the inflation appreciation trade-off revisited the monetary management of the zambian copper boom by...
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The inflation appreciation trade-off revisited
The monetary management of the Zambian copper boom
by
Elva BovaPhD candidateSOAS, University of London,NCCR Trade Regulation, WTI, Berne
Email: [email protected]
Introduction
Presentation outlineTheoretical framework:
exchange rate management and the RER
The nominal appreciation of the Kwacha:
impact on non traditional exports
Inflation, food and non food: Cointegrated VAR for exchange and money channel
Results and policy implications
Theoretical framework: the trade off
Further to a commodity boom the economy is exposed to the risk of a RER appreciation:
Dutch disease (Pt/Pnt) Money inflation linkresource switching effect (e Pt/Pnt)spending effect
flexible fixednominal appreciation inflation
(money-exchange channels)
Theor.framework: the trade-off revisited
Neutrality argument: the real exchange rate (Pt/Pnt) appreciates under the two regimes
Hypothesis: RER not neutral to the exchange rate regime.
-food component in CPI
-economy operates not at full employment, yet absorptive capacity is limited
How to maintain export competitiveness in an inflation stabilising monetary framework?
The copper boom in ZambiaThe copper boomThe increase in export receipts, Debt relief at the end of 2005 and
a surge in foreign capital put pressure on the Zambian Kwacha.
Monetary framework: Monetary targeting (M3, reserve money) with price stability as the main objective for monetary policy. Flexible exchange rate (IMF managed float) with interventions mainly aimed at smoothing volatility.
The Kwacha appreciation
The nominal appreciation
Non Traditional Exports (NTEs)
Zambian exports 2000-2007
010002000300040005000
2000 2001 2002 2003 2004 2005 2006 2007
US$
Mill
ions
Metals Total Non Metals CIF
Source: Export board of Zambia
The nominal appreciation
Sectors
2005-06 2006-07% change 05-07
US$'000%
NTEs US$'000%
NTEs
Engineering products 96,419 17.07% 288,592. 38.11% 199.31%
Agriculture 196,975 34.85% 176,913 23.36% -10.19%
Processed Refined Food 66,933 11.83% 103,573 13.68% 54.74%
Horticulture 32,094 5.67% 17,839 2.36% -44.42%
Floriculture 20,507 3.63% 23,024 3.04% 12.27%
Textiles 26,937 4.76% 19,583 2.59% -27.30%
Other manufactures 22,216 3.39% 24,512 3.24% 10.34%
Gemstones 31,607 5.59% 18,694 2.47% -40.86%
Source: Export board of Zambia
Inflation
Source: Bank of Zambia
Two main channels from exchange rate management to inflation:Money supply channelExchange rate channel
Inflation (2000-2008)
0.05.0
10.015.020.025.030.035.040.0
Jan-
00
Jul-
00
Jan-
01
Jul-
01
Jan-
02
Jul-
02
Jan-
03
Jul-
03
Jan-
04
Jul-
04
Jan-
05
Jul-
05
Jan-
06
Jul-
06
Jan-
07
Jul-
07
Jan-
08
Food inflation Non food inflation Headline inflation
The modelThe unrestricted VAR:
Xt = ΠXt-1 + Φ1 Dtt + μ1 t + μ0 + εt εt ~ Np (0, Σ), t=1,….., T
Variables: M3 = log M3sea – log CPIz, Ex = log CPIz – log CPIus –NEus-z CPI f, CPI nf
Exog.: real copper price, real oil price*
Residual Analysis Identification of the cointegrated VARLong run: Short run
Results and interpretationsFood inflation:
not significantly related to money supply (or copper price); long run relationship with the exchange rate;
in the short run adjusts more to its previous values (0.52) than with respect to deviations from its equilibrium with exchange rate (0.17).
Non food inflation: significant long run relationship with money supply, not with the exchange rate;it adjusts rapidly to deviations from its equilibrium with money supply;
The exchange rate:related in the long run with money supply and the price of copper (commodity currency hypothesis);
Conclusions
Under the flexible exchange rate regime with a monetary target and price stability as overriding objective, the Zambian Kwacha has appreciated in nominal terms (2005, 2007).
The nominal appreciation (2005) has fed into a real appreciation with deterioration of some non traditional exports: tobacco, cotton, coffee and horticulture, with increase in unemployment and possible rural-urban bias.
Had Bank of Zambia managed more the exchange rate, inflation would have increased but not that much more likely through the exchange rate channel, since the money channel is only valid for non food prices, which comprise 30% of total headline CPI.
Conclusions
Thank you very much
The copper boomCopper prices
0
2000
4000
6000
8000
10000
1957
m01
1960
m04
1963
m07
1966
m10
1970
m01
1973
m04
1976
m07
1979
m10
1983
m01
1986
m04
1989
m07
1992
m10
1996
m01
1999
m04
2002
m07
2005
m10
US
$ pe
r m
etri
c to
n
0
20
40
60
80
100
120
Nominal price lft-scale Real price rgt-scale
Copper price and exports in Zambia
0
10,000
20,000
30,000
40,000
50,000
60,000
Jan-
95
Jan-
96
Jan-
97
Jan-
98
Jan-
99
Jan-
00
Jan-
01
Jan-
02
Jan-
03
Jan-
04
Jan-
05
Jan-
06
Jan-
07
Met
ric to
nnes
0
100
200
300
400
500
copper exports (volume) lft-scale copper price (index) rgt-scale
Source: IMF-IFS, Bank of Zambia
The KwachaThe appreciation of the Kwacha
0100020003000400050006000
1990
m01
1991
m03
1992
m05
1993
m07
1994
m09
1995
m11
1997
m01
1998
m03
1999
m05
2000
m07
2001
m09
2002
m11
2004
m01
2005
m03
2006
m05
2007
m07
Kwac
ha p
er U
S$
0
20
40
60
80
Nominal exchange rate Real copper price
Foreign exchange intervention (net purchases)
-30.000-20.000-10.000
0.00010.00020.00030.00040.000
07/0
1/00
07/1
1/00
07/0
9/01
07/0
7/02
07/0
5/03
07/0
3/04
07/0
1/05
07/1
1/05
07/0
9/06
07/0
7/07
US $
Mill
ion
0100020003000400050006000
2000
m01
2000
m11
2001
m09
2002
m07
2003
m05
2004
m03
2005
m01
2005
m11
2006
m09
2007
m07
ZMK-
US$
Forex lft-scale NE rgt-scale
Source: IMF-IFS, Bank of Zambia
Headline CPI composition
Composite Index WeightsFood and Beverage Index 57%
Transport and Communication 9.60%
Rent, Fuel and Lighting 8.50%
Furniture and Household Goods 8.20%
Medical care 8%
Clothing and Footwear 6.80%
Recreation and Education 4.90%
All other goods and services 4.10%
Residual analysisMultivariate tests
Tests for Autocorrelation Ljung-Box(37): ChiSqr(560) = 674.636 [0.000] LM(1): ChiSqr(16) = 39.811 [0.001] LM(2): ChiSqr(16) = 18.501 [0.295]
Test for Normality: ChiSqr(8) = 14.927 [0.061]
Univariate Tests
Std.Dev Skew. Kurtosis ARCH(2) Normality R-SquaredM3 0.021 -0.097 3.111 2.727 [0.256] 0.721 [0.697] 0.510CPI f 0.009 0.241 2.823 0.735 [0.692] 1.684 [0.431] 0.755CPInf 0.006 0.434 2.853 3.735 [0.155] 6.306 [0.043] 0.735Ex 0.024 -0.101 3.720 5.131 [0.077] 4.872 [0.088] 0.612
Trace test for number of cointegrating relations
p-r r Eig.Value Trace Trace* Frac95 P-Value P-Value*4 0 0.506 191.011 181.954 63.659 0.000 0.0003 1 0.279 90.130 86.714 42.770 0.000 0.0002 2 0.204 43.341 41.043 25.731 0.000 0.0001 3 0.072 10.671 10.052 12.448 0.101 0.127
Trace Test Statistics
The test statistics are scaled by the 5% critical values of the `Basic Model'
2000 2001 2002 2003 2004 2005 2006 2007 20080.0
0.4
0.8
1.2
1.6
2.0
2.4
2.8X(t)
H(0)|H(4) H(1)|H(4) H(2)|H(4) H(3)|H(4)
2000 2001 2002 2003 2004 2005 2006 2007 20080.0
0.5
1.0
1.5
2.0
2.5R1(t)
Source: RATS estimation
Long run identification
M3 CPI-f Ex CPI-nf COP T(2005:12) TREND
Beta(1) 0.225 0.000 1.000 0.000 -0.377 0.000 -0.007
(2.107) (.NA) (.NA) (.NA) (-12.009) (.NA) (-8.803)
Beta(2) 0.000 1.000 0.195 0.000 0.000 0.009 -0.016
(.NA) (.NA) (6.010) (.NA) (.NA) (9.418) (-119.363)
Beta(3) 0.020 0.000 0.000 1.000 0.000 0.000 0.000
(4.632) (.NA) (.NA) (.NA) (.NA) (.NA) (.NA)
TEST OF RESTRICTED MODEL: CHISQR(7) = 3.748[0.879]
Source: RATS estimation
Short run identification M3 Ex CPIf CPInf
Ex-1 0.1550 0.2492 -0.0514 (0.0218) (0.0004) (0.0069)
CPIf-1 -0.5693 0.5172 0.1163 (0.0003) (0.0000) (0.0082)M3-1 -0.2938
(0.0001)ECM1-1 -0.0670 -0.1688
(0.0543) (0.0000)ECM2-1 -0.1696
(0.0000)ECM3-1 -0.7982
(0.0000)Dcop 0.1469
(0.0000)
LR test of over-ident. restrictions:Chi^2(43)=61.645 [0.0613]
Source: RATS estimation