Monday, May 4, 2009

Weekly Hurriyet Column: (dis)Inflation Report and sloppy reporting

Below is the unedited version of my column for this week. You can read the final version at Hurriyet's authors archive. Again, here are a couple of extra points I would like to raise:
  • Another overlooked part of the Inflation Report is the section where the Bank highlights the growing NPLs. I like that they have chosen to concentrate on consumer loans and credit cards, a dangerous issue I had raised in last week's column.
  • In terms of shooting itself in the foot, the record auction demand and the ensuing bond rally (following a lower-than-expected April inflation reading) are certainly cases in point. It is great that the Treasury's borrowing is going smoothly, without much trouble from the quantity of price front, but this is definitely crowding out private credit.I had commented on the inconsistencies in the government’s latest macro framework two weeks ago. I am not sure if they were envious of the attention, but the Central Bank has now joined the bandwagon of sloppy reporting with its latest Inflation Report.

The feature of the report that got the most attention was the inflation forecasts, which were revised down to 6 percent for this year, 5.3 percent for 2010 (both mid-points of the Bank’s forecast range) and 4.9 percent for 2011. The one percent difference between my own year-end expectation and the Bank’s is just a matter of the alphabet: Bank’s outlook of an L versus my projection of a very wide V for the path of inflation. While inflation is expected to fall sharply in the next few months because of base-year effects, I expect it to creep upwards later in the year, while the Bank’s outlook is for inflation to more or less stay put after the sharp falls.

I would, however, not be too surprised if the Bank turns out to be right at the end. After all, they have infinitely much more research power than my team of three (me, my laptop and my Eviews statistical package). I would even be just slightly in awe if inflation continued to fall once global and domestic conditions cease to be supportive of disinflation even though I am even more skeptical of the Bank’s 2010 and 2001 figures. However, at the end of the day, it is not the numbers but the Bank’s policy stance that I am worried about.

The Central Bank’s main focus for the past few months has been thawing credit markets and reviving growth. To adopt such a stance, the Bank has effectively outsourced inflation targeting to exogenous events, betting that the recessionary domestic and global environment will keep prices at bay. In a similar fashion, the Bank is implicitly counting on the IMF program to take care of currency and fiscal risks.

Of course, other than the small detail that the IMF program still hangs in the air, this strategy involves major risks. For one thing, the easing has only exacerbated banks’ preference for bonds over credit. Moreover, rate cuts run the risk of slowing down locals’ foreign currency sales, which have been an important safeguard of the lira’s relative strength. Then, the corporate sector’s large foreign currency position would suddenly turn out to be a bigger danger than the Bank admits at this stage.

Despite all this, the part that seemed sour to me the most in the Inflation Report was the Bank’s analysis of output gap and inflation under different policy scenarios since November 2008. Such analysis could lead to dangerous questions: For one thing, it would be perfectly right to question, after reading the analysis, why the Bank had not pursued similar aggressive policy during when inflation had turned out to be higher than the Bank’s targets. For my part, I would have liked to see some justification for this asymmetric policy response.

Moreover, anyone who has delved into Economics at a somewhat rigorous level would know that such counterfactual exercises can be highly inaccurate. In addition, publishing such analysis in an Inflation Report runs the risk for misinforming the masses on the power of monetary policy, in effect raising the expectations bar and forcing the Bank to even more accommodative policy. Don’t get me wrong, I am all for transparency and information; I just think that putting the material of a working paper in an Inflation Report is not the way to go.

While the Bank’s actions could undermine its own efforts to combat the economic contraction, I have come to learn to live with this and even admire the Bank to a certain extent, as one admires a daredevil. However, it seems that the Bank is trying real hard to shoot itself in the foot.

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