© International Monetary Fund
March 2014
IMF Policy paper
IMF POLICY PAPER
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
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The Policy Paper on Conditionality in Evolving Monetary Policy Regimes, prepared by
IMF staff and completed on March 5, 2014 for the Executive Board's consideration on
March 26, 2014.
A Press Release summarizing the views of the Executive Board as expressed during its
March 26, 2014 consideration of the policy paper.
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International Monetary Fund
Washington, D.C.
March 5, 2014
CONDITIONALITY IN EVOLVING MONETARY POLICY
REGIMES
EXECUTIVE SUMMARY
With single-digit inflation and substantial financial deepening, developing
countries are adopting more flexible and forward-looking monetary policy
frameworks and ascribing a greater role to policy interest rates and inflation
objectives. While some countries have adopted formal inflation targeting regimes,
others have developed frameworks with greater target flexibility to accommodate
changing money demand, use of policy rates to signal the monetary policy stance,
and implicit inflation targets.
Many Fund-supported programs assess the monetary policy stance through
central bank balance sheet targets (net domestic assets or reserve money). An
assessment of programs in developing countries with scope for independent
monetary policy shows generally good adherence to net domestic asset ceilings
but weak adherence to reserve money targets. No statistical correlation is
observed between reserve money target deviations and inflation deviations in a
low inflation context, raising the question of whether reserve money targets are
reliable indicators of the monetary policy stance given financial innovation and
shocks to money demand. Fund-supported programs for some members that have
formal inflation targeting regimes have adopted a review-based approach to
monetary policy conditionality through inflation consultation clauses.
A review-based conditionality to assess monetary policy is proposed as an option
to replace a performance criterion on net domestic assets or reserve money, for
countries with evolving monetary policy frameworks that have a good track record
of monetary policy implementation supported by central bank technical and
institutional development, or are committed to a substantial strengthening of the
policy framework. Fund-supported programs would clearly articulate monetary
policy objectives and set money or inflation target bands for each review. A
monetary policy consultation clause would provide the necessary safeguards for
the use of Fund resources in the event of deviations from the target band. The
traditional framework for monetary conditionality would remain an option in
countries where it has proven to be effective in achieving program objectives.
The review-based approach to monetary conditionality rests upon enhanced
central bank capacity to analyze monetary conditions. The Fund’s training and
technical assistance provision in this area is already substantial, reflecting existing
efforts to meet a strong demand from members.
March 5, 2014
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
2 INTERNATIONAL MONETARY FUND
Approved By
Siddharth Tiwari
Prepared by a staff team led by Chris Lane and Catherine Pattillo, and
comprising Maxwell Opoku-Afari, Marco Arena, Filiz Unsal, and
Noah Ndela Ntsama (all SPR), Hamid Davoodi (ICD), Rafael Portillo
(RES), Bernard Laurens (MCM), and Stephen O’Connell (RES/SPR
Visiting Scholar) with contributions from Svitlana Maslova and
Sarwat Jahan (all SPR). Research assistance was provided by
Barbara Dabrowska, Carla Intal, Arshia Karki, Lamin Njie, and
Sibabrata Das. Production assistance was provided by Lucía
Hernández and Merceditas San Pedro-Pribram (all SPR). This paper
has benefited from proposals made by an interdepartmental working
group on flexible monetary policy regimes led by Michael Atingi-Ego,
comprising AFR, MCM, and RES. Overall guidance was provided by
Hugh Bredenkamp and Seán Nolan.
CONTENTS
GLOSSARY _______________________________________________________________________________________ 4
MOTIVATION ____________________________________________________________________________________ 5
THE CHANGING LANDSCAPE OF MONETARY POLICY IN DEVELOPING ECONOMIES _______ 7
PERFORMANCE OF PROGRAM MONETARY CONDITIONALITY ______________________________ 13
ENHANCING THE MONETARY POLICY CONDITIONALITY TOOLKIT _________________________ 20
IMPLICATIONS FOR TECHNICAL ASSISTANCE AND RESOURCES ____________________________ 32
ISSUES FOR DISCUSSION ______________________________________________________________________ 33
REFERENCES _____________________________________________________________________________________34
BOXES
1. Interest Rate Volatility and the Monetary Policy Transmission Mechanism in East Africa ______ 18
2. Monetary Targeting in Fund-Supported Programs ____________________________________________ 21
3. Inflation Consultation Clause and Fund Conditionality ________________________________________ 22
4. Armenia—Transition to Flexible Monetary Policy _____________________________________________ 31
FIGURES
1. Monetary Policy Regimes in Developing Countries: 2003–2011 ________________________________ 8
2. Inflation and Inflation Volatility Distribution, 1990–2012 _______________________________________ 9
3. Financial Deepening (LICs and EMs) ____________________________________________________________ 9
4. The Relation Between Broad Money Growth and Inflation, 1990–2012 ________________________ 12
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 3
5. Conditionality Landscape in GRA and PRGT Programs, 2002–2012 ____________________________ 14
6. Money and Inflation Target/Projection Misses in Fund-Supported Programs, 2002–2011 _____ 15
7. Proportion of Annual Reserve Money Target Misses for PRGT- and GRA-Supported Programs,
2002–2012 _______________________________________________________________________________________ 16
8. NDA Deviations and NFA Deviations in Programs with Reserve Money Target ________________ 16
9. Projected and Actual Changes in Velocity _____________________________________________________ 17
10. Projected and Actual Changes in Multiplier __________________________________________________ 17
11. Proposed Outline of the Modified Monetary Conditionality Framework _____________________ 24
TABLES
1. Inflation: 1990–2002 vs. 2002–2012 ____________________________________________________________ 8
2. Money Growth and Inflation: Cross-Section Estimation (OLS) _________________________________ 11
3. Comparison of Conditionality: Traditional Money, MPCC, and ICC ____________________________ 28
APPENDICES
I. Country Classification by Monetary Policy Regimes (Based on 2013 AREAER) _________________ 37
II. Additional Empirical Analysis for the Landscape and Performance of Program Conditionality 38
III. List of Countries Used in Analysis of Program Performance __________________________________ 42
IV. Evolving Monetary Policy Regimes in Fund-Supported Programs: Country Case Studies _____ 43
V. Implementation of ICC under Fund-Supported Programs _____________________________________ 50
VI. A Model-Based Approach to Monetary Policy Analysis _______________________________________ 54
VII. Technical Assistance and Training on Modernizing Monetary Policy Frameworks ___________ 56
VIII. Data Requirements for Monetary Policy ____________________________________________________ 58
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
4 INTERNATIONAL MONETARY FUND
Glossary
AFRITAC African Regional Technical Assistance Center
CBR Central Bank Rate
CPI Consumer Price Index
DFID Department for International Development
DSGE Dynamic Stochastic General Equilibrium
ECF Extended Credit Facility
EFF Extended Fund Facility
EM Emerging Markets
ESF Exogenous Shocks Facility
FDI Foreign Direct Investment
FPAS Forecasting and Policy Analysis System
GLS Generalized Least Squares
GRA General Resources Account
ICC Inflation Consultation Clause
IT Inflation Targeting
LICs Low-Income Countries
M3 Broad Money including Foreign Currency Deposit
MEFP Memorandum of Economic and Financial Policies
MERP Monetary and Exchange Rate Policies
MPA Monetary Policy Analysis
MPC Monetary Policy Committee
MPCC Monetary Policy Consultation Clause
NDA Net Domestic Assets
NCG Net Credit to the Government
NFA Net Foreign Assets
NIR Net International Reserves
NSO National Statistical Office
OLS Ordinary Least Squares
PC Performance Criteria
PRGT Poverty Reduction and Growth Trust
PSI Policy Support Instrument
RM Reserve Money
RMP Reserve Money Program
RMSE Root Mean Squared Error
RTAC Regional Technical Assistance Center
SBA Stand-By Arrangement
TA Technical Assistance
SSA Sub-Saharan Africa
VAT Value-Added Tax
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 5
MOTIVATION
1. Monetary policy frameworks in a number of countries with IMF-supported programs
are evolving toward more flexible operational targets and more forward-looking policies.
Many developing countries have moved away from operating monetary policy frameworks centered
solely on periodic quantitative targets for money aggregates to greater reliance on policy rates to
signal the monetary policy stance. Several other countries with Poverty Reduction and Growth Trust
(PRGT)- or General Resources Account (GRA)-supported programs have adopted some form of an
inflation targeting (IT) regime, where the inflation forecast is the intermediate target and a short-
term policy interest rate typically serves as the operational target/policy instrument, although some
of those countries have not committed to an explicit inflation target. Looking ahead, many other
developing countries that seek support under Fund facilities intend to modernize the conduct of
monetary policy by using a more flexible framework.
2. This shift reflects the evolution of global thinking and practice, and the increasing
sophistication of domestic financial markets in developing countries. Targets on monetary
aggregates have been the traditional nominal anchor in most Fund-supported programs, and they
have played an important role in helping stabilize inflation in the late 1990s and early 2000s and in
supporting external stability. The liberalization of domestic financial markets has nevertheless
expanded the scope for active management of market interest rates, while lower levels of inflation,
frequent and large exogenous shocks, and increasing instability in money demand, among other
factors, have weakened the relationship between money and prices and increased the priority on
more nuanced policy frameworks as opposed to just “holding the line.” Further, several GRA-
supported program countries that were forced off pegs after sudden reversals of capital inflows
have introduced hybrid frameworks, with a significant role for inflation alongside exchange rate and
money objectives. The observance of reserve money performance criteria or indicative targets in
Fund-supported programs has weakened, with more than half of the targets not observed, while at
the same time there is no association between monetary target misses and inflation overshoots in
low-inflation countries. Conversely, when monetary targets were observed, real GDP and inflation
often differed significantly from projections. In other cases, adherence to the monetary program has
led to unwarranted volatility of interest rates, thereby undermining a country’s objectives of
strengthening the role of policy rates in communicating the stance of monetary policy. The
fundamental question is not whether money matters, but whether money targets continue to
remain reliable indicators of the monetary policy stance, given financial innovation and shocks to
money demand.
3. The evolution of monetary policy frameworks has implications for monetary
conditionality in Fund-supported programs. There are clear guidelines and established practices
for monetary conditionality for money targeting and IT frameworks. However, guidance is limited
and practice has varied for countries with evolving monetary policy frameworks. For money
targeting frameworks, conditionality consists of a floor on net international reserves (NIR) and
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
6 INTERNATIONAL MONETARY FUND
typically a ceiling on net domestic assets (NDA) or reserve money (RM), and in some cases net credit
to government (NCG).
1
For IT frameworks, normally a review-based approach is employed under
which a floor on NIR is maintained (to ensure external sustainability), while performance criteria on
net domestic assets or reserve money are replaced with an inflation consultation clause (ICC).
2
4. However, neither of these existing conditionality frameworks is well-suited for
countries with evolving monetary policy regimes (countries experiencing increasing financial
deepening, where policies are becoming more forward looking, including the nascent use of short-
term policy interest rates to adjust the monetary policy stance). In such circumstances, relying on
monetary aggregates alone is not sufficient, as policies become increasingly forward looking. A
more comprehensive approach that analyzes monetary policy along a number of dimensions, and is
not limited to an assessment of monetary aggregates alone, could achieve the objectives of
conditionality while responding to the changing needs of members.
5. This paper proposes a review-based monetary conditionality framework as an option
for countries with evolving monetary policy regimes. Under this approach, the Fund-supported
program would introduce a set of quarterly or semi-annual (depending on the frequency of
program reviews) monetary or inflation bands that the member would be expected to observe
during the arrangement. This would replace the current performance criteria on reserve money
and/or net domestic assets of the central bank, even though they may still serve as a tripwire
depending on country-specific risks. Under the review-based framework, a deviation from the target
band would trigger a formal consultation with the Executive Board in the context of a program
review. Access to the Fund’s resources under the relevant arrangement would be interrupted until
the required consultation with the Executive Board takes place and the relevant program review is
completed. This consultation would be informed by staff’s assessment of (i) the reasons for
deviations from the monetary policy objectives, taking into account compensating factors, and (ii) in
light of this assessment whether or not remedial actions are needed to bring policies back on track.
6. The proposed review-based approach would be appropriate for countries with scope
for independent monetary policy.
3
Specifically, the review-based approach would normally be
appropriate for members that have made significant progress in achieving central bank
independence along with other supportive institutional features, including minimal fiscal dominance,
a solid quantitative understanding of the inflation process, and an increasing focus on achieving an
inflation objective. In some cases, enhanced policy advice and technical assistance (TA) would be
1
Evolution of conditionality is discussed in IMF (2009a). See 2002 Revised Guidelines on Conditionality.
2
As suggested in IMF (2000a) and IMF (2000b), monetary policy is subject to periodic reviews focusing on current and
forecasted inflation, and reviews would have to be completed by the Board before disbursements could be made.
Furthermore, reviews would not be completed unless the Board is satisfied that the members’ policies are consistent
with the program objectives. See also IMF (2006).
3
The universe would include countries with monetary targeting regimes, other monetary policy regimes, and
crawling pegs/crawl-like arrangements as categorized in the Annual Report on Exchange Arrangements and
Exchange Restrictions (AREAER) classification (see Appendix I).
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 7
needed to meet these conditions or to further develop central bank capabilities for effective
monetary policy analysis prior to the adaptation of the review-based approach. The decision to
implement the review-based approach in a particular country would be made on a case-by-case
basis, based on discussions between staff and the authorities. However, the review-based approach
to monetary conditionality should not be interpreted as necessarily implying an eventual move to an
inflation targeting regime. This review examines the changing landscape in countries with evolving
regimes, assesses the performance of the current monetary conditionality framework in Fund-
supported programs, and reviews the practical application of conditionality in several case studies of
Fund-supported programs. Concluding sections discuss operational modalities of the review-based
approach and the implications for the Fund’s resources and technical assistance delivery.
THE CHANGING LANDSCAPE OF MONETARY POLICY
IN DEVELOPING ECONOMIES
7. Many developing countries are moving toward more flexible monetary policy
frameworks and more forward-looking policies. From 2003 to 2011, the number of countries
implementing money targeting has declined by about 25 percent—about 40 percent of the
emerging market (EM) countries and 20 percent of low-income countries (LICs) have moved away
from money targeting (Figure 1).
4
Most of these countries (for example, Albania, Armenia, Ghana,
Georgia, Moldova, Serbia, and Uruguay) adopted a formal inflation targeting framework, while a few
have started to implement mixed regimes such as monetary targeting and an exchange rate
anchor.
5
Moreover, among money targeting countries, two evolving policy regimes—flexible money
targeting and IT-lite/informal IT—have recently been implemented. Uganda (2009–2011) and, more
recently, Rwanda (since 2012) were among the countries that experimented with some form of
flexible money targeting; Uganda has recently adopted an IT-type framework.
4
The data on monetary policy regimes are available from 2003.
5
Many EM countries adopted a fully-fledged IT regime or many elements of it in the late 1990s as a transition
arrangement, mostly in response to difficulties in keeping pegged currencies stable in the wake of the East Asian
crisis. During 2003–2011, the move from fixed exchange rate arrangements to inflation targeting or mixed policy
regimes continued among EM countries.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
8 INTERNATIONAL MONETARY FUND
Figure 1. Monetary Policy Regimes in Developing Countries: 2003–2011
8. The change of policy regimes reflects significant changes in the monetary landscape in
many developing economies over the last decade.
Countries have generally been more successful
in anchoring inflation expectations and limiting the impact of domestic and external shocks on
inflation—the mean inflation rate has declined from 18.6 percent in 1990–2002 to 9.3 percent in
2002–2012 (Table 1). Average inflation has fallen in both EM countries and LICs. Inflation volatility
has also decreased—the average standard deviation of inflation declined more than half during the
same period. The frequency of cases with high inflation volatility was also significantly lower in the
more recent period (Figure 2).
6
Table 1. Inflation: 1990–2002 vs. 2002–2012
(Average of end of period consumer price inflation, in percent)
1990–2002
2002–2012
Mean
18.6
9.3
Median
12.9
9.0
Standard deviation
17.9
7.2
Sources: World Economic Outlook and IMF staff calculations.
Note: Data are for 64 countries (35 EMs and 29 LICs) with some scope for an independent monetary policy. LICs are defined
as countries eligible to use PRGT resources. EM countries are defined as non-PRGT eligible EM and developing countries in
the WEO classification.
6
The analysis in this section includes EM and developing countries (WEO definition), excluding countries that are
members of a currency union, operate a currency board, or have a de facto fixed exchange rate, as presented in the
2012 AREAER Report.
0
10
20
30
40
50
60
2003
2011
2003
2011
2003
2011
2003
2011
Exchange rate anchor 1/
Monetary aggregate target
Inflation-targeting
framework
Other monetary
framework 2/
Emerging market countries
Low-income countries
Number of Countries
Source: IMF AREAER Database.
1/ The exchange rate anchor includes regimes where the exchange rate serves as the nominal anchor or intermediate target
of monetary policy and includes pegs (with or without bands), crawling pegs, currency board arrangements, no separate
legal tender regimes, and other managed arrangements.
2/ Other monetary framework includes regimes with multiple objectives, typically inflation
or money target together with an exchange rate anchor.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 9
Figure 2. Inflation and Inflation Volatility Distribution, 1990–2012
9. Fast developing financial systems have also contributed to changes in the policy
landscape over the last decade. Median bank deposits and credit to the private sector (both
expressed as a share of GDP) in developing countries have increased by close to one-third between
2002 and 2010 relative to 1990–2002 (Figure 3). In particular, LICs experienced a rapid financial
deepening during this period—bank deposits and private credit almost doubled as a share of GDP.
Interest rate spreads, which reflect amplified borrowing costs, declined by about 400 basis points in
EM countries and 300 basis points in LICs. More developed financial markets in developing countries
over the last decade have increased both the feasibility and the desirability of using short-term
policy interest rates to steer the monetary policy stance while increasing the importance of
managing expectations in monetary policymaking.
Figure 3. Financial Deepening (LICs and EMs)
(Medians, from 1990–2012)
0
5
10
15
20
25
30
Deposits/GDP
Private credit/GDP
Interest rate spread
Percentages
1990-2002
2002-2010
Sources: Finstat, WDI,and IMF staff calculations
0
5
10
15
20
25
30
<3
3-5
5-8
8-12
12-20
>20
Frequency
Inflation rate
Inflation distribution, LICs and EMs
Medians, from 1990-2012
1990-2002
2002-2012
Source: World Economic Outlook
0
5
10
15
20
25
<1
1-2
2-3
3-5
5-10
10-20
>20
Frequency
Inflation rate
Inflation volatility distribution, LICs and EMs
Medians, from 1990-2012
1990-2002
2002-2012
Source: World Economic Outlook
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
10 INTERNATIONAL MONETARY FUND
10. Velocity and money multipliers have been subject to frequent and large fluctuations
that have complicated the conduct of monetary policy. Over the last two decades, about half of
the countries in the sample have experienced two or more structural breaks in money multipliers
and velocity.
7
These breaks imply (i) an unstable relation between the intermediate target (broad
money) and the policy tool (reserve money) and hence a limited control of the money supply under
a money targeting framework, and (ii) unstable and/or unpredictable money demand, potentially
altering the co-movement between monetary aggregates and inflation or the real economy.
11. The long-term relationship between broad money growth and inflation has weakened
over time, especially in low-inflation countries. Cross-section regressions were used to
characterize the relation between inflation movements and changes in monetary aggregates, while
controlling for other factors including the impact of output growth (Appendix II). A long-run relation
between inflation and money growth for developing countries was confirmed. However, the
estimated coefficient of money growth decreases from 0.64 in 1990–2002 to 0.29 in 2002–2012
(Table 2). The regression coefficient for money growth in high-inflation countries is about 30 percent
and 50 percent larger than for low-inflation countries, respectively, for the two periods.
8,
9
Moreover,
in countries with higher financial development, the association between money growth and inflation
is weaker in the more recent period.
10
These findings do not imply that increases in money supply
are not inflationary. Rather, they indicate that in countries with low inflation, long-run money growth
has been driven by factors other than monetary policy (particularly changes in money demand)
thereby lowering the predictability of the relationship between the two variables.
7
Over the period 1990–2012, velocity and money multipliers were subject to about four structural breaks on average.
Structural breaks are determined using the Bai and Perron (1998, 2003) methodology with a trimming parameter of
10 percent. Each breakpoint is treated as unknown and estimated using least squares.
8
In this paper, high (low)-inflation countries are defined as countries with inflation greater than or equal to (less
than) 10 percent, which is median level of inflation throughout the period.
9
Cross-country regressions of inflation on money averaged over long periods typically show a strong positive
relationship notwithstanding different financial institutions and monetary and fiscal policies (Woodford, 2008) as
would be expected by quantity theory of money (Dwyer and Hafer, 1988; Barro, 1990; McCandless and Weber, 1995;
and Rolnick and Weber, 1998). However, de Grauwe and Polan (2005) using a sample of 160 countries, emphasize
that the link between money growth and inflation is mostly a function of high-inflation cases. Thornton (2008),
employing a sample of 36 African economies, also reports that there is a stronger relation between money and
inflation for high-inflation countries, but the relation (weakly) exists for low-inflation cases as well.
10
When the global crisis period (2009–2012) is excluded, the association between money and inflation is even lower
in the more recent period, 2002–2008 (0.22).
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 11
Table 2. Money Growth and Inflation: Cross-Section Estimation (OLS) 1/
Dependent variable: Inflation (y/y)
1990-2002
2002-2012
Constant
2.521
5.27***
(0.77)
(4.47)
Income growth (y/y)
-0.574
-0.46**
(-1.25)
(-2.23)
Money growth (y/y)
0.638***
0.286***
(3.12)
(4.15)
Money growth *High inf.
0.185**
0.141***
(2.01)
(4.46)
Money growth *High fin. dev.
0.076
-0.075**
(0.68)
(-2.21)
Number of countries
62
63
Adjusted R²
0.635
0.635
Sources: World Economic Outlook and IMF staff calculations.
1/ Values of t-statistics reported in the parentheses are calculated using heteroscedasticity-
consistent standard errors; * significant at 10 percent; ** significant at 5 percent; *** significant at
1 percent.
12. The shorter-term relationship between broad money growth and inflation has also
progressively weakened. Across LICs and EM countries, the correlation between yearly broad
money growth and inflation has been steadily falling from 0.63 in 1990–2002 to 0.33 in 2002–2012
(Figure 4).
This is also supported by panel estimates—over shorter horizons (a year), the estimated
coefficients of money growth and its lags are lower in the more recent period (Appendix II, Table
II.2). The short-term relation between money and inflation was stronger for countries with high
inflation and low financial development in the earlier period, but it declined across the board over
the last decade.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
12 INTERNATIONAL MONETARY FUND
Figure 4. The Relation Between Broad Money Growth and Inflation, 1990–2012
13. The observed weaker short-term link between money growth and inflation points to
some limitations in relying solely on monetary aggregates to anchor and signal the policy
stance. As broad money growth has become an increasingly weak indicator of the evolution of
inflationary conditions, its usefulness as an intermediate objective has been significantly reduced for
some countries while remaining relevant in others, particularly those with high-inflation rates or low
levels of financial development. Without question, money still “matters” for inflation in that an
exogenous increase in the money supply is likely to be expansionary. And money aggregates should
continue to be used as one of the many indicators to assess the monetary policy stance. Analysis of
monetary aggregates provides one piece of information for central banks in assessing inflationary
conditions. However, in this environment, it is more difficult for nominal monetary targets to signal
the stance of monetary policy; this could impair the link between monetary policy actions and their
impact on economic activity and inflation.
14. The weakening link between monetary aggregates and inflation does not imply that
monetary policy is ineffective. Some empirical evidence suggests that the monetary policy
transmission mechanism—the set of channels through which policy decisions influence real activity
and inflation in the short-to-medium term—is weak or unreliable in developing countries (Mishra
and Montiel, 2012). Although there may be specific country circumstances where this is the case,
regression-based assessments often struggle to disentangle the cause and effect of policy decisions.
In addition, the transmission mechanism is often endogenous to the events in the economy and the
policy framework. For example, as discussed later, Berg and others (2013) find evidence that
0
30
60
90
0 20 40 60 80
Inflation (in percent)
Broad money growth (in percent)
1990-2002
2002-2012
Source: World Economic Outlook
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 13
monetary policy has stronger effects in countries where policy is more clearly signaled to financial
markets through a meaningful policy rate, such as Kenya and Uganda.
11
PERFORMANCE OF PROGRAM MONETARY
CONDITIONALITY
15. This section reviews the characteristics of monetary conditionality in Fund-supported
programs between 2002 and 2012. Since 2002, there have been 105 Fund-supported programs
(63 PRGT and 42 GRA-supported programs)
12
for countries with scope for independent monetary
policy. This section documents the landscape of conditionality and analyzes program performance in
achieving monetary and inflation objectives, taking into account country-specific characteristics.
Country case studies shed light on how monetary policy conditionality in Fund-supported programs
has responded to developments in monetary policy frameworks (see Appendix IV).
16. The majority of Fund-supported programs include the traditional net domestic asset
target (alongside net international reserves), although close to half also included a target on
reserve money. Since 2002, performance criteria (PC) on NDA have been set for about 70 percent
of Fund-supported programs. Adherence to NDA ceilings has been generally good in Fund-
supported programs. Reserve money is targeted in 44 percent of programs, as a PC in one-third of
these cases and an indicative target in the remainder. All Fund-supported programs had Net Foreign
Assets (NFA)/NIR targets, and most programs that cite reserve money as an indicative target already
include NDA as a PC. Many programs included structural conditionality to track efforts to strengthen
monetary operations and produce high-frequency indicators.
17. There is increasing adaptation to the growing diversity in monetary policy frameworks
in GRA-supported programs as compared to PRGT-supported programs (Figure 5). More GRA-
supported programs are shifting away from money targeting to the use of review-based
conditionality through ICCs (about 30 percent of GRA-supported programs include ICCs). As a result,
the proportion of programs targeting reserve money is lower in the case of GRA-supported
programs (under 27 percent) than in PRGT-supported programs (about 55 percent). However, most
GRA-supported programs continue to use the NIR/NDA framework in addition to other forward-
looking indicators, including the use of short-term interest rates, to assess the monetary policy
stance, while only two Fund-supported programs had no NDA or reserve money targets.
11
The empirical evidence on the performance of using interest-based instruments is broadly supportive of their
effectiveness in delivering low inflation and anchoring inflation expectations in both industrialized and emerging
market economies. Hyvonen (2004) and Vega and Winkelried (2005) find that the move away from money targeting
at least partly contributed to lower inflation and lower inflation volatility in the 1990s and 2000s. IMF (2005) argues
that policy regimes that use an interest rate as a policy instrument with an explicit inflation objective appear to have
been more effective than alternative monetary policy frameworks in anchoring price expectations.
12
See Appendix III for a list of country programs. Programs in countries with currency board arrangements, exchange
rate arrangement with no separate legal tender or conventional peg arrangements, GRA-supported programs in
advanced economies, and Exogenous Shocks Facility (ESF) cases were excluded.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
14 INTERNATIONAL MONETARY FUND
Figure 5. Conditionality Landscape in GRA and PRGT Programs, 2002–2012
18. Adherence to reserve money targets in Fund-supported programs over the past
decade has been weak, although money target misses have not been correlated with inflation
deviations at low inflation levels. Estimates from 89 program reviews (based on 38 programs for
25 countries) that had an explicit target on reserve money (either as a PC or indicative target) show
that the reserve money target was not observed in 51 percent of such reviews.
13
Considering PCs
alone, about 20 percent of reserve money targets were not observed. In high-inflation countries,
reserve money target misses were positively and significantly correlated with higher-than-
programmed inflation, while proportionately large deviations in reserve or broad money growth are
associated with generally small deviations in inflation.
14
In both PRGT- and GRA-supported low-
inflation countries, however, reserve money target deviations and inflation deviations are not
correlated (see Figure 6).
15
Similar results hold for the relationship between broad money and
inflation target deviations.
16
This lack of correlation implies not just that money target misses are
13
A target is not observed when the actual outturn of reserve money exceeds the target at the test date. This holds
for both PCs and indicative targets.
14
In the case of reserve money target deviations, panel regressions using fixed-effects find a positive and statistically
significant association in the case of high-inflation countries, which is robust to controlling for GDP deviations from
projections, terms of trade shocks or food prices shocks, and time dummies. In addition, this result would also be the
case for the sub-sample of PRGT-supported programs. In the case of broad money deviations, the association with
inflation deviations would still be positive and significant after controlling for GDP deviations from projections, terms
of trade shocks, and time dummies. However, the association is positive but not significant when including food price
shocks. It becomes significant when excluding the time dummies.
15
A similar result is found in IMF (2008) for a sample of 16 SSA countries. Also, IMF (2005) finds no statistically
significant relation between projection deviations of money growth and inflation for a sample of 15 PRGT-supported
programs in mature stabilizers during the 2002–2003 period.
16
For programs only targeting NDA, there was no clear association between reserve money projection misses and
inflation misses when inflation is low but some evidence of association with high inflation.
1/ There are also cases (Turkey 2005 and Armenia 2009) where conditionality was defined in terms of reserve money and NDA despite the existence of an ICC at the time.
40%
10%
17%
29%
5%
0%
10%
20%
30%
40%
50%
Monetary Conditionality in GRA-supported programs
(In percent of total number of GRA programs)
NDA only
Base or RM target only
NDA and RM target
ICC
17
2
4
12
7
44%
19%
35%
2%
0%
10%
20%
30%
40%
50%
Monetary Conditionality in PRGT-supported programs
(In percent of total number of PRGT programs)
NDA only
Base or RM target only
NDA and RM target
NDA and ICC
28
12
22
1
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 15
uninformative about inflation in low-inflation countries, but also that money target achievement can
be relatively uninformative about inflation.
17
Figure 6. Money and Inflation Target/Projection Misses in Fund-Supported Programs,
2002–2011
19. Money target misses peaked during the onset of the global financial crisis, but they
had been elevated throughout the past decade (Figure 7). The proportion of misses, relative to
the number of program reviews, peaked in 2009 (at about 90 percent), during a period of extreme
financial turbulence, price volatility, and rapidly shifting macroeconomic policies that were difficult
to incorporate in short-term program projections. However, the proportion of target misses ranged
between 30 and 60 percent in other years during the past decade.
17
This lack of correlation does not imply that money supply shocks are not inflationary but that such shocks are not
a salient driver of money/inflation dynamics in the data.
y = 0.0567x - 0.0072
R² = 0.1548
-4
-3
-2
-1
0
1
2
3
4
5
-20 -15 -10 -5 0 5 10 15 20
Actual minus program inflation
(percent)
Actual minus program reserve money growth (percent)
Program Deviations in Inflation and Reserve Money
Growth, PRGT and GRA, Years T to T+2
(High-inflation Countries)
y = 0.0327x - 0.0376
R² = 0.1186
-4
-3
-2
-1
0
1
2
3
4
5
-30 -20 -10 0 10 20 30
Actual minus program inflation
(percent)
Actual minus program money growth (percent)
Program Deviations in Inflation and Money Growth, PRGT
and GRA, Years T to T+2 (High-inflation Countries)
y = -0.0031x + 0.3756
R² = 0.0004
-4
-2
0
2
4
6
-30 -20 -10 0 10 20 30
Actual minus program inflation
(percent)
Actual minus program reserve money growth (percent)
Program Deviations in Inflation and Reserve Money
Growth, PRGT and GRA, Years T to T+2
(Low-inflation Countries)
y = -0.0038x + 0.3582
R² = 0.001
-4
-2
0
2
4
6
-40 -30 -20 -10 0 10 20 30 40 50
Actual minus program inflation
(percent)
Actual minus program money growth (percent)
Program Deviations in Inflation and Money Growth, PRGT
and GRA, Years T to T+2 (Low-inflation Countries)
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
16 INTERNATIONAL MONETARY FUND
Figure 7. Proportion of Annual Reserve Money Target Misses for PRGT- and GRA-Supported Programs,
2002–2012
20. Most of the non-observance of reserve money targets can be explained by higher-
than-projected net foreign assets of the central bank (Figure 8). However, neither NDA misses
nor NFA misses, individually, are statistically significantly related to inflation deviations from
projections. Staff estimates show that higher-than-programmed deviations in NFA are not fully
offset by reductions in NDA, resulting in reserve money target misses.
18
Figure 8. NDA Deviations and NFA Deviations in Programs
with Reserve Money Target
18
This analysis is based on the 38 Fund-supported programs with explicit targets on reserve money.
y = -0.8846x + 1.7287
R² = 0.8711
-80
-60
-40
-20
0
20
40
60
80
-80 -60 -40 -20 0 20 40 60 80
NFA deviation
NDA deviation
NFA and NFA Deviation from Target- Percent of Reserve Money
(PRGT and GRA programs, High Inflation countries, Periods T to T+2)
y = -0.93x + 0.7868
R² = 0.8621
-100
-50
0
50
100
150
-100 -50 0 50 100
NFA deviation
NDA deviation
NFA and NFA Deviation from Target- Percent of Reserve Money
(PRGT and GRA programs, Low Inflation countries, Periods T to T+2)
y = -0.8765x + 2.1178
R² = 0.8595
-80
-60
-40
-20
0
20
40
60
80
-80 -60 -40 -20 0 20 40 60 80
NFA deviation
NDA deviation
NFA and NFA Deviation from Target- Percent of Reserve Money
(PRGT programs, High Inflation countries, Periods T to T+2)
y = -0.9261x + 0.9975
R² = 0.8596
-100
-50
0
50
100
-100 -80 -60 -40 -20 0 20 40 60 80
NFA deviation
NDA deviation
NFA and NFA Deviation from Target- Percent of Reserve Money
(PRGT programs, Low Inflation countries, Periods T to T+2)
0
20
40
60
80
100
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 17
21. Program projections of velocity and the money multiplier are on average close to
outturns, although the averages mask a great deal of volatility that contributes to money
target misses. On average, programs project a 3 percent annual decline of velocity reflecting, inter
alia, a projected increased demand for money, while actual data also show a 3 percent velocity
decline (Figure 9). However, there is considerable volatility in the projections, reflected in a root
mean squared error (RMSE) of 9. Similarly, while on average, programs project an increase in the
money multiplier of 1.5 percent compared to an outturn of 1.7 percent, volatility—exhibited by a
RMSE of 9—is also considerable (Figure 10). While there is no trend bias in velocity or multiplier
projections, the compounded impact of volatility in both factors would explain difficulties in
accurately projecting reserve money demand in relation to broad money demand and nominal GDP.
Figure 9. Projected and Actual Changes in Velocity
Figure 10. Projected and Actual Changes in Multiplier
22. These changed circumstances have led to some limited experimentation with a more
flexible monetary conditionality, including setting narrow bands on reserve money (Tanzania
and Rwanda). In practice, the focus in these programs remained on the upper side of the reserve
money band (PCs were set on the upper band). The overall implementation experience of more
flexible monetary conditionality has been mixed and has generally not provided sufficient flexibility
in the view of some country authorities, while contributing to interest rate volatility that has
obscured the signaling of the policy stance (see Box 1).
0
10
20
30
40
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
More
Frequency (%)
Annual change in velocity (%)
Projected Annual Change in Velocity: PRGT-and
GRA-Supported Programs
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
More
Annual change in velocity (%)
Actual Annual Change in Velocity: PRGT-and
GRA-Supported Programs
0
10
20
30
40
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
More
Frequency (%)
Annual change in multiplier (%)
Projected Annual Change in Multiplier:
PRGT-and GRA-Supported Programs
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
More
Annual change in multiplier (%)
Actual Annual Change in Multiplier: PRGT - and
GRA-Supported Programs
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
18 INTERNATIONAL MONETARY FUND
Box 1. Interest Rate Volatility and the Monetary Policy Transmission Mechanism in East
Africa
Strict adherence to the announced monetary target in the face of money demand shocks can generate
substantial, but often temporary, movements in interbank rates that do not signal policy intentions.
Evidence from Kenya, Uganda, and Tanzania (from January 2005 to December 2012) shows that short-
term volatility of the interbank interest rate (measured as the frequency of greater-than-1-percent
deviations from a moving average) varies considerably according to their monetary policy regimes (text
box).
Tanzania adheres closely to its de jure money targeting regime, and this is reflected in higher volatility in
interest rates during the period. Uganda also experienced very volatile interest rates prior to its move
away from strict money targeting. Since October 2009, however, the Bank of Uganda has allowed more
flexibility in daily money market operations in order to smooth short-term money market rates. This
immediately reduced the volatility of interbank rates. In July 2011, the Bank of Uganda officially adopted
an IT-lite regime and introduced the Central Bank Rate (CBR) to target the interbank rate, described in
Appendix IV. After the switch, interest rates in Uganda have been relatively stable.
Kenya has been paying increasing attention to short–term interest rates, which is reflected in less volatile
interest rates since the mid 2000s. Following policy implementation challenges in 2010–2011, the Central
Bank of Kenya (CBK) introduced a new framework for monetary operations in October 2011, centered on
its CBR, supported by greater use of open market operations (Andrle and others, 2013).
2005-2009 2010-2012 2005-2012
Kenya 0.0 84.3 84.3
Uganda 89.5 25.4 114.9
Tanzania 111.5 174.7 286.2
Source: Berg and others (2013)
Sum of Square Deviations from the 1 % Band
-2
0
2
4
6
8
10
12
14
16
18
20
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Interbank Rates (percent)
Tanzania: Developments in Interbank Rates
(Within a band of +/- 1 percent)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Interbank Rates (percent)
Uganda: Developments in Interbank Rates
(Within a band of +/- 1 percent)
0
1
2
3
4
5
6
7
8
9
10
Jan-05
Apr-05
Jul-05
Oct-05
Jan-06
Apr-06
Jul-06
Oct-06
Jan-07
Apr-07
Jul-07
Oct-07
Jan-08
Apr-08
Jul-08
Oct-08
Jan-09
Apr-09
Jul-09
Oct-09
Jan-10
Apr-10
Jul-10
Oct-10
Interbank Rates (percent)
Kenya: Developments in Interbank Rates
(Within a band of +/- 1 percent)
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 19
Box 1. Interest Rate Volatility and the Monetary Policy Transmission Mechanism in East
Africa (Concluded)
The monetary policy regime has an impact on the
strength of the transmission mechanism. Using a
narrative approach following Romer and Romer
(1989), Berg and others (2013) analyze a
significant tightening of monetary policy that
took place in 2011 in Kenya, Uganda, and
Tanzania. The event study suggests that the
transmission mechanism in these economies is
alive and well: after a large policy-induced rise in
the short-term interest rate, lending and other
interest rates rose, the exchange rate tended to
appreciate, output fell, and inflation declined.
However, there are differences in the strength of
the transmission among countries, largely
explicable in terms of the nature of the policy
adjustment and regime.
In particular, the transmission was the clearest in
Kenya and Uganda, where the regimes used
policy rates to signal changes in the monetary
policy stance and explicitly prioritized the inflation
objective. It was less clear in Tanzania, where the
effects on some interest rates, activity, the
exchange rate, and inflation were still broadly
evident, but lending rates failed to respond,
perhaps reflecting the fact that the money targeting regime led to highly volatile short-term interest rates
and hence made it harder to discern the stance of policy.
0
5
10
15
20
25
30
35
0
5
10
15
20
25
30
35
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Interbank Rate (%)
Kenya
Uganda
Tanzania
-5
0
5
10
15
20
25
30
-5
0
5
10
15
20
25
30
Jan-10
Apr-10
Jul-10
Oct-10
Jan-11
Apr-11
Jul-11
Oct-11
Jan-12
Apr-12
Jul-12
Oct-12
Inflation
Channel Evidence Lag (quarter) Evidence Lag (quarter) Evidence Lag (quarter)
Interest Rates Channel: Money Market Rates Yes 1 Yes 1 Yes 1
Interest Rates Channel: Deposit Rates Yes 1 Yes 1 Yes 1
Interest Rates Channel: Lending Rates Yes 2 Yes 2 No n.a.
Interest Rates Channel: Activity Yes 3 Yes 3 Yes 1
Exchange Rate Channel: Arbitrage Yes 1 Yes 1 Yes 1
Exchange Rate Channel: Pass-through Yes 1 Yes 1 Yes 1
Credit Channel Yes 1 Yes 1 Yes 1
Phillips Curve Yes 2-3 Yes 2 Inconclusive n.a.
Source: Berg and others (2013).
Kenya
Uganda
Tanzania
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
20 INTERNATIONAL MONETARY FUND
23. Several country case studies suggest that Fund conditionality has not consistently
provided an appropriate policy anchor for some countries with evolving monetary policy
regimes (Box 2 and Appendix IV). While program conditionality also evolved, there were challenges.
In some cases, there was a lag: the Fund-supported programs targeted different intermediate
targets than those that were the primary focus of the authorities, which led to a lack of clarity on
monetary policy objectives, limited gains in building central bank credibility, and conflicting signals
to market participants (Armenia, Uganda, and Moldova). In the case of the Dominican Republic,
during the period preceding the adoption of IT, traditional monetary conditionality was deemed
appropriate since the monetary policy framework was in fact not significantly changing. In Tanzania,
minor changes such as period average rather than end-period reserve money targets were useful in
making money targeting more effective, and there may be scope within this framework for the type
of discussions envisaged in a Monetary Policy Consultation Clause (MPCC) on assessing implications
of reserve money target misses.
ENHANCING THE MONETARY POLICY
CONDITIONALITY TOOLKIT
24. The Fund’s monetary policy conditionality is intended to assist members in resolving
their balance of payments problems, while safeguarding the use of the Fund’s resources.
Program conditionality aims to ensure that: (i) recourse to Fund resources is temporary; (ii) Fund
resources will be used to help members solve their balance of payments problems and achieve
medium-term external viability while fostering sustainable economic growth; and (iii) members
using Fund resources maintain the capacity to repay the Fund.
25. The “traditional” monetary policy conditionality has two standard PCs derived from
the Polak 1950 model and the monetary approach to the balance of payments. The floor on
NIR and a ceiling on NDA were originally designed to ensure external sustainability in a world of
fixed but adjustable exchange rates. The PC on NIR (floor) aimed to ensure external sustainability,
while the ceiling on NDA of the central bank reinforced this objective by ensuring that future
sustainability was not derailed by excessive expansion in credit. While containing excessive credit
expansion supported the viability of the exchange rate as an inflation anchor, the NDA ceiling was
not primarily set for inflation control (Box 2). The combination of a floor and ceiling on the
components of reserve money does not provide an automatic safeguard against excessive monetary
expansion because sustained overperformance on the external position can result in excessive
monetary expansion if not offset by reductions in NDA.
26. When disinflation became a key objective of most Fund-supported programs, an
additional PC (or indicative target) on reserve money (base money) was often introduced.
Reserve money targets then acquired greater prominence in Fund-supported programs during the
1990s, particularly among LICs seeking to lower inflation rates. However, there are conceptual and
practical problems for evolving regimes that use money targeting. Key issues that arise are: (i)
whether the framework gives enough weight to inflation (or disinflation) objectives; (ii) whether its
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 21
focus on the monetary base remains appropriate as countries move toward greater operational
reliance on short-term interest rates; and (iii) whether it provides a coherent framework for
monetary policy analysis in these countries.
Box 2. Monetary Targeting in Fund-Supported Programs
The monetary regime in Fund-supported programs typically includes a framework for quarterly projections
of key monetary aggregates—referred to as a broad monetary program (BMP). Operationally, the central
bank focuses weekly and daily projections of the main items of the central bank’s balance sheet—or reserve
money program (RMP). The BMP is based on the premise of a stable relationship between money and the
price level (i.e., in the form of a money demand equation) over the medium term. It provides an assessment
of the monetary stance (via broad money targets) in relation to the fiscal accounts and the balance of
payments. The RMP is based on the premise of a stable relationship between broad money and base money
(the money multiplier). It supplies the central bank with an operational tool to guide the calibration of its
monetary operations when base money is used as the operating target for monetary policy.
27. In recognition of the adoption of inflation targeting, the reserve money/NDA PC was
replaced with a review-based approach to monetary policy conditionality. This approach to
monetary conditionality was implemented through the ICC to respond to tensions between the
practicalities of IT implementation and the requirements of the NIR/NDA/RM conditionality
framework (Box 3). Since 2000, a number of Fund-supported programs applied the review-based
approach to monetary policy conditionality through the inclusion of ICCs in the relevant Fund
arrangements, mostly in advanced and EM economies along with a handful of developing
economies (mostly lower middle-income countries).
19
28. The review-based approach to monetary policy conditionality involves setting bands
around a target inflation variable, and a consultation with staff or the Board is triggered if
actual inflation deviates outside the band.
20
The target variable was adjusted at the time of some
program reviews, but generally the width of the band has not been adjusted. Consultations with the
Board took place relatively infrequently (See Appendix V).
29. Neither the “traditional” conditionality nor the IT review-based conditionality (ICC) is
necessarily well suited for evolving regimes.
21
Traditional monetary targets set as program PCs
19
See IMF (2000a).
20
The review-based approach for monetary policy conditionality approved by the Board in 2000 (IMF, 2000a; and
IMF, 2000c) has been implemented in practice through the inclusion of consultation clauses in Fund arrangements.
Under these clauses, if the member’s inflation exceeds the inner band, a consultation with Fund staff is triggered; and
if the member’s inflation exceeds the outer band, access to resources under the arrangement is interrupted until the
member consults with the Executive Board and the relevant program review is completed (see description of these
clauses in specific country cases in IMF (2006), paragraph 60).
21
An IMF paper (IMF, 2005) looked at the need for possible adjustments in the design of Fund-supported programs
for LICs deemed mature stabilizers. The paper identified scope for some changes in the design of monetary
programs by improving programming assumptions regarding velocity but did not explore options to better align
conditionality to the changing characteristics and challenges of developing economies.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
22 INTERNATIONAL MONETARY FUND
continue to serve many countries well and can be flexibly applied, including through the use of
adjustors that anticipate exogenous shocks, the application of waivers, and the subsequent
modifications of targets.
22
However, the benefits of these nominal monetary anchors can be
undermined if they are frequently missed when policy objectives are being achieved or when they
are subject to complex mechanical adjustments. Evolving regimes have unique challenges: they
need to use considerable judgment regarding money targets; monetary policy is becoming
increasingly forward looking; and yet there is no clear commitment to a numerical inflation target
within a pre-set time horizon. There are clear benefits from modifying monetary policy conditionality
for evolving regimes. A modification to the conditionality framework would in effect be catching up
with actual practice while at the same time providing a framework for coherent monetary policy
analysis to prevent a situation where “anything goes.” However, countries that have adopted an
effective inflation targeting framework would be typically expected to use the review-based
approach through the inclusion of ICCs in Fund arrangements.
Box 3. Inflation Consultation Clause and Fund Conditionality
The Fund’s 2000 policy on monetary conditionality under inflation targeting switched from the NIR/NDA/RM
framework to a review-based conditionality for IT countries. This review-based conditionality was
implemented in practice through the introduction of ICCs in the arrangement to replace the PCs on NDA
and RM. The review-based conditionality had the following key components:
An introduction of a periodic (usually quarterly) review with emphasis on assessment of current
inflation against forecast and implications for inflation outlook;
Where there are deviations from the targeted inflation path, following the assessment above, Fund
staff and authorities would reach an understanding ex ante on a timely remedial monetary policy response;
The use of the floor on NIR to maintain external sustainability and safeguard the use of Fund
resources; and
A mechanism to deal with country-specific risks. This mechanism could be allowance of enough
room in setting of the NIR floor for unprogrammed intervention or the use of NDA ceilings where necessary.
Where NDA ceilings are maintained, it is required to make clear to the public the relationship between NDA
and inflation targets.
Since 2000, a number of Fund-supported programs applied the review-based approach to monetary policy
conditionality through the inclusion of ICCs in Fund arrangements, mostly in advanced and EM economies
with a handful of developing economies (mostly lower middle-income countries).
Although assessment of monetary policy during reviews need not be confined to a narrow set of variables, it
was necessary to define a set of indicators on which such an assessment would be primarily based, hence
the introduction of the inflation bands and the ICCs triggered by the member’s deviation from the outer
band. Under the ICC, an inflation target (usually the target of the authorities), as well as a tolerance band, is
set as a basis to guide monetary policy assessment and reviews. Typically, programs would specify an
inflation path (mostly quarterly) consistent with authorities’ inflation targets, and current and projected
inflation would be assessed against these target paths, and an understanding on specific remedial action
22
Including, but not limited to, countries where actual or potential fiscal dominance remains and where the central
bank strongly influences bank operations.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 23
Box 3. Inflation Consultation Clause and Fund Conditionality (Concluded)
would be expected whenever the outlook suggested that future inflation objectives were likely to be missed
by a pre-specified margin. Consultation bands introduced in Fund-supported programs since 2000 have
generally taken the following form:
Annual central inflation target + a quarterly path with a two-tier consultation band around central
target.
Outer band: ±X percent around central target. Consultation with the IMF Executive Board if actual
12-month chosen inflation index falls outside outer band.
Inner band: ±Y percent around central target; (Y<X). Informal consultation with IMF staff if actual
12-month chosen inflation index falls outside inner band.
The authorities would have to present remedial measures for consultation with the Executive Board
for approval when outer band consultation is triggered.
A total of 13 Fund-supported programs with six members have used the review-based approach to
monetary policy through the inclusion of ICCs in Fund arrangements since 2000. Overall, some flexibility has
been applied in the choice of the target variable and width of bands, while central paths have been
frequently adjusted in some programs particularly where there was a disinflation objective. More recently,
some countries have been using single bands under the ICC framework. Out of a total of 70 reviews under
these programs, about 27 percent have triggered a monetary policy consultation, of which 10 percent were
consultations with Fund staff (informal consultation) and 17 percent were consultations with the Executive
Board. The latter have taken place through consultation letters from country authorities explaining the
causes of a deviation from the inflation target range and remedial measures, if any, that were taken or are to
be taken (see Appendix V, Table V.1).
30. For these evolving regimes, the paper proposes a review-based MPCC framework with
two objectives :
To provide flexibility and incentives for the development of a coherent framework for monetary
analysis and monitoring under Fund-supported programs. Under the MPCC, monetary
conditionality would include a quantified macroeconomic framework with a set of quarterly or
semiannual monetary or inflation targets set within a tolerance band. Deviations from the band
would trigger a consultation with the Executive Board which would focus on: (i) a broad-based
assessment of the stance of monetary policy and whether the Fund-supported program is still
on track; and (ii) the reasons for program deviations, taking into account compensating factors
and proposed remedial actions if deemed necessary.
To maintain external sustainability while safeguarding the use of Fund resources. This would be
served by maintaining the use of the NIR floor as a PC to ensure external sustainability. The
performance criterion on NIR would also reinforce the country’s commitment to some exchange
rate flexibility, ensuring that the Fund’s resources provide support for the adjustment needed to
lead a sustainable external position. If, however, a significant margin for intervention were
appropriate, an accompanied tightening of monetary conditions could be needed to limit
inflation pressures. Additional tripwires (as indicative targets) may be needed to address
country-specific risks, e.g., external stability or fiscal dominance concerns. The need and choice
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
24 INTERNATIONAL MONETARY FUND
of tripwires would be determined on the basis of understandings reached with country
authorities, and would not rule out the continued use of NDA or monetary aggregates as
tripwires, if warranted for these purposes.
31. The MPCC would be an option under the review-based conditionality framework
(Figure 11).
23
The decision to implement the MPCC would be the outcome of discussions between
staff and the authorities, while remaining the responsibility of Fund staff. While it would normally be
adopted at the start of a program, authorities could also request to modify the type of monetary
conditionality and adopt an MPCC during the program if circumstances change. Consistent with the
guidelines on conditionality, the authorities are responsible for the selection, design, and
23
The choice of a review-based approach is consistent with the way monetary policy is formulated in evolving
regimes. Unlike conditionality based solely on performance criteria, a review-based approach with an MPCC entails a
comprehensive assessment of monetary policy and the inflation outlook. Such an assessment is based on a wide
range of indicators, some of which may be country-specific.
Figure 11. Proposed Outline of the Modified Monetary Conditionality Framework
(NIR/NDA/RM)-
Framework
(Traditional Money
Targeting Regimes)
Review-Based
Monetary Policy
Conditionality
Modified Conditionality
Framework
Monetary Policy
Consultation Clause (MPCC)
for Regimes with evolving
Monetary Policy
Inflation Consultation
Clause (ICC)
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 25
implementation of economic policies while the Fund is fully responsible for the establishment and
monitoring of all conditionality including the MPCC. The introduction of the MPCC does not affect
the design or operation of the ICC.
32. The MPCC would be based on a specified central path for the target variable (i.e.,
monetary aggregate or inflation). The central path should be consistent with, or on a convergent
disinflation path to, any formal or informal public inflation objective. However, the central path
would not necessarily be tied to a formal inflation target and hence, unlike the review-based
monetary conditionality that works through ICCs, the authorities would not have to publicly
announce and commit to an inflation target. The choice of variable for the central path would reflect
monetary policy practice in the program country. Countries in which policy discussions are de facto
centered on the inflation outcome and prospects could use inflation as the trigger variable, whereas
those countries in which policy discussions continue to focus on monetary aggregates could choose
monetary aggregates as the trigger variable. In program discussions, staff and the authorities would
reach understandings on the framework that underpins the authorities’ approach to monetary policy
implementation: the key monetary policy objectives; operating and intermediate targets; and the
available monetary policy instruments. These understandings would shape the design of the
MPCC—making it country specific. The design of the central path (inflation or monetary aggregates)
would have to be consistent with an inflation objective over a relatively short-time horizon, e.g.,
12 months.
24
For regimes that choose inflation as the central path, either a headline or a core
inflation measure could be used, depending on which one would best communicate the monetary
policy stance to the public. For economies aiming to reduce inflation, the path could be designed to
decline by a certain proportion over time. This path could either be a disinflation path or a monetary
aggregate path set to achieve a specific inflation objective over a given time horizon.
33. The target variable subject to a monetary policy consultation would normally have a
single tolerance band. This parsimonious approach would provide a clear signal of the monetary
program objectives.
However, in regimes that select inflation as the target variable, as in the ICC
framework, in addition to an outer band, a narrower inner band could be used as an early warning
to check that monetary policy is not veering off track. A deviation from the inner band triggers a
staff consultation, but there would be no interruption of purchases if the consultation is not held. An
inner band in the case of regimes that select money as the target variable may limit the additional
flexibility the MPCC is meant to provide, as it would place excessive attention on monetary
aggregates instead of the desired broader assessment of the policy stance.
34. The width of the tolerance band would be set sufficiently wide to provide adequate
flexibility on a case-by-case basis, balanced against the need to steer monetary policy toward
achieving its objective. Several factors would be relevant in setting the width of the band including
the recent volatility of the target variable, the level and path of the target variable, and the choice
24
The inflation objective would be similar to the inflation objective used in financial programming for Fund-
supported programs. Beyond that, the authorities would not have to publicly commit to an inflation target if the
country has not adopted an explicit inflation targeting regime.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
26 INTERNATIONAL MONETARY FUND
and effectiveness of monetary instruments. The considerations in deciding the width of the band
would also differ somewhat for a country choosing a band for inflation versus a band for a monetary
aggregate. In general, a narrowly defined band would have a clear benefit of more strongly
anchoring expectations than a broad band, but has to be weighed against the potential reputation
costs for frequent deviations. This benefit would be particularly important for countries using an
inflation band. For monetary target bands, when there are significant structural changes in the
demand for money, narrow bands for monetary targets could be associated with higher interest rate
volatility, with undesirable implications when trying to strengthen the role of policy rates to signal
the policy stance. Ultimately, the band width would have to be determined based on country-
specific circumstances and reviewed regularly to ensure it provides an adequate anchor and
flexibility for the implementation of monetary policy.
35. Program reviews would include enhanced monetary policy assessment in the context
of a clearly defined monetary policy objective. Reviews would involve assessing ex post
outcomes for recent inflation or money as well as the near-term outlook, using a given set of
indicators. Staff would also assess the authorities’ capacity to implement the monetary program
going forward, including maintaining the MPCC target variable within the band.
25
The set of
indicators used in the review would include, but not be limited to, developments in monetary
aggregates, interest rates, recent inflation outcomes (both headline and core), leading and
coincident indicators of inflation and economic activity, survey-based indicators (business and
consumer confidence surveys), and other available forward-looking variables.
26
The analysis would,
among other things, discuss the drivers of inflation, the inflation outlook, and implications for the
inflation objective. It would also be important to consider interactions between fiscal and monetary
policy as the absence or limited scope of direct monetary financing does not imply that fiscal
pressures have disappeared. Coordination of fiscal and monetary policy is also particularly important
for countries with large aid or natural resource inflows.
36. Fund staff could draw on the ongoing work by RES, ICD, and MCM to develop a
system that would help organize the underlying economic information in a structured way to
support monetary policy implementation in developing economies (Appendix VI and VII). This
analysis and the related training and TA could help with both the setting of the target and the
interpretation of target misses, and whether a target miss reflects an excessively accommodative
policy or other factors, e.g., money demand shocks. The analysis of target misses would be
automatically complemented by a broader analysis of the state of the economy. Model use,
however, would be optional, as other methods (including the use of leading and coincident
25
Monetary policy discussions would also consider the implications of monetary policy for financial stability where
relevant.
26
STA, in conjunction with the Africa Regional Technical Assistance Center (AFRITAC) East, has started a pilot
program to provide TA to central banks (Bank of Uganda and National Bank of Rwanda) on compiling leading
indicators, with a view to rolling out these pilots to other SSA countries. See Appendix VIII for a detailed discussion of
the role of high-frequency indicators in monetary policy decision making and a roadmap to help central banks begin
compiling these indicators.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 27
indicators) could be used for forward-looking policy analysis. In addition, a focus on improving
short-term monetary operations and liquidity management is critical for developing countries
working to modernize their monetary policy frameworks.
37. A formal consultation with the Executive Board would be triggered should the
observed outcome of the target variable deviate from the band. In these cases, access to Fund
resources would be interrupted until the consultation with the Executive Board takes place and the
relevant program review is completed. The program review would not be completed unless the
Executive Board is satisfied that the member’s monetary policies are consistent with program
objectives. In regimes that select inflation as the target variable, a deviation from the outer band
would trigger consultation with the Executive Board, and if a narrower inner band is included,
deviation from this band would trigger a consultation with staff.
38. The formal consultation with the Executive Board would be informed by staff’s
assessment of the monetary policy stance. Staff would assess whether deviations from bands are
explained by compensating factors (including exogenous shocks) and make judgments as to the
appropriate actions and policy commitments needed to correct program slippages. Staff reports
would include the authorities’ views in cases where there is divergence of views between staff and
authorities on the assessment of monetary policy. The authorities would also be expected to present
their assessment of the monetary policy stance as part of the Memorandum of Economic and
Financial Policies (MEFP) or in a letter to the Managing Director, explaining reasons for the deviation
from the target bands and remedial actions introduced where necessary. In the event of weak policy
commitments to correct slippages, and in the context of an overall assessment of a member’s
economic and financial policies, staff and management could decide not to recommend completion
of the relevant program review. Implementation of remedial actions could result in delay in
completion of reviews. The review process will follow the normal review cycle of the Fund-supported
program. However, staff will continue to maintain a dialogue with the authorities between program
reviews (as is the standard practice) to monitor monetary policy developments.
39. The MPCC would provide flexibility attuned to the changing monetary policy
frameworks in evolving regimes. It would provide the needed structure for organizing economic
information to support the conduct of monetary policy, as well as the necessary safeguards for use
of Fund resources and the country’s capacity to repay the Fund by maintaining the NIR floor as a PC
as well as, where necessary, a tripwire on NDA or other indicators.
27
It would provide a predictable
and credible nominal anchor that is aligned with a members’ monetary policy framework. Unlike the
existing review-based approach to monetary policy conditionality through ICCs for countries with IT
regimes, the proposed MPCC would provide the option to choose either a monetary aggregate or
an inflation objective as the central path in the design of the consultation clause (see Table 3). This
would particularly appeal to evolving regimes that are often experimenting with multiple (flexible)
operating targets and have not explicitly committed to an inflation target. The MPCC would provide
27
The use of tripwires (including NDA, NCG, etc.) would provide additional check for country-specific risks.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
28 INTERNATIONAL MONETARY FUND
additional flexibility by not tying the central path of the consultation clause to a publicly announced
inflation target and thus create room for evolving regimes to build credibility while structures are
put in place to enhance transparency and accountability.
Table 3. Comparison of Conditionality: Traditional Money, MPCC, and ICC
Traditional Monetary
Program (NIR/NDA)
MPCC
ICC
External Reserves Target
(NIR/NFA)
PC
PC
PC
NDA Target
PC if no reserve money
PC
Optional as tripwire (IT)
Optional as tripwire (IT)
Reserve Money Target
PC if no NDA PC or IT
with NDA PC
Single band (when no
inflation band is set)
Not Applicable
Inflation Target Bands
Not applicable
Normally single band
(when no reserve money
band is set), but optional
inner band
Inner and outer bands in
a majority of cases
Board Consultation
Not applicable
When target band is not
observed
When outer inflation
band is not observed
Staff Consultation
Not applicable
Not required (except
where inner band option
is chosen) but staff
maintains continuous
dialogue with authorities
When inner band is not
observed but outer band
is observed
Waivers
For PCs not observed
For PCs not observed
For PCs not observed
Corrective Actions (PCs)/
Remedial Actions
(consultation clause)
May be required for the
waiver, if PCs not
observed
Required to conclude
monetary policy
consultation when the
deviation from the band
cannot be explained by
compensating factors, or
for waiver of non-
observance of NIR PC
Required to conclude
inflation consultation
when target is not
expected to be met, or
for waiver of non-
observance of NIR PC
Misreporting
Applies to PCs and prior
actions
Applies to NIR PC, prior
actions and band target
variable
Applies to NIR PC, prior
actions and outer
inflation target band
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 29
40. The proposed MPCC framework will have implications for misreporting risks and
safeguards on the use of Fund resources:
The replacement of NDA and/or RM as performance criterion with an MPCC would reduce
program monetary data that are subject to misreporting, while NIR data and other program
targets will continue to be subject to the misreporting framework.
28
To address this risk, a formal consultation with the Executive Board would be a condition for
completing the program review and thus for resuming purchases or disbursements under the
terms of the relevant Fund arrangement, and the Fund’s GRA and PRGT misreporting
frameworks would continue to apply in the context of the target variable subject to a
consultation (including the application of the de minimis misreporting policy).
29
Risks relating to use of Fund resources could arise from removing the PC (ceiling) on NDA. In
cases where the NIR floor is set with a considerable margin for intervention, there is a risk that in
the event of un-programmed reserve losses, the contractionary impact on monetary aggregates
is sterilized by an expansion of NDA, when in fact, a tightening of monetary policy might have
been appropriate, depending on the nature of the shock. To avoid unnecessarily accommodative
monetary policy under the MPCC where there are significant margins used in setting the NIR
floor, there would be a commitment not to loosen monetary conditions and to consult with staff
if accumulated intervention reached a pre-defined threshold over any fixed time period. Where
margins are relatively modest, indicating generally flexible exchange rates, such a commitment
would normally be unnecessary. Even in these cases, however, an NDA ceiling could be retained
as an indicative target if there are significant risks to external stability.
Another risk that might arise is that over-performance of NIR leads to pressures to expand one
or more elements of NDA for policy purposes, e.g., quasi-fiscal operations. This risk should be
addressed through a thorough staff assessment of the independence of the central bank prior to
adoption of the MPCC, including the staff assessment of the legal framework and autonomy that
features in safeguards assessments, if available.
28
Data for the period 2008–13 indicate that there were zero cases of misreporting of net domestic assets or reserve
money in PRGT and GRA programs.
29
The misreporting framework would apply to the following situation: a member, when providing information on the
target, represented that there was no deviation from the outer band, and based on such information, a consultation
with the Executive Board did not take place and the member made the purchase or obtained the disbursement upon
completion of the relevant review, but it was later proven that there was deviation from the outer band and that a
consultation with the Board was needed in order to complete the relevant review. As a result, such purchase or
disbursement would be noncomplying and subject to the misreporting policy.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
30 INTERNATIONAL MONETARY FUND
41. Staff anticipates that the MPCC would be introduced in countries after consideration
of country-specific circumstances relative to a “standard.” In particular, there would be clear
benefits from adopting an MPCC in countries that can more clearly signal the monetary policy
stance through the policy rate, and have the capacity to adjust policies in a flexible way to achieve
their monetary policy objectives. In contrast, there could be costs to introducing an MPCC and
monetary targets may be appropriate in countries where commitment to low and stable inflation is
often compromised by other objectives and data quality is weak. Evidence supporting the position
that this “standard” was met in particular countries would include a strong track record of policy
implementation, a relatively low and stable inflation rate, and progress toward basic institutional and
structural guideposts in these areas:
Central bank institutional set up: de facto central bank autonomy in monetary operations and
setting the policy rate; price stability as the de facto primary objective of monetary policy;
structures to enhance communication and transparency of monetary policy decisions well
aligned with the way monetary policy is designed and implemented;
Macro and financial development and stability: absence of high dollarization, a set of monetary
and foreign exchange instruments for policy implementation allowing the central bank to be in a
position to effectively manage liquidity; sound financial relationship between the central bank
and the government that eschews monetary financing; stable financial sector, in particular the
absence of systemic weaknesses; and,
Data and analytical capacity: availability of high-frequency data; quality of other macro data;
liquidity forecasting, and developing understanding of inflation and the transmission channels of
monetary policy.
42. Programs could also support a strengthening of performance to meet the “standard”
required for an MPCC. In cases where the policy implementation track record has been lacking in
some respects or where moderate gaps in the institutional set-up exist, the MPCC could be
considered provided that the authorities are undertaking, or are committed to undertake, reforms
that would address these limitations.
30
43. There will also be cases when, in the staff’s judgment, members have not made
sufficient progress toward the guideposts for adopting a more flexible conditionality
framework. When advising against premature adoption of the framework and maintaining
monetary performance criteria, staff could consider advising structural benchmarks focused on
adoption of institutional reforms in central banks, strengthening the operation of financial markets,
and building statistical and analytical capacity in the form of a road map to modernizing monetary
policy.
30
Batini and Laxton (2007) note that many EM countries developed their policy framework substantially as they
improved their nascent inflation targeting regimes.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 31
44. Most countries with evolving monetary policy regimes are already introducing reforms
to support adoption of flexible monetary policy implementation. An illustrative case is Armenia,
where there have been clear drawbacks to the traditional monetary targeting and the authorities are
developing a more flexible monetary framework, backed by reforms in key areas (Box 4). As Armenia
has demonstrated a strong policy implementation track record over the years, a new Fund-
supported program envisages a move toward a consultation clause framework centered around
inflation, while initially maintaining a performance criterion on NDA (with a margin) and dropping
the indicative target on reserve money.
Box 4. Armenia—Transition to Flexible Monetary Policy
In the mid-2000s, the Central Bank of Armenia’s efforts to sterilize foreign exchange purchases slowed the
pace of appreciation brought about by rising remittances and capital inflows. Moreover, in the context of
favorable macroeconomic conditions and elevated confidence in the domestic currency, money demand was
changing rapidly, making it difficult to pin down the relation between money and inflation. The reserve
money targets were repeatedly not observed, due to foreign exchange purchases and the injection of dram,
but inflation remained low due to higher money demand. The frequent non-observance of reserve money
targets in the presence of low inflation led to a loss of credibility for the money targeting regime; to
continue to follow the target would have implied that monetary policy was too tight. Accordingly, in 2006
the Central Bank of Armenia elected to move to full-fledged IT over the medium term, subject to a transition
period of IT-lite.
Since then, there have been a number of institutional and operational reforms. First, the repurchase rate was
chosen as the operational target, with an interest rate corridor using standing facilities. With the support of
Fund TA, the Central Bank of Armenia has progressively strengthened the new policy framework. It has
developed its modeling/forecasting capacity, started issuing quarterly inflation reports, and published
minutes of its board meetings. The Central Bank of Armenia has also made efforts to improve the
transmission mechanism by enhancing liquidity management, narrowing the interest rate corridor,
promoting activity on the interbank market, and taking steps to reduce dollarization.
The Fund team and authorities plan to build on the significant gains made through the reforms introduced
by moving toward a review-based monetary conditionality in the next Fund-supported arrangement. Staff
has reached understandings with the authorities on key components of the new Fund-supported program
that would: drop the reserve money as an indicative target and introduce an indicative target band on
headline inflation, retain the NIR PC, and retain the NDA PC but introduce a small margin to limit the need
for abrupt operations to meet targets. Reserve money would, however, continue to be shown in the PC table
as a memorandum item.
There are also plans to continue to strengthen both institutional and operational capacity to support the
eventual move toward an MPCC or ICC framework. The focus of reforms would be on monetary operations
(possibly further narrowing the interest rate corridor and development of longer-term instruments) and
improving market and public communications.
45. The traditional framework for monetary conditionality would continue to be an option
in countries where it has proven to be effective in achieving program objectives. Even in those
countries that maintain traditional money targeting conditionality, however, there could be scope
for enhanced monetary policy analysis, as these countries strengthen their policy frameworks.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
32 INTERNATIONAL MONETARY FUND
IMPLICATIONS FOR TECHNICAL ASSISTANCE AND
RESOURCES
46. Enhanced central bank capacity for monetary policymaking is needed in evolving
monetary regimes. Building institutional capacity for monetary policy analysis and implementation
in countries with evolving monetary policy frameworks requires in-depth training and TA (see
Appendixes VII and VIII on data requirements and existing capacity-building activities for monetary
policy frameworks). Coordinated interdepartmental TA and training are already ongoing in SSA
countries, where RES, MCM, and ICD work with country teams and SSA central banks to strengthen
capacity in model-based forecasting and policy analysis, and monetary policy implementation. For
example, RES has a pilot program with the Central Bank of Kenya, involving the training of staff to
prepare reports for the monetary policy committee; MCM and RES are collaborating with the
authorities in Uganda and Mozambique to develop forward-looking monetary policy frameworks.
ICD has also stepped up its offerings of the Monetary and Exchange Rate Policies (MERP) course, in
support of SSA central banks’ staff and is exploiting synergies with TA efforts from other
departments. Complementing these efforts, a large increase in MCM TA in FY14 reflects increased
assistance to central banks in introducing elements of forward-looking monetary policy. SSA has
received almost half of MCM’s TA in central bank modernization in the last four fiscal years.
47. Training and TA (capacity development) are also being provided in other regions. ICD’s
MERP, and the more advanced model-based monetary policy analysis (MPA) course, have been
offered in a range of developing countries. MCM offers TA on a broad range of issues related to
monetary and foreign exchange policy and operations, central bank governance, reserves
management, and development of financial market infrastructure.
48. Continued efforts at strengthening capacity development in this area are ongoing and
planned. In 2014, ICD will offer the MPA course to Fund staff at an SSA regional training event, and
as a global course at headquarters. RES is extending its pilot program to at least three additional
SSA countries (Mozambique, Rwanda, and Tanzania). MCM is placing several resident advisors in
regions and countries with significant central bank reform programs, and is conducting assessments
of operational arrangements for monetary policy conduct in several countries covered by AFRITAC
South. An interdepartmental committee will look at ways to enhance synergies between training, TA,
and peer-to-peer learning to support operational priorities of country teams and authorities,
possibly through a product jointly developed by area and functional departments.
49. The proposed review-based approach to monetary policy conditionality through the
MPCC could have some resource implications for capacity development. However, since
relatively few Fund arrangements are expected to adopt this new conditionality framework in the
near term, the resource implications are expected to be manageable within existing budget
envelopes. As the new framework is a response to developments already occurring in many
countries, in these cases it would likely not be a catalyst for new capacity development demands.
Since in other cases, however, there may be an increased demand for resources, departments
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 33
providing capacity development in consultation with area departments could seek to prioritize
resources for this area.
31
Developing ways to leverage current resources—such as online
collaborative sites for peer-to-peer learning and in-depth training of a small number of staff in an
area department who could assist their colleagues—could also help. However, resource implications,
particularly for area departments, should be monitored for initial Fund arrangements with the MPCC
option.
ISSUES FOR DISCUSSION
50. Directors may wish to discuss the following issues:
Do Directors see merit in employing a review-based approach to program monetary
conditionality in the form of an MPCC for assessing monetary policy in place of performance
criteria, for members with an evolving monetary policy regime that have developed a good track
record of policy implementation underpinned by operational autonomy and technical and
institutional development of the central bank?
Do Directors agree to a measured approach to the introduction of the MPCC option, subject to
review after sufficient experience has been gained?
Does the proposed framework provide sufficient safeguards on the use of Fund resources,
including through the misreporting framework?
Do Directors believe that the provision of TA and capacity building for monetary policymaking is
presently adequate, providing that efforts are made to prioritize such assistance in line with
members’ needs?
31
As the scale of operations is rising in some Regional Technical Assistance Centers (RTACs) thanks to additional
donor contributions, it may also be possible in some cases to get approval from RTAC Steering Committees to
allocate more RTAC resources to the monetary policy area. For example, this approach was successfully utilized in the
case of AFRITAC East.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
34 INTERNATIONAL MONETARY FUND
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CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 37
Appendix I. Country Classification by Monetary Policy
Regimes (Based on 2013 AREAER) 1/
Monetary aggregate target
Other monetary regimes
Crawling Peg/Crawl-like
arrangement 3/
LIC
EM
LIC 2/
EM
LIC
EM
Afghanistan
Argentina
Bolivia
Angola
Ethiopia
Botswana
Bangladesh
Paraguay
Haiti
Belarus
Honduras
Croatia
Burundi
Seychelles
Lao
Costa Rica
Nicaragua
Jamaica
Congo, DR
Sri Lanka
Mauritania
Azerbaijan
Kazakhstan
Gambia
Ukraine
Myanmar
Egypt
Guinea
China
Solomon Islands
India
Kenya
Malaysia
Kyrgyz Republic
Mauritius
Madagascar
Russia
Malawi
Tunisia
Mozambique
Mongolia
Nigeria
Pakistan
Papua New Guinea
Rwanda
Sierra Leone
Tajikistan
Tanzania
Uzbekistan
Uganda
Yemen
Zambia
1/
Countries in this table have monetary policy regimes (in 2011) that provide scope for independent monetary
policy. These countries would have to be assessed to have made significant progress toward meeting the
guideposts before adopting an MPCC framework.
2/ Excludes Somalia (no relevant information on the monetary policy framework was available) and Sudan (the
monetary policy framework is primarily a nominal exchange rate anchor vis-à-vis the U.S. dollar.
3/ Countries with crawling peg or crawl-like arrangements (monetary policy framework classified as exchange
rate anchor) but with scope for independent monetary policy.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
38 INTERNATIONAL MONETARY FUND
Appendix II. Additional Empirical Analysis for the Landscape
and Performance of Program Conditionality
The relation between inflation and money growth is investigated over a long period (about 10 years)
and a shorter period (1 year) using cross section ordinary least squares (OLS) and panel generalized
least squares (GLS) regressions respectively, for the period 1990–2012. The variables used in the
regression analysis are inflation (defined as the year over year (y/y) change in Consumer Price Index
(CPI), money growth (y/y change in broad money), output growth (y/y change in real GDP), financial
development (domestic credit to the private sector as a share of GDP), public debt (gross general
government debt as a share of GDP), and commodity price inflation (y/y changes in commodity fuel
price index). All data is from the World Economic Outlook database of the IMF except for domestic
credit to private sector, which comes from the World Bank’s World Development Indicators.
Table II.1 presents results for the cross section regressions. First, following the existing literature,
inflation period averages are regressed against money and income growth period averages.
Although estimated coefficients for both variables have the expected sign and are significant for the
whole period as well as for the sub-periods (1990–2002 and 2002–2012), the estimated coefficient
for money growth declines by more than 40 percent in the recent period (Specification I). This result
holds when the presence of countries with high inflation (defined as countries with inflation greater
than or equal to the sample median of 10 percent) and low financial development (countries with
domestic credit to the private sector as a share of GDP lower than or equal to the sample median of
18 percent)—which generally leads to a significantly stronger relation between inflation and money
growth—are accounted for (Specifications II and IV). Estimated coefficients for high and low money
growth countries (countries with money growth greater than or equal to the median of 17 percent),
high and low public debt (countries with public debt as a share of GDP greater than or equal to the
sample median of 46.5 percent), and EM countries and LICs are not statistically different from each
other (Specifications III, VI, and VII).
The results for the panel estimates are shown in Table II.2.
32
First, a fixed effect model is estimated
using yearly observations of inflation, money, and income growth for all countries in the sample. In
line with the cross section results, the coefficients for money growth and its lags are positive and
highly significant for 1990–2012, but decrease over time by about half in the last decade
32
The use of panel data requires checking for the existence of unit root variables. Since some of the variables in the
data set are stationary and some are not, standard nonstationary panel data methods could not be implemented and
a fixed effect model using yearly observations for all countries in the sample is employed.
REVIEW OF MONETARY POLICY CONDITIONALITY
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 39
(Specification I).
33
This result is not driven by the inclusion of high inflation/high money growth/low
financial development countries (Specifications II, III, and IV), and is robust to adding commodity
prices (Specification VII). In general, the association between inflation and money growth does not
vary significantly with the country classification by high debt level (Specification V) and by income
level (Specification VI).
33
We test the significance of up to four lags of money (income) growth, but only two (one) lags are statistically
significant in most cases.
Table II.1 Inflation and Money Growth: Cross Section Estimates 1/
Dependent variable: Inflation
1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012
Constant 1.580 1.149 3.049** 3.419 2.794 4.251*** -0.036 0.577 2.760 0.568 0.835 4.164*** 2.219 2.521 5.274*** 1.768 2.642 5.045*** 2.348 2.019 5.217***
(2.75) (3.41) (1.41) (2.62) (3.46) (1.22) (-0.01) (0.14) (1.43) (0.41) (3.54) (1.35) (0.71) (0.77) (4.47) (0.60) (0.73) (4.38) (0.79) (0.62) (4.32)
Income growth -0.729* -0.831** -0.649*** -0.419 -0.598 -0.441* -0.721* -0.852** -0.650*** -0.686* -0.831** -0.668*** -0.348 -0.574 -0.463** -0.355 -0.610 -0.439** -0.333 -0.598 -0.448**
(0.40) (0.39) (0.22) (0.38) (0.45) (0.22) (-1.80) (-2.11) (-2.91) (0.15) (0.38) (0.19) (-0.90) (-1.25) (-2.23) (-0.98) (-1.49) (-2.14) (-0.86) (-1.33) (-2.30)
Money growth 0.735*** 0.880*** 0.508*** 0.472*** 0.676*** 0.302*** 0.854*** 0.929*** 0.534*** 0.748*** 0.869*** 0.486*** 0.475*** 0.638*** 0.286*** 0.468*** 0.629*** 0.275*** 0.482** 0.625*** 0.308***
(0.15) (0.17) (0.07) (0.17) (0.19) (0.07) (2.82) (3.60) (3.96) (0.09) (0.17) (0.07) (0.16) (3.12) (4.15) (2.94) (2.78) (3.48) (2.59) (2.77) (3.76)
Money growth *High inf. 0.187*** 0.168* 0.143*** 0.196*** 0.185** 0.141*** 0.192*** 0.182** 0.142*** 0.200*** 0.174* 0.141***
(0.06) (0.09) (0.03) (0.05) (2.01) (4.46) (3.69) (2.07) (4.18) (3.64) (1.89) (4.41)
Money growth*High money growth -0.070 -0.036 -0.015
(-0.66) (-0.37) (-0.25)
Money growth *High fin. dev. 0.061 0.053 -0.08** 0.077 0.076 -0.075** 0.080 0.072 -0.071* 0.064 0.110 -0.089**
(3.31) (0.12) (0.04) (0.09) (0.68) (-2.21) (1.01) (0.65) (-1.92) (0.59) (0.59) (-2.23)
Money growth *High public debt 0.060 0.026 0.027
(0.87) (0.24) (0.71)
Money growth *LIC dummy -0.025 0.063 -0.033
(-0.25) (0.37) (-0.72)
Number of countries 64 63 64 64 63 64 63 62 63 63 62 63 64 62 64 64 63 64 64 63 64
Adjusted R² 0.589 0.627 0.552 0.627 0.635 0.619 0.589 0.623 0.569 0.589 0.623 0.569 0.632 0.635 0.635 0.634 0.629 0.633 0.626 0.632 0.634
Sources: World Economic Outlook and IMF staff calculations.
1/ Value of t statistics reported in the parenthesis are calculated using heteroscedasticity-consistent standard errors; * significant at 10 percent; ** significant at 5 percent; *** significant at 1 percent.
Specification VII
Specification I
Specification II
Specification III
Specification IV
Specification V
Specification VI
REVIEW OF MONETARY POLICY CONDITIONALITY
REVIEW OF MONETARY POLICY CONDITIONALITY
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40 INTERNATIONAL MONETARY FUND
Table II.2. Inflation and Money Growth: GLS Estimates 1/
REVIEW OF MONETARY POLICY CONDITIONALITY
REVIEW OF MONETARY POLICY CONDITIONALITY
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 41
Dependent variable: Inflation
1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012 1990-2012 1990-2002 2002-2012
Constant -1.266 0.782 3.658** -1.533 0.144 3.575*** -1.400 0.036 3.980** -1.581 0.315 3.324** -1.612 0.248 3.594** -1.660 1.286 4.069*** 0.182 5.325* 3.076*
(-0.57) (0.30) (2.43) (-0.68) (0.05) (2.34) (-0.64) (0.01) (2.59) (-0.77) (0.12) (2.10) (-0.88) (0.09) (2.22) (-0.83) (0.47) (2.74) (-0.10) (-1.75) (-1.98)
Income growth -0.52*** -0.432** -0.225** -0.484*** -0.402* -0.238** -0.493*** -0.418* -0.201* -0.493*** -0.406* -0.234** -0.492*** -0.381* -0.244** -0.479*** -0.344 -0.222** -0.468*** -0.362 -0.303***
(-4.56) (-2.05) (-2.18) (-4.17) (-1.84) (-2.22) (-4.32) (-1.93) (-1.99) (-4.21) (-1.82) (-2.49) (-4.21) (-1.68) (-2.54) (-4.09) (-1.60) (-2.41) (4.88) (1.45) (3.06)
Income growth (-1) -0.399*** -0.418*** -0.085 -0.367*** -0.389*** -0.097 -0.376*** -0.374*** -0.072 -0.373*** -0.371*** -0.116 -0.375*** -0.366*** -0.104 -0.369*** -0.355*** -0.105 -0.351*** -0.590*** -0.050
(-3.50) (-3.10) (-0.70) (-3.19) (-2.95) (-0.82) (-3.21) (-2.77) (-0.60) (-3.30) (-2.81) (-1.01) (-3.32) (-2.79) (-0.92) (-3.32) (-2.75) (-0.92) (3.58) (3.43) (0.39)
Money growth 0.256*** 0.335*** 0.025 0.236*** 0.449*** 0.046 0.260*** 0.324*** -0.019 0.148 0.464*** 0.035 0.105 0.394*** 0.098 0.200* 0.413** 0.170* 0.065 0.387* 0.039
(4.06) (4.19) (-0.58) (3.37) (3.68) (0.67) (3.13) (2.68) (-0.32) (1.29) (3.24) (0.52) (0.95) (2.70) (1.34) (1.71) (2.40) (1.68) (-0.55) (-1.88) (-0.57)
Money growth (-1) 0.397*** 0.393*** 0.229*** 0.287*** 0.189** 0.292*** 0.280*** 0.277*** 0.133* 0.26*** 0.307** 0.209*** 0.220** 0.187 0.224*** 0.291*** 0.239 0.290*** 0.290*** 0.362*** 0.201***
(8.82) (6.05) (4.58) (4.70) (2.49) (3.32) (4.31) (2.95) (1.99) (2.92) (2.42) (3.03) (2.34) (1.31) (2.67) (2.91) (1.61) (4.14) (-3.54) (-3.04) (2.91)
Money growth (-2) 0.229*** 0.15* 0.118** 0.232*** 0.156** 0.121*** 0.231*** 0.148* 0.116** 0.223*** 0.156** 0.117*** 0.162** 0.190* 0.045 0.130* 0.016 0.040 0.215*** 0.134 0.121***
(4.67) (1.97) (2.62) (4.73) (2.08) (2.81) (4.81) (1.97) (2.58) (4.74) (2.11) (2.72) (2.53) (1.79) (0.83) (1.94) (0.19) (0.48) (-4.78) (-1.60) (-2.81)
Money growth *High inf. 0.032 -0.158 -0.029 0.075 -0.17 -0.027 0.083 -0.159 -0.022 0.083 -0.202 -0.015 0.102 -0.257 -0.027
(0.27) (-1.08) (-0.34) (0.60) (-1.17) (-0.33) (0.71) (-1.10) (-0.28) (0.61) (-1.36) (-0.18) (-0.80) (1.21) (0.32)
Money growth *High inf. (-1) 0.183* 0.348** 0.097 0.191* 0.286** -0.049 0.187* 0.294** -0.052 0.197* 0.258* -0.037 0.116 0.191 -0.044
(1.87) (2.64) (-0.97) (1.82) (2.10) (-0.56) (1.91) (2.12) (-0.61) (1.81) (1.76) (-0.46) (-1.18) (-1.39) (0.50)
Money growth *High money growth -0.003 0.049 0.057
(-0.03) (0.33) (0.75)
Money growth *High money growth (-1) 0.180* 0.231 0.125
(1.86) (1.65) (1.45)
Money growth *High fin. dev. 0.181 -0.01 0.023 0.177 0.003 0.026 0.162 0.056 -0.085 0.267* 0.113 0.010
(1.36) (-0.08) (0.26) (1.53) (0.02) (0.31) (1.25) (0.37) (-0.88) (-1.85) (-0.58) (-0.11)
Money growth *High fin. dev. (-1) 0.044 -0.202* 0.179 0.042 -0.154 0.178 0.044 -0.131 0.122 0.038 -0.315*** 0.190*
(0.42) (-1.70) (1.61) (0.46) (-1.21) (1.65) (0.39) (-0.89) (1.26) (-0.34) (2.69) (-1.73)
Money growth*High public debt 0.085 0.106 -0.154*
(0.82) (0.80) (-1.81)
Money growth*High public debt (-1) 0.088 0.160 -0.038
(1.21) (1.52) (-0.49)
Money growth*High public debt (-2) 0.114 -0.049 0.148*
(1.24) (-0.35) (1.70)
Money growth *LIC dummy -0.079 0.072 -0.213**
(-0.59) (0.40) (-2.15)
Money growth *LIC dummy (-1) -0.047 0.097 -0.139**
(-0.46) (0.66) (-2.28)
Money growth *LIC dummy (-2) 0.153* 0.217 0.099
(1.70) (1.64) (1.02)
Commodity Price Index -0.021* -0.139*** 0.026**
(1.91) (3.56) (-2.16)
Commodity Price Index (-1) -0.026** -0.024* -0.000
(3.25) (1.85) (0.00)
Commodity Price Index (-2) -0.056*** -0.232*** -0.012
(4.67) (3.87) (0.92)
Number of observations 1210 525 685 1210 525 685 1210 525 685 1210 525 685 1210 525 685 1210 525 685 1083 398 685
Number of countries 64 62 64 64 62 64 64 62 64 64 62 64 64 62 64 64 62 64 64 62 64
Adjusted R² 0.365 0.300 0.124 0.371 0.318 0.126 0.370 0.309 0.128 0.376 0.322 0.135 0.384 0.324 0.151 0.378 0.330 0.156 0.355 0.281 0.145
Sources: World Economic Outlook and IMF staff calculations.
1/ Value of t statistics reported in the parenthesis are calculated using heteroscedasticity-consistent standard errors; * significant at 10 percent; ** significant at 5 percent; *** significant at 1 percent.
Specification VI
Specification VII
Specification I
Specification II
Specification III
Specification IV
Specification V
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
42 INTERNATIONAL MONETARY FUND
Appendix III. List of Countries Used in Analysis of Program
Performance
34
34
Years in table refer to year of program request.
NDA target (28) NDA and Money targets (22) NDA target (17) ICC (12)
Albania 2002 Armenia 2005 Bolivia 2003 Brazil 2002
Albania 2006 Armenia 2010 Costa Rica 2009 Colombia 2003
Bangladesh 2003 Bangladesh 2012 Croatia 2003 Colombia 2005
Burundi 2004 Burundi 2012 Croatia 2004 Guatemala 2009
Burundi 2008 Congo, Democratic Rep. 2009 Dominican Republic 2003 Hungary 2008
Gambia 2002 Georgia 2004 Dominican Republic 2009 Peru 2004
Gambia 2007 Ghana 2003 Georgia 2008 Peru 2007
Gambia 2012 Guinea 2007 Guatemala 2002 Romania 2009
Georgia 2012 Haiti 2006 Guatemala 2003 Romania 2011
Guinea 2012 Haiti 2010 Honduras 2008 Serbia, Republic of 2009
Honduras 2004 Kyrgyz Republic 2005 Iraq 2010 Serbia, Republic of 2011
Honduras 2010 Kyrgyz Republic 2011 Jamaica 2010 Turkey 2005
Kenya 2003 Malawi 2005 Mongolia 2009
Kenya 2011 Malawi 2010 Pakistan 2008 No NDA/ RM target (2)
Madagascar 2006 Malawi 2012 Paraguay 2003 Angola 2009
Mauritania 2006 Moldova 2006 Paraguay 2006 Macedonia (FYR) 2011
Mauritania 2010 Moldova 2010 Serbia and Montenegro 2002
Nicaragua 2002 Mozambique 2004
Nicaragua 2007 Sao Tome and Principe 2009
Sao Tome and Principe 2005 Tanzania 2003
Sierra Leone 2006 Uganda 2010 Money targets (4)
Sierra Leone 2010 Zambia 2008 Seychelles 2008
Solomon Islands 2010 Seychelles 2009
Solomon Islands 2011 NDA and ICC (1) Sri Lanka 2009
Tajikistan 2002 Ghana 2009 Ukraine 2008
Tajikistan 2009
Yemen 2010
Zambia 2004
Money targets (12)
Afghanistan 2006 NDA and Money targets (7)
Afghanistan 2011 Armenia 2009
Mozambique 2007 Dominican Republic 2005
Mozambique 2010 Ukraine 2010
Nigeria 2005 Argentina 2003
Rwanda 2002 Romania 2004
Rwanda 2006 Uruguay 2002
Rwanda 2010 Uruguay 2005
Tanzania 2007
Tanzania 2010
Uganda 2002
Uganda 2006
PRGT (63)
GRA (42)
List of 105 Fund-supported programs
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 43
Appendix IV. Evolving Monetary Policy Regimes in Fund-
Supported Programs: Country Case Studies
Fund conditionality has not consistently provided an appropriate policy anchor for some countries
with evolving monetary policy regimes. The country cases of Dominican Republic, Moldova, and
Uganda developed more flexible monetary policy regimes during Fund-supported programs, while
in the case of Tanzania, minor changes between period average and end-of-period reserve money
targets were useful in making money targeting more effective. Program conditionality also evolved.
In some cases there was a lag: the Fund-supported program targeted different intermediate targets
than those that were the primary focus of the authorities, which in turn led to conflicting signals
being sent to market participants and a lack of clarity on monetary policy objectives (Armenia,
Moldova, and Uganda). These cases could have benefitted from a monetary policy consultation
clause that would have: (i) clarified the objectives of monetary policy; (ii) supported the development
of policy rates; and, (iii) provided a mechanism to review the consistency of program targets with
macroeconomic objectives and take remedial actions as necessary.
Uganda
Strong foreign exchange inflows and volatile external demand in 2007 made it clear that rigid
reliance on a RMP in Uganda might not provide sufficient flexibility to respond to shocks. To
increase flexibility of the policy framework and to limit the cost of sterilization, NDA was introduced
as the near term operating target, coupled with a benchmark objective for reserve money with a
±5 percent variation margin. In response, the conditionality in the Fund-supported program was
adjusted—NDA was set as a performance criterion and reserve money as an indicative target.
This step was generally perceived as a part of the early transition stages to inflation targeting. In
2009, following a reversal of carry-trade and associated volatility in short-term interest rates, the
Bank of Uganda revised the operating procedures for monetary policy. The revisions included the
delinking of structural liquidity management from daily-liquidity management. In the flexible
approach to RMP, the Bank of Uganda was set to periodically review deviations from the money
target to assess the need for a change in the stance of monetary policy. However, flexible money
targeting failed to provide a strong anchor and created confusion between multiple operating
targets. In 2011, the Bank of Uganda accelerated the adaptation of inflation targeting “lite” and
introduced the central bank rate as the policy rate. During the initial stages of transition, the Bank of
Uganda and Fund staff agreed that it would be premature to include an inflation consultation clause
because the policy framework needed to be strengthened in several different aspects such as central
bank independence and operational capacity. Therefore, the program still adopted the traditional
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
44 INTERNATIONAL MONETARY FUND
NIR/NDA conditionality with a continued focus on monetary aggregates. This was not very
effective—the indicative targets on reserve money were missed 75 percent of the time. Also, it
potentially confused the public about the objectives of the central bank and hindered the efforts to
build credibility. To alleviate these concerns, the inflation corridor was added as a memorandum
item in 2012.
In 2013, the Bank of Uganda requested inclusion of an ICC in the new Policy Support Instrument
(PSI) monitoring framework to reflect the current monetary policy framework in place. Backed by
Fund TA, it was stated that successful use of the inflation targeting lite framework in monetary
management presents a case for moving to inflation as the nominal anchor in the new program—an
ICC with a 5 percent medium-term target in lieu of the former PC on NDA—was adopted. The
indicative target on reserve money, however, was maintained.
Moldova
The National Bank of Moldova adopted an IT framework in 2010 to contain persistently high
inflation. Previously, the National Bank of Moldova had struggled to push consumer price inflation
into single digits, while controlling monetary aggregates in the environment of significant
remittance inflows. The National Bank of Moldova set its inflation target range at 5 percent
±1 percent for 2010 and then widened its bands to ±1.5 percent in 2012.
35
The widening of the
inflation target band was mainly driven by the lagged effect of monetary policy instruments on
inflation, CPI basket volatility, and confidence intervals of forecasting models (Figure IV.1).
To achieve the inflation target, the National Bank of Moldova has a relatively wide range of
monetary policy instruments. The main instrument is the National Bank of Moldova base rate, which
is used as a reference for open market operations. It is complemented by standing facilities, required
reserve ratios, and interventions on foreign exchange market. That said, the National Bank of
Moldova has mostly intervened on the foreign exchange market to smooth excess foreign exchange
volatility and to replenish its reserves in a way consistent with the IT framework.
The IT framework has performed relatively well so far, but there are several avenues for its
improvement. The framework has contributed to reducing the rate and volatility of inflation since
early 2010. However, a relatively weak transmission mechanism and large share of volatile
commodity prices in the CPI basket pose challenges for the implementation of monetary policy.
35
The inflation target for 2011 did not have any range, and the official target for 2011 was inflation rate in mid-single
digits.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 45
Measures to improve communication with the public, deepen financial markets, and better calibrate
responses to the nature of the shocks could be beneficial to strengthen the impact of monetary
policy on the economy.
The monetary conditionality during the Fund’s 2010–2013 Extended Credit Facility (ECF)/Extended
Fund Facility (EFF) arrangements evolved more slowly than the National Bank of Moldova’s policy
framework. At the onset of the arrangements, the program conditionality had performance criteria
on National Bank of Moldova’s net domestic assets and net international reserves along with an
indicative target on the ceiling on reserve money. In early 2011, the indicative target on reserve
money was dropped due to possible conflicts with the IT framework. However, the National Bank of
Moldova continued to closely monitor developments in monetary aggregates in its assessment.
Figure IV.1. Inflation and Interest Rate Developments in Moldova
Dominican Republic
Beginning in 2012, the Central Bank of the Dominican Republic formally adopted a monetary policy
framework based on inflation targeting. Starting from a target of 5.5 percent ±1 percent in 2012, the
plan was for the target to fall by 50 basis points every year until 2015, when it would remain at
4 percent ±1 percent. The long-term inflation target of 4 percent was deemed as an "optimal level,"
sustainable over time and compatible with the potential GDP growth rate (Central Bank of
Dominican Republic, Press Release, December 2011). The inflation target in the Dominican Republic
is defined as the year-on-year change in the CPI.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
46 INTERNATIONAL MONETARY FUND
The Stand-By Arrangement (SBA) approved in 2009 included a structural benchmark (for June 2010)
to formulate a plan to adopt an inflation targeting regime in early 2012. At the time of approval of
the SBA, the authorities had yet to establish a proper monetary anchor.
36
The central bank agreed
on the need for more clarity in monetary policy formulation. It was thought that the adoption of an
inflation anchor would serve the Dominican authorities better than a monetary anchor as the
relationship between the monetary base and inflation had weakened after Dominican Republic’s
banking crisis period in 2004–05. In addition, the exchange rate had also been playing an anchoring
role. It was intended that the introduction of a full-fledged inflation targeting regime would clarify
objectives and policy instruments (IMF, 2009b).
The SBA adopted traditional monetary aggregates conditionality. At the time of the approval of the
SBA, the authorities proposed a monetary program using base money as the anchor. The central
bank used the overnight policy rate to signal its policy stance and conducted open market
operations to control liquidity. Monetary conditionality consisted of limits on monetary
aggregates—a ceiling on NDA and a floor for the level of NIR as a safeguard for the Fund’s
resources. Alongside the monetary program the authorities followed a de facto crawl-type exchange
rate arrangement in which the exchange rate fluctuated within a narrow margin. While the
Dominican Republic adopted an official inflation targeting regime in January 2012, the program
went off-track in mid-2011. Structural benchmarks included during the SBA to strengthen
macroeconomic monitoring and forecasting and improve communication through monetary policy
reports proved to be useful after the introduction of the inflation targeting regime.
At the time of program design, the focus was to invigorate growth as the Dominican economy was
decelerating rapidly with private credit losing steam and some segments of the credit market almost
frozen. Thus, the program included a fiscal impulse (about 1 percent of GDP by end-2009), partly
financed by the Fund, and a monetary program for 2010 consistent with the inflation target of 6 to
7 percent. To facilitate the economic recovery, all the increase in the demand for base money was to
be satisfied by increases in NDA (i.e., a credit expansion), with the NIR target relatively flat. The
pattern was to be reversed in 2011–12 to allow for NIR accumulation.
The authorities’ record on achieving the inflation target was mixed in 2010–11 but was achieved in
2012, the inaugural year of the new regime. The central bank met the NIR targets during the
36
The central bank still needed to gradually introduce more flexibility in the exchange rate to avoid giving the
impression that the monetary anchor in the economy was the exchange rate. This was especially important given the
low levels of gross reserves (IMF, 2009b).
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 47
program but the levels attained proved transitory in a context of fiscal dominance. At two and a half
months of imports at end 2012 reserves remained low, particularly for a very open economy.
Tanzania
Tanzania has had long periods of uninterrupted program engagement with the IMF. Supported by a
money targeting framework, successive programs focused on macro stabilization policies which
reduced inflation from over 20 percent in the mid-1990s to about 6 percent in late 2013. As in other
countries in the region (including some with different monetary policy frameworks), inflation rose to
high levels during two episodes in the past few years (reaching 20 percent in late 2011), largely as
the result of spikes in food and fuel prices. Tanzania’s RMP uses reserve money as its operating
target, broad money (M3) as its intermediate target, and a variety of instruments to maintain low
and stable inflation consistent with balanced and sustainable growth and an inflation objective of
5 percent over the medium term. The Bank of Tanzania attains its reserve money targets primarily by
choosing its path of sales of foreign exchange, as well as through repo and other operations.
Monetary conditionality in Tanzania’s Fund-supported programs has been adapted somewhat over
time. From the mid-1990s through June 2005, a ceiling on NDA of the Bank of Tanzania, a floor on
Bank of Tanzania’s NIR, and a ceiling on reserve money constituted the monetary conditionalities,
with the latter two as performance criteria and the former as an indicative target. In April 2007, as
part of Tanzania’s request for a PSI, three changes in monetary conditionality were introduced:
(i) NDA was dropped as an indicative target; (ii) the ceiling on end-of-quarter reserve money was
replaced with period-average reserve money (average of daily reserve money during the last month
of the quarter) which reduced the need to use liquidity operations to meet end-of-period targets;
and (iii) to respond to shocks to reserve money, symmetric upper and lower bands (±1 percent)
were introduced around the projected level of average reserve money.
These changes were primarily technical. The move to period-average reserve money reduced the
likelihood of window-dressing or abrupt moves at the end of the quarter. The use of bands provided
a safeguard to avoid breaches of the PC (upper band) as the authorities aimed for the middle of the
band. These changes seem to have led to a smoother evolution of money aggregates. During the
past few years, M3 and reserve money were below the middle of their respective bands most of the
time, with M3 more frequently and by larger margins (Figure 10).
37
37
The program did not set bands for M3. The reported M3 bands are derived from the reserve money band and the
programmed M3 multiplier.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
48 INTERNATIONAL MONETARY FUND
Programmed reserve money targets were revised upward in 2009 to allow for countercyclical
monetary policy, given concerns with spillovers of the global recession as Tanzania’s growth
declined from 7½ percent in 2008 to 6 percent in 2009. In 2011, following a continued build up of
inflationary pressures from international food and fuel prices and domestic food supply shocks, the
Bank of Tanzania reduced real money growth and then, faced with a soaring inflation rate of
20 percent in late 2011 and a weakening currency, tightened monetary policy further in the fourth
quarter of 2011. Among other measures, the Bank of Tanzania increased its reserve requirements
and hiked its bank rate (the policy rate) by 442 basis points to 12 percent. At that time, the overnight
interbank market rate, T-bill rates, and repo rate also rose significantly in nominal terms though,
with higher inflation, real interest rates subsequently turned negative for a few months (Figure 10).
More generally, the policy rate does not seem to be actively used by the Bank of Tanzania, and its
impact on other interest rates is limited; in addition, the transmission mechanism of changes in
short-term interest rates to broad monetary aggregates and real output is relatively limited.
The deviations from programmed target ranges for reserve money during this period seem to have
been consistent with the Bank of Tanzania’s commitment to its inflation target and with its
preferences regarding the real economy. These include the expansionary deviation at the onset of
the global financial crisis and the sequence of contractionary deviations since late 2010 in the face
of unanticipated food and fuel price shocks and declines in the growth of money demand
(Figure 10). The policy dialogue with Fund staff focused on revising the reserve money targets in
light of understandings reached on objectives for inflation and economic stabilization. To gauge the
appropriate extent of the revisions, it also sought to draw information from the level of real market
interest rates (such as the interbank market rate and the repo rate).
Going forward, and drawing on technical assistance, the Bank of Tanzania intends to complement
the current reserve money targeting framework with a more active use of interest rates in
implementing its monetary policy. To this end, the Bank of Tanzania has started an internal review of
its existing liquidity operations and interest rate structure as part of the process to develop an active
policy rate.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 49
Figure IV. 2. Money and Interest Rate Developments in Tanzania
Sources: Tanzanian authorities, IMF Staff Reports (various issues) and IMF Staff estimates.
2.2
2.4
2.6
2.8
3.0
3.2
3.4
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3
2011Q2
2012Q1
2012Q4
M3 Multiplier
Program
Actual
-10
-5
0
5
10
15
20
25
2006Q4
2007Q2
2007Q4
2008Q2
2008Q4
2009Q2
2009Q4
2010Q2
2010Q4
2011Q2
2011Q4
2012Q2
2012Q4
2013Q2
Percent
Deviation of Reserve Money and M3
from their Respective Middle Bands
and Inflation Performance
Reserve Money
M3
Inflation (y-o-y)
0
5
10
15
20
25
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3
2011Q2
2012Q1
2012Q4
Percent
Structure of Interest Rates
Interbank rate
Repo
T-bill
Policy rate
0
5
10
15
20
25
30
35
40
45
2000Q1
2000Q4
2001Q3
2002Q2
2003Q1
2003Q4
2004Q3
2005Q2
2006Q1
2006Q4
2007Q3
2008Q2
2009Q1
2009Q4
2010Q3
2011Q2
2012Q1
2012Q4
Percent
Monetary Policy Performance
Inflation (y-o-y)
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
50 INTERNATIONAL MONETARY FUND
Appendix V. Implementation of ICC under Fund-Supported
Programs
Since the adoption of the review-based approach to monetary policy (IMF, 2000a), 14 Fund-
supported programs with nine countries have included an ICC framework, mostly in EM economies
and, more recently, in LICs (Table V.1).
In all cases, the ICC targets end of period 12-month consumer price inflation. The central path
inflation objective has varied from a maximum of 14.6 percent (Ghana, 2009) to a minimum of
2.5 percent in the cases of Peru (2004, 2005, and 2007) and Romania (2010). In multiyear programs,
the central path has tended to reduce over time. Several programs adjusted the central path target
one or more times during a calendar year (Guatemala, Romania, and Serbia). Eleven programs set
inner and outer bands for staff and board consultations respectively, while three programs set only
an outer band (Serbia (SBA, 2011) and two Fund-supported programs in Colombia (SBA, 2003,
2005)). Consultations were held and completed on 17 occasions for non-observance of the inner or
outer bands, including seven occasions relating to Turkey’s SBA.
Brazil
Brazil adopted inflation targeting in July 1999 as a new nominal anchor in response to the balance
of payments crisis of 1998 which rendered the then exchange rate band ineffective. The Fund
adapted its conditionality to align with the framework (see Box 2), and Brazil was the first country
with a Fund-supported SBA (1999) to adopt the new ICC framework. In the design of Brazil’s
monetary conditionality, staff and authorities reached an understanding to use the CPI
38
as the
central path of the ICC with a symmetric band set relatively wide (±2 percent) due to the broad CPI
index chosen as the central path, which was programmed to decline by 0.5 percentage points each
quarter, from 8 percent in December 1999 to 6 percent in December 2000 and further to 4 percent
by December 2001.
39
Non-observance of this band required formal consultation with the Fund
Executive Board, while non-observance of an inner band of ±1 percent required an informal
consultation with Fund staff when triggered.
40
NDA was downgraded from a performance criterion
to an indicative target and was set in a way to leave room for short-term interest rates to be
38
The CPI was used for two reasons: (i) ease of understanding by the general public; and (ii) ability to establish
inflation target on the basis of a widely known and understood index.
39
See IMF (2000b).
40
The program adopted the authorities’ official band as the outer band of the ICC.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 51
managed flexibly and in line with the central bank’s inflation objective. Staff and authorities reached
an understanding that the target could be adjusted on the basis of supply shocks. The consultation
mechanism was triggered several times, as a result of various supply shocks during the series of
Brazil’s Fund-supported programs until 2005.
41
There were four informal consultations with staff and
two formal consultations with the Executive Board (Table V.1). While staff consultations were
conducted in the context of program reviews, consultations with the Executive Board were
accompanied by a letter from the governor of the central bank explaining the reasons for exceeding
the band and remedial actions introduced to return to the target path.
Colombia
The 2003 SBA for Colombia included an ICC (also following the Brazilian design). Staff and
authorities reached an understanding to set quarterly inflation targets for 2002–03 based on the
12-month CPI. In a slightly modified specification of the ICC, Colombia had a single band (set at
±2 percent) around the central path (which was also the 12-month CPI).
42
The authorities were to
conclude consultations with the Executive Board, outlining the proposed policy response before
purchases from the Fund, should the observed quarterly CPI deviate from the band. Rather than
having an inner band, staff consultation was triggered when there was a “marginal” deviation from
this band—leaving room for judgment by staff on what constituted a marginal deviation. There was
also an understanding with the central bank to share monthly information on inflationary
developments, forecasts, and policy actions. The design also allowed for adjustment to the target
based on direct effect of the Value Added Tax (VAT) reform on the CPI. Subsequently, in the 2005
SBA approved for Colombia, the tolerance band was reduced from 2 percentage points, to signal
the authorities’ commitment to take the necessary actions to meet the inflation target. Unlike Brazil,
formal consultation with the Executive Board was never triggered during the period of the program
(Table V.1), but the period was characterized by heavy foreign exchange intervention to defend the
peso.
41
IMF (2006).
42
This central path was not a disinflation path even though it fluctuated between 5.5 percent and 6 percent.
Table V.1. Assessment of ICC Under Fund-Supported Programs
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
52 INTERNATIONAL MONETARY FUND
Country Pr og r am type Other PC/ IT** Tar get Me t/Not M e t Natur e o f consulta tion Outcome o f consulta tion Centr a l Path o f IC C
Consul tation ba nd
Centr a l Pa th ( E nd -o f-yea r )
Brazil SBA (1999) NDA (IT)
inner band: +1% 8.0% (1999) 12-month rate of IPCA*
outer band: +2% 6.0% (2000)
5.8% (2001)
Brazil SBA (2002)
inner band: +1% 6.5% (2002) Mar 2002: Inflation consultation letter All reviews completed 12-month rate of IPCA*
outer band: +2% 5.0% (2003) Jun 2002: Inflation consultation letter
Dec 2002: Inflation consultation letter; Request to
modify inflation consultation bands
Colombia SBA (2003)
inner band: None 5.9% (2003) 12-month inflation rate
outer band: +2% 5.5% (2004)
Colombia SBA (2005)
inner band: None 5.0% (2005) 12-month inflation rate
outer band of +2% 4.5% (2006)
Ghana ECF (2009) NDA (IT)
inner band: +2% 14.6% (2009) 12-month CPI
outer band: +3% 9.5% (2010)
8.6% (2011)
Guatemala SBA (2009)
inner band: +2%
5.5%, 2.5%, 0.8% (2009)
+
12-month end of period CPI
outer band: +3%
5.0%, 4.5%, 5.5% (2010)
+
Peru SBA (2004)
inner band: +2% 2.5% (2004) 12-month rate of inflation
outer band: +3% 2.5% (2005)
Peru SBA (2007)
inner band: +2% 2.5% (2007) All reviews completed 12-month rate of inflation
outer band: +3%
Inflation consultation letter; Request for Waiver of
Applicability of PC
Inflation consultation letter; Request for Waiver of
Applicability of PC
Inflation consultation letter; Request for Waiver of
Applicability of PC
Romania SBA (2009)
inner band: +1% 4.5% (2009) 12-month CPI
outer band: +2%
2.5%, 3.5%, 8.0% (2010)
+
Romania SBA (2011)
inner band: +1% 3.7% (2011) June 2011: Consultation with fund staff All reviews completed 12-month CPI
outer band: +2% 3.6% (2012)
Serbia SBA (2009)
inner band: +2%
8.0%, 10.0%, 7.5% (2009)
+
Sept 2009: Request for waiver for the non-
observance of targets and modification of PCs.
All reviews completed 12-month end of period CPI
outer band: +3%
6.5%, 6.0% (2010)
+
Sept 2010: No description of consultation
Dec 2010 : Inflation consultation letter
Serbia SBA (2011)
inner band: None 7.9% (2011) 12-month end of period CPI
outer band: +2%
Turkey SBA (2005) Base Money (QPC)
inner band: +1% 5.0% (2006) Jun, Sep, 2006: Request for waiver for non- All reviews completed 12-month rate of inflation
NDA (IT)
outer band: +2% 4.0% (2007) observance and modification of PCs.
Dec 2006: Request for waiver for non- observance
and applicability of PCs
March 2007: Request for waiver for non-
observance and applicability of PCs
Jun, Sep, Dec 2007: Request for waiver for non-
observance of PCs
*IPCA - consumer price index
** All programs listed had NIR as a QPC
+
Central band has been revised several times within the given year
Other no te s
Guatemala had a request for modification of the ICC (Review 1) when it's July inflation breached the outer band
Romania (2011) In the second review, they also had requested for a modification in PC's for NFA (but not for ICC).
NIR/NFA (QPC) - Brazil, Columbia, Ghana, Guatemala, Peru, Romania, Serbia and Turkey
No, 3 times: Sept 2009 (Outer), Sept 2010
(Outer) and Dec 2010 (Outer)
December actuals not available (program is
until 1st review only)
No, 7 times: June 2006 (Outer), Sep 2006
(Outer), Dec 2006 (Outer), March 2007 (Inner),
June 2007 (Inner), Sep 2007 (Inner), Dec 2007
(Outer)
Yes
Yes
Yes
No, 4 times: March 2007 (Inner),March 2008
(Outer), June 2008 (Outer), Sep 2008 (Outer)
No: June 2011 (Inner)
Yes
No (Breached inner band in Dec 2001)
No, 3 times: Mar 2002 (Inner), Jun 2002
(Outer), Dec 2002 (Outer)
Inflatio n C o ns ultatio n Cla us e
Yes
Yes
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 53
Ghana
The Bank of Ghana used the period 2002 and 2007 to introduce transition arrangements to IT before
formally adopting IT in May 2007. The transition period was used to re-establish credibility and
anchor inflation expectations after a long period of fiscal dominance and very high inflation. In the
2009 ECF for Ghana, the ICC was introduced with a consultation band around the 12-month CPI
which was used as the central path.
43
There were both inner (±1 percent) and outer bands
(±2 percent). An observed CPI outside the outer band would trigger a formal consultation with the
Executive Board, which would interrupt further purchases under the arrangement unless the
consultation took place and the relevant program review was completed. The authorities would
conduct discussions with the Fund staff when the observed CPI fell outside the inner band. Program
conditionality under the ECF arrangement for Ghana also included NCG as an indicative target (a
tripwire) due to Ghana’s specific risk of lingering fiscal dominance. No consultation was triggered
during the program period (Table V.1).
Peru
Peru’s IT implementation under the 2004 Fund-supported SBA had unique challenges, as it was
implemented during a period characterized by a high degree of dollarization. The ICC design was
based upon the design used in Brazil’s programs. However, unlike Brazil, Peru’s consultation band
was significantly wider than the authorities’ own official band. The upper consultation band was
±3 percent for Executive Board consultations and ±2 percent for staff consultations, while the official
band was only ±1 percent. This relatively wide band gave room for the authorities to intervene
heavily to offset the strong upward pressure on the currency, which undermined the inflation target.
As expected, the wide band accommodated significant variations in inflation and there were no
consultations triggered during the program period. However, the 2007 SBA had one informal
consultation with staff and three formal consultations with the Executive Board (Table V.1).
43
This central path was a disinflation path which was designed to fall from 19.7 percent in June 2009 to 9.7 percent
in June 2010 and ultimately to 7 percent by June 2011.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
54 INTERNATIONAL MONETARY FUND
Appendix VI. A Model-Based Approach to Monetary Policy
Analysis
This appendix describes a model-based tool that has proven helpful for policy analysis and
forecasting in many central banks. As Fund-supported programs move beyond the analysis of
money target misses and focus on a broader assessment of the monetary policy stance, IMF country
teams could also benefit from adopting a similar model-based approach. The latter would help
structure the policy discussions and allow for interactions with the central bank staff at a technical
level, yet it does not require explicit acknowledgment in the design of the program. Ongoing
applications by selected teams suggest large payoffs to this approach.
Consistent with the modernization of monetary policy described in this paper is a growing need for
sound policy analysis and inflation forecasting capacity within central banks, to support policy
decisions and facilitate its communication to financial markets. The experience of central banks in
many advanced and EM countries that went through a similar process has yielded a set of best
practices in this area, namely the development of a forecasting and policy analysis system (FPAS).
The FPAS denotes a broad set of processes and arrangements within the central bank, ranging from
data collection to the organization of the central bank’s research department, to help staff come up
with the best possible forecast of inflation and key macroeconomic variables and to make policy
recommendations to the bank’s senior management.
At the core of the FPAS in countries that start a transition toward forward-looking policy frameworks
is a simple quarterly projection model. This model provides a coherent and plausible view of the
monetary transmission mechanism.
44
In its simplest form, it consists of an aggregate demand
equation, a price setting equation (Phillips curve), a relation between exchange rates and domestic
and foreign interest rate differentials, and a policy reaction function that relates the policy variable
(typically interest rates) to variables like output and inflation.
45
These models embody the principle
that the fundamental role of monetary policy is to provide an anchor for inflation and inflation
expectations, and that aggregate demand and monetary policy matter for output and inflation
determination in the short run. Many central banks have eventually developed more sophisticated
models, e.g., dynamic stochastic general equilibrium (DSGE), but only once the FPAS was solidly in
place.
44
See Laxton, Rose, and Scott (2009) for a thorough description of FPAS. The discussion here focuses narrowly on the
macroeconomic model at the center of the FPAS.
45
See Berg, Karam, and Laxton (2006) for an exposition of a simple model along these lines.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 55
Staff in central banks use these models to: (i) interpret data and assess the state of the economy,
including the incidence of various macroeconomic shocks (aggregate demand, supply, external,
etc.), and (ii) to help produce macroeconomic forecasts and provide policy recommendations to the
senior management of the central bank (i.e., the Monetary Policy Committee (MPC)). Note that the
models themselves do not produce the forecasts, as these are based mostly on judgment, especially
over the short term (one or two quarters ahead). However, the models are useful for a number of
reasons. First, they clarify the link between the forecast and the policy reaction function, the types of
shocks, and the structure of the economy. They therefore allow for alternative forecasts (relative to a
baseline) that are directly related to alternative assumptions, e.g., about external shocks. Second, the
probabilistic nature of the models provides an ideal setting for characterizing uncertainty about the
future, e.g., via fan charts and its implications for policy. Third, the systematic use of a coherent
model imparts a great deal of discipline into the forecasting process, as it prevents the excessive use
of sui generis-type reasoning. Fourth and most important, they ensure consistency between the
forecast and the policy recommendations, i.e., they show what path the policy variable must follow
for inflation to return to its target over the medium term.
Reflecting the need for such an analysis, various central banks in SSA have partnered with the IMF to
develop their own in-house FPAS. These include Kenya, Uganda, Rwanda, Ghana, and Mozambique;
other countries are likely to follow. The adoption of FPAS requires considerable training of the staff
in how to operate these models, interpret their output, and use them for policy analysis, and should
be thought of as a learning process for both staff and the management.
However, staff in some central banks such as Kenya, Uganda, and Rwanda, are already making use of
these frameworks for policy analysis and presentations to their MPC. The long-term success of these
efforts, i.e., the entrenchment of this type of analysis in the periodic forecasting and policy cycle of
these central banks, will depend on the institutional support they receive, especially by the senior
management. The usefulness of such tools suggests these efforts will be successful.
Although these models were originally designed for countries that set operational targets on short-
term interest rates, recent IMF research has extended their application to hybrid or evolving regimes.
Andrle and others (2013) designed an FPAS model for countries that have targets on both reserve
money and short-term interest rates, and where ex post adherence to the target is a policy choice.
The framework allows for an analysis of money target misses in terms of macroeconomic shocks,
which makes it applicable to regimes where the analysis of target misses remain an important
dimension of policy analysis.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
56 INTERNATIONAL MONETARY FUND
Appendix VII. Technical Assistance and Training on
Modernizing Monetary Policy Frameworks
Coordinated TA and Training by RES and ICD in SSA
Interdepartmental initiatives aimed at modernizing monetary policy frameworks in SSA are
harnessing synergies between TA and training (IMF, 2013b). These initiatives by RES, ICD, and AFR
include: (i) a seminar to train SSA country teams and central bankers from Tanzania, Rwanda,
Uganda, and Zambia, followed by two in-depth two-week workshops with forecasting teams from
Uganda and Rwanda; (ii) a pilot program with RES and external experts training staff to present
forecasting and policy analysis reports to the MPC of the Central Bank of Kenya; (iii) a RES pilot
engagement with the Central Bank of Ghana to build institutional capacity for its inflation targeting
regime; (iv) online collaborative sites set up to facilitate peer-to-peer learning among trained
officials and staff; and (v) internal training and support for AFR desk economists provided by an
ICD/RES course on model-based MPA. These efforts are supported by the RES/SPR partnership with
the U.K.’s Department for International Development (DFID) to provide relevant research and
support close collaboration with LIC policymakers on utilizing these frameworks.
46
To support the TA
activities, ICD doubled its delivery of monetary policy courses in SSA during 2013.
ICD Monetary Policy Training Courses
ICD is expanding training in monetary policy. ICD offers a course on MERP, which includes a block
on quarterly forecasting models used in central banks. The course is aimed at central bank staff who
are “users” of the forecast. A more advanced
course on MPA targets model operators,
analysts writing monetary policy reports, as well
as policymakers. To date, around
1000 participants from LICs and EM countries
have participated in the MERP course, and
around 100 in the MPA course.
46
See http://www.imf.org/external/np/res/dfidimf/
0
50
100
150
200
250
AFR
APD
EUR
MCD
WHD
Number of participants
Participants in ICD Monetary Policy Training
Courses (By Region)
MERP
MPA
Source: IMF Staff calculations.
Notes: MERP (Monetary and Exchange Rate Policy ), MPA (Monetary Policy
Analysis), CY 2007- 2014 (Past and Planned).
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 57
MCM TA in Central Bank Modernization
MCM is providing extensive support to central banks around the world in their efforts to strengthen
conformity with best practices for effective monetary policy. Over the last four fiscal years MCM TA
on monetary policy related issues has
totaled an annual average of about
17.5 FTEs. About half of MCM TA was
devoted to strengthening of the
operational capacity to conduct monetary
and foreign exchange policy and
operations. TA activities in central bank
governance (i.e., accounting, internal
controls, and organization) and reserves
management have each absorbed about
20 percent of the overall TA envelope; and
TA activities in financial market
infrastructure have absorbed a much
smaller fraction (about 5 percent).
The delivery modes of MCM TA are diverse. This has involved assessment missions led by
headquarters-based staff to assess the level of conformity with the building blocks for effective
monetary policy, and design an action plan for monetary policy modernization. These missions
generally involve external experts from cooperating central banks, as well as the MCM advisors in
the RTACs whenever the beneficiary countries are covered by an RTAC. Typically, these assessment
missions are followed by a short-term experts’ mission in those areas that have been identified as in
need of capacity building. In some countries where the program of reforms is significant, MCM has
placed long-term resident advisors to facilitate the delivery and coordination of TA in the various
areas.
SSA has received almost half of MCM TA in central banking. The other geographical areas share the
remaining part more or less equally (Figure). The sharp increase in the demand for MCM TA in FY14
is distributed among all regions, but with a larger share in SAA. This evolution reflects an increase in
the number of TA requests to assist central banks in introducing elements of forward-looking
monetary policy. This increase in SSA also reflects the placement of several MCM resident experts
covering regional groupings and a few individual countries.
Regional Allocation of
Technical Assistance in Central Banking
Source: MCM Regional Allocation Plan. FY14 includes all
completed and planned TA activities.
0.00
2.00
4.00
6.00
8.00
10.00
12.00
AFR
APD
EUR
MCD
WHD
FY11
FY12
FY13
FY14
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
58 INTERNATIONAL MONETARY FUND
Appendix VIII. Data Requirements for Monetary Policy
It is important to consider the institutional contexts for developing the sustained provision of timely,
high-frequency (monthly or weekly) data series needed to support monetary policy analysis. Most
countries have reasonably long-standing monthly series on inflation (generally the CPI) and the
exchange rate, but not all have the requisite GDP volume statistics with the coverage, periodicity,
and timeliness desired for monetary policy analysis. High-frequency indicators, especially on
economic activities, are also lacking in many countries.
Statistical information on policy variables or policy instruments (such as interest rates and financial
sector positions and flows) may be immediately available to the central banks executing the policy
framework. This is provided that central banks have timely, smoothly functioning systems of
recording, archiving, and analyzing these variables. Where needed, the Fund’s STA provides TA
services to central banks in maintaining these data flows from accounting data and banking system
surveys.
The credibility and effectiveness of monetary policy are enhanced by sourcing the data on other
indicators relevant for monetary policy analysis from another independent and impartial source: the
national statistical office (NSO). In LICs, however, the budgetary and staff resources of the NSO often
are insufficient to produce high quality principal macroeconomic indicators—price indexes and
national accounts—much less the indicator series supporting the macro framework. Thus, in the
long run, scoping and addressing the problem of building the institutional capacities of NSOs to
handle the production of high-frequency data is essential for a successful monetary policy
formulation.
While NSO capacity is being built, the short-term policy need for high-frequency indicators may
have to be met using central bank resources. This can be undertaken either through central banks
collecting and processing the needed data themselves, or contracting the NSO through an intra-
governmental agreement. Any information the NSO collects that is infrequently published or not
published at all can also be made available to the central bank on a timely basis via the interagency
agreement, within the legal constraints covering national statistics. Early experience with the central
banks of Uganda and Rwanda through AFRITAC-East has been encouraging in this regard. The
AFRITAC-East Macroeconomic Statistics and Macro-Fiscal Advisors have worked together to
improve central bank access to high-frequency statistics and assisted their analytical staffs with
aggregating them into usable indicators.
CONDITIONALITY IN EVOLVING MONETARY POLICY REGIMES
INTERNATIONAL MONETARY FUND 59
Current versus capital expenditure is a key distinction to keep in mind in marshalling the resources
to build NSO institutional capacity for the principal macroeconomic and high-frequency indicators
needed for monetary policymaking. Capacity building needs to be two-pronged: securing national
and donor resources for building human and nonhuman statistical capital, and securing the
commitment of the home government to provide sufficient budget for current expenditure to retain
staff and maintain facilities, as well as for human capital maintenance through training, TA, and on
the job experience. Fund TA focuses strongly on building human capital. While the Fund provides
technical advice on the conduct of price surveys, it is not as active in providing TA on establishment
and household surveys that underlie significant components of the national accounts and thus
collaboration with other donors is key to enable countries to establish a robust statistical
organization. Finally, the Fund needs to advocate for adequate budgetary support from the home
government for at least the current expense of maintaining a robust statistical system to sustain
hard fought gains in statistical capacity.
