors of measurement.
- Other important variables (such as the product’s gap or the potential growth of the economy) are not readily available and therefore have to be estimated by means of indirect models and indicators.
- In some cases, it is difficult to distinguish the origin, effects, length and magnitude of impacts affecting the economy. The following are examples of such impacts:
- External exchange rate or capital-flow changes.
- Oil and coffee export-price increases
- Food supply decreases
- In addition, the scope and effects of monetary policy are not always predictable, because they depend on:
- Future expectations about the interest rate, exchange rate, economic activity, and inflation performance.
- The time taken for monetary policy to affect the economy. The transmission of policy decisions to the rest of the economy can experience long and variable delays, from between 12 to 24 months.
- The channels used are not always the same, nor is their effect long-lasting. In addition, a changing economy may be subject to new channels that did not exist previously.
|
What are the measures taken by the Banco de la República in order to reduce uncertainty?
- The Bank makes explicit use of its constitutional mandate to achieve and guarantee price stability—the prime objective of monetary policy.
- The Bank announces the inflation targets with sufficient notice thereby enabling economic agents to take them into account in their decision making.
- The bank analyses various economic indicators and uses a wide variety of models with diverse foci (statistical and forecasting, structural and simulation) to strengthen further its ability for making economic forecasts.
- The Bank carries out sensitivity
analyses for risk management. It assesses changes in inflation forecasts under different domestic and international scenarios.
- The Bank is well known for having a top class team of economists and other professionals in their field, as well as for keeping up-to-date with the latest developments in economic analysis and techniques in use world-wide.
- The Bank carries out research work, thereby contributing to understanding the way the economy works, as well as developing better analysis methodologies.
- The Bank interacts with other Central Banks and is open to the opinion of the national and international academic communities by means of organising and participating in seminars and forums dealing with subjects that are central to the Colombian and world economies.
- The Bank organises periodical meetingswith various sectors of Colombian society (businessmen, employees, Congressmen, etc.) with the purpose of hearing their opinions and of explaining the Bank’s policy-decisions and their results.
- In its policy of transparency,
the Bank publishes reports explaining decisions on monetary policies. This is done by means of the following channels of communication:
In its inflation report, the Board of the Banco de la República presents monthly analyses of the following information relating to inflation:
- Consumer and producer price series
- Measures related to basic inflation core
inflation
- Production and cost indicators
- Price series on money, credit, interest rates, and asset prices
- International economic indicators: world growth rates, including those related to the Bank’s main commercial partners, as well as foreign liquidity and interest rates.
The report, prepared by the Bank’s team of experts, contains an analysis of the economy, the inflation situation and its medium- to long-term prospects and, based on this, provides makes recommendations to the Board on its position regarding monetary policy.
In accordance with Law 31, Art. 5, dated 1992, the Board of Directors of the Banco de la República presents a twice-yearly report to Congress on the economy’s performance and prospects. The report also covers the basic monetary and exchange rate policies during each period, including the level of international reserves and the Bank’s financial situation.
The subjects covered by the reports are the following:
- Economic activity and employment
- Monetary and exchange rate policy
- Fiscal policy
- Balance of Payments
- Level and management of international reserves
- Financial situation of the Banco de la República
The reports are presented within the first ten working days of the new Congressional sessions (which start in March and July)..
The Banco de la República’s broad policy measures
involving core inflation
seek to eliminate temporary movements and price impacts.
Not included in the price of the shopping basket are those items which show a high degree of volatility or that are beyond the control of monetary policy. For example:
- Food prices
- Some regulated prices (fuels,
utilities, transport)
These measure the long-term price trends. This is the particular inflation that is directly affected by the Board’s monetary policy decisions.
|
|
