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 SUMMARY
A) Inflation Targeting in Romania
I. Rationale Behind the Adoption of Inflation Targeting
II. Key Features
III. International Experience
IV. Prerequisites
V. Advantages
VI. Features of NBRs Inflation Targeting Strategy
VII. Exchange Rate Policy
VIII. Quarterly Forecasting & Decision-Making Process
IX. Forecast Horizons
X. Forecasting Cycle
XI. The Core Model
XII. The New Inflation Report
XIII. Communication

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B) Charts
1. Inflation Rate (annual data)
2. Inflation Rate (monthly data)
3. Inflation Forecast
4. NBR Policy Rate
5. Financial Intermediation
6. General Government Deficit/GDP
7. Reserves and Debt Indicators
8. Total External Debt
9. M&LT External Debt
10. Public Debt Stock
11. Inflation Rate and Interest Rates
12a. Non-Government Credit
12b. Total Credit and Non-Government Credit

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 I. Rationale Behind the Adoption
of Inflation Targeting

Necessary commitment to disinflation due to forthcoming

European accession

Weakening relationship between money aggregates

and inflation

Needed focus on inflation rather than on intermediary

targets

With capital account liberalization, exchange rate

pegging is not a viable alternative: inflation still high,
Balassa-Samuelson effect would slow down disinflation

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 II. Key Features

Primary objective of monetary policy: to ensure

and maintain the aggregate price stability

Use of the whole range of monetary policy tools

for reaching the inflation target

Proactive monetary policy stance (forward-looking

behaviour)

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 Key Features (2)

Transparency of the monetary policy strategy

by communicating to the general public the
objectives, the decisions adopted, the rationale behind
monetary policy decisions and the associated risks and
uncertainties

Increased efficiency of monetary policy on medium-term

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 III. International Experience

Central banks of 21 countries adopted inflation targeting

strategy

Initially, inflation targeting strategy was adopted only

by some developed countries

Subsequently, the strategy proved to be an attractive

alternative to emerging countries

Large economic imbalances had been solved prior

to the adoption of inflation targeting strategy

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 IV. Prerequisites

The annual inflation rate is in the single-digit range

The NBR has full operational independence

(by its legal Statute)

The financial sector is stable and sound, although

financial intermediation is needed to increase

Fiscal dominance is no longer a threat

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 Prerequisites (2)

Inflation targets for the coming years have been agreed

on together with the government

The central bank has improved its inflation-forecasting

capacity

Disinflation progress over the past few years has led

to the strengthening of NBR credibility

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 V. Advantages

Reducing time inconsistency by increasing the

responsibility of the central bank for achieving its primary
objective, i.e. price stability

Flexible and transparent regime that is operational even

under an unstable relation between monetary
aggregates and inflation

Disinflation with relative minimisation of costs, a more

direct impact on inflation expectations

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 VI. Features of NBRs
Inflation Targeting Strategy

CPI-based inflation target

Target set as a midpoint within a target band

of 1 percentage point

Annual targets set for a longer time horizon

(initially 2 years)

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 Features of NBRs
Inflation Targeting Strategy (2)

Flexible interpretation of inflation targeting

(mainly its co-existence with the managed floating
regime)

Ex ante definition of a narrow set of circumstances which

are independent from the monetary policy influence and
restrict the NBRs responsibility for reaching the inflation
target (escape clauses)

Joint announcement of inflation targets by the NBR

and the government

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 VII. Exchange Rate Policy

Further managed floating regime, with market playing

an increasing role in determining the exchange rate

Less frequent interventions by the NBR

Exchange rate unpredictability in the short run, in order

to discourage speculative capital inflows following capital
account liberalization

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 VIII. Quarterly Forecasting
& Decision-Making Process
Task Force interdepartmental working group:
Prepares near- and medium-term forecasts on economic growth
and inflation rate
Monitors the main economic and monetary indicators on a monthly basis
Draws up the Inflation Report
Monetary Policy Committee:
Examines the initial conditions for the core model
Assesses the forecasts and recommendations on the monetary policy
measures
Analyses the Inflation Report and makes recommendations
NBR Board:
Makes the monetary policy decision taking account of the formulated
risks and uncertainties
Analyses and adopts the Inflation Report

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 Quarterly Forecasting
& Decision-Making Process (2)
Flow of information in the forecasting process
at the National Bank of Romania
Near-term forecast
Near-term models
(ARMAX) NTF Inflation, GDP, EUR/RON etc.
and Expert forecast Final
Medium-term medium-term
(core) forecast
model
Assessment of initial Trends & Gaps
conditions
and medium-term trends

Anticipated Tuning
shocks, fiscal
Exogenous variables forecasts impulse etc.

Uncertainty
Expert judgement

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 IX. Forecast Horizons

Near-term forecast (2 quarters)

ARMAX model for the main CPI components

(food, non-food, services)

Expert judgement forecast for CPI components

Useful for determining the starting point of medium-term

forecast and for monitoring in between two forecasting
cycles

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 Forecast Horizons (2)
Medium-term forecast (8 quarters)
Based on a quarterly projection model (QPM) that provides
a description of dynamics of the main macroeconomic variables
and their interaction
QPM is used for generating macroeconomic development scenarios,
assessing the risks of potential shocks and analysing alternative
monetary policy measures
QPM is based on economic theory, assuming modelling of economic
agents expectations and the convergence of the economy towards
long-term equilibrium
QPM is a flexible model allowing the use of additional information and
expert opinions provided by specialists of the NBR and of other
institutions
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 X. Forecasting Cycle

Quarterly cycle relying on frequency of data on GDP

Forecasting process, formulation of monetary policy

decisions and drafting of Inflation Report last for about one
month

Forecasting cycle does not require quarterly frequency of

monetary policy decisions
monetary decisions may also be taken between two forecast
meetings based on the developments identified during monitoring

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 XI. The Core Model
Assessing the current position of the economy:
Initial conditions for the core model: GDP trend, neutral real
interest rate, equilibrium real exchange rate, their medium-term
profiles and current gaps
Providing a consistent view on recent economic developments,
current inflationary pressures, and real monetary conditions
stance
Role:
Integrates information from history, near-term forecasting
and expert judgement
Generates endogenous interest rate path which can serve
as policy guideline
Used to generate risk scenarios and policy analysis
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 The Core Model (2)

Characteristics:

Small semi-structural calibrated model

New-Keynesian core (short-term and medium-term non-

neutrality)

Well behaved steady-state

Consistent with achieving multi-period inflation targets

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 The Core Model (3)
Structure:
Core inflation determined by own persistence, agents expectations,
output gap, and import price inflation
Output gap determined by own persistence and real monetary
conditions
Exchange rate determined according to uncovered interest parity
including risk premium
Forward-looking policy interest rate rule reacts to deviations
of inflation from target, the output gap and smoothes out interest
rate volatility
Agents expectations modelled as hybrids of backward-looking
(inertial) and forward-looking (model-consistent) expectations

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 The Core Model (4)

Features of the transmission mechanism:

Expectations channel quite significant for monetary policy direct
influence on inflation
Exchange rate channel also important
direct channel, via pass-through strongest
indirect channel, through influences on real sector
relatively weaker at present

Interest rate channel

relatively weak in the past, steadily strengthening
monetary policy impulses intermediated by relatively sluggish bank
deposit and lending rates

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 XII. The New Inflation Report
Main communication tool with the public in order to anchor
inflation expectations
Since August 2005 quarterly Inflation Report
Sections:
assessment of current economic developments
rationale behind the monetary policy decisions in the reviewed
period
NBR projection on inflation rate developments on eight-quarter
time horizon
uncertainties and risks associated with the projection
implications of the context on the monetary policy future stance

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 XIII. Communication

More transparent policy

Formal announcement of adoption of full-fledged inflation
targeting regime, with details on bandwidth, formalized
exceptions etc.
Formal announcement of calendar for policy-related
Board meetings
External communication based on publishing the new quarterly
Inflation Report and on regular press conferences
occasioned by its release
Press releases on contents of between-forecast meetings
and on the monetary policy decisions

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 CHARTS

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 1.

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 2.

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 3.

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 4.

22 Sep. 05

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 5.

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 6.

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 7.

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 8. 9.

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 10.

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 11.

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 12b.

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