## _wp07133

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### Introduction and purpose
- Armenia and Georgia faced similar monetary and exchange rate policy challenges despite relatively favorable recent inflation performance.
- Key challenges: sizable foreign exchange inflows, shifts in money demand amid high dollarization, and relatively shallow and unsophisticated securities markets, complicating choice of a credible nominal anchor.
- FFIT evidence: recent empirical evidence for emerging market countries suggests FFIT outperforms other regimes on inflation, inflation expectations, and volatility in the output gap, exchange rate, interest rate and international reserves (Batini and Laxton, 2005).
- Feasibility judgment: FFIT was judged not feasible in the short term in Armenia or Georgia because of vulnerability to economic shocks; poor fiscal–monetary coordination; underdeveloped financial systems; institutional weaknesses; limited central bank technical capacity.
- Transitional option: an implicit or “lite” inflation targeting (IT) framework can be a transitional regime (Stone, 2003).
- Purpose: review experiences of Armenia and Georgia with current monetary and exchange rate policy frameworks, analyze transmission mechanisms, and identify gaps and recommendations toward FFIT.
- Paper based on information available as of September 30, 2006.

### Historical overview (1998–2006)
- Late 1990s: both countries relied on IMF-supported programs to reduce inflation to single digits.
- Early 2000s: low inflation and exchange rates allowed to fluctuate around smooth trends; focus on base money operating targets.
- 2003–05 shocks: large inflows—remittances, FDI and export-related foreign exchange—plus relaxed fiscal policies financed largely by external resources.
- Central bank responses: increased exchange rate flexibility to different extents to absorb shocks while relying on base money operating targets.

### Current monetary and exchange rate regimes (end-June 2006)
- Armenia (Central Bank of Armenia, CBA)
  - Announced adoption of IT lite in 2005 and move to FFIT in the medium term.
  - Inflation target for 2006: 0–3 percent (end-year CPI); target consistency confirmed with 2006 budget in parliamentary-approved monetary program.
  - Primary operating target: government securities repurchase agreement (“repo”) rate.
  - Secondary operating target: local currency base money (reflected in monetary program).
- Georgia (National Bank of Georgia, NBG)
  - Announces an end-of-year forecast (not a formal target); 2006 forecast: 5–6 percent (end-year CPI).
  - 2006 monetary program objectives: maintain external purchasing power of the currency and price stability.
  - In practice since late 2004: limited exchange rate flexibility; exchange rate band operates as de facto primary operating target.
  - Numerous 2006 budget revisions with limited NBG consultation undermined credibility of monetary program; NBG delayed revising base money path when inflation exceeded forecast in May 2006 to avoid nominal exchange rate appreciation outside a +/-2 percent band.
- Table 1 summary (end-June 2006) — selected items
  - Armenia
    - Inflation target announced: Yes
    - Time horizon: Calendar year
    - Who determines the target: Central bank and government
    - Type of inflation target: End-year CPI
    - Specificity: Less than 3 percent
    - Public commitment to transition to FFIT: Yes
    - Primary intermediate target: Inflation forecast
    - Primary operating target: Repo interest rate
    - Secondary operating target: Local currency base money
  - Georgia
    - Inflation target announced: Yes (end-of-year forecast not a target)
    - Time horizon: Calendar year
    - Who determines the target: Parliament approves central bank suggestion
    - Type of inflation target: End-year CPI
    - Specificity: Varies; 2006: 5–6 percent
    - Public commitment to transition to FFIT: No
    - Primary intermediate target: De facto, an exchange rate band
    - Primary operating target: De facto, exchange rate band
    - Secondary operating target: Local currency base money

### Exchange rate flexibility and inflation outcomes
- Armenia
  - Greater exchange rate flexibility supported absorption of shocks and helped keep inflation close to the target.
  - Strong public commitment to low inflation in IT lite, progress on indirect instruments, and increased exchange rate flexibility contributed to inflation performance.
  - Minor target overshooting since mid-2006 mainly explained by supply-side shocks.
- Georgia
  - Limited exchange rate flexibility since late 2004 contributed to sharply rising inflation since early 2006.
- Political pressures in both countries: resist real exchange rate appreciation to maintain competitiveness; preserve local currency value of dollar-denominated remittance inflows and foreign currency-denominated savings.

### Empirical analysis: VAR overview and identification
- VAR for 2000–06 to quantify importance of exchange rates, interest rates, and cash in circulation (CIC) for CPI dynamics.
- Methods: Granger causality tests; variance decomposition; impulse response analyses. Innovations identified using Choleski decomposition with ordering: real GDP, CPI, an interest rate, an exchange rate, and the CIC.
- Caveat: results interpreted with caution given data weaknesses (Annex).

### Empirical findings (Granger causality, pass-through, impulse responses)
- Granger causality tests
  - Joint significance of policy variables overall; bivariate tests mixed.
  - Armenia: exchange rate and key policy interest rate have high predictive power for the CPI; CIC insignificant.
  - Georgia: only CIC "Granger" causes the CPI in bivariate terms.
- Exchange rate pass-through and impulse responses
  - Armenia: strong exchange rate pass-through; an exchange rate appreciation leads to a decline in prices within three months, statistically significant for over 2 quarters.
  - Georgia: pass-through correctly signed and small in magnitude but statistically insignificant because of wide confidence bands.
  - Bakradze and Billmeier (2007): using quarterly data 1996–2006 find positive pass-through significant for 2 to 4 quarters; rate shocks contribute very little to CPI variance once an interest rate is included in the VAR.
- Other policy variables
  - Armenia: strong impact of interest rates on CPI; shocks to the interest rate explain a significant part of CPI variance; a shock to the repo rate results in a rapid decline in prices significant for seven months. (Repo rate used in Armenia.)
  - Georgia: CIC has statistically significant impact on prices; shocks to CIC have moderate explanatory power for CPI variance in Georgia but not in Armenia; inflationary effects of expansionary monetary shock are rapid and significant in Georgia.
  - Results reported at a 5 percent significance level.
  - CIC is highly correlated with local currency base money in both countries.

### Near-term policy implications from empirical analysis
- Armenia
  - Repo interest rate and exchange rate have statistically significant impacts on transmission mechanisms.
  - Current operating framework using the repo interest rate is broadly appropriate.
  - Recommendations:
    - CBA should develop money markets and indirect instruments to strengthen effectiveness of policy interest rates.
    - Continue to follow exchange rate developments and influence exchange rate level, if needed, through indirect channels (e.g., interest rates) rather than direct intervention, consistent with a managed float.
- Georgia
  - Only CIC has a statistically significant impact on prices.
  - Inconclusive evidence on exchange rate pass-through raises doubts about effectiveness of the de facto exchange rate band to achieve low inflation.
  - Recommendation: NBG may need to adopt base money as de facto primary operating target and adjust it in a timely fashion to absorb shocks — requiring greater exchange and interest rate flexibility.

### Preconditions for FFIT adoption and macroeconomic context
- Common desirable preconditions:
  - (i) relatively stable macroeconomic fundamentals;
  - (ii) price stability as primary goal, de facto instrument independence, and transparency/accountability;
  - (iii) lack of fiscal dominance;
  - (iv) some degree of control over short-term interest rates and reasonably developed securities markets;
  - (v) a reasonably stable financial system;
  - (vi) a relatively well-developed foreign exchange market.
- Relative positions
  - Armenia and Georgia have lower inflation, higher growth, and sounder fiscal balances than some emerging market FFIT adopters pre-adoption.
  - Public debt levels somewhat higher than some peers but not substantially concerning for medium-term fiscal sustainability.
  - Financial sector development lags: lower broad money, private sector credit, and stock market capitalization relative to GDP.
  - High dollarization can amplify exchange rate importance in transmission.

### Institutional prerequisites, central bank independence, and financial strength
- Central bank independence and primacy of inflation objective
  - Armenia: de jure and de facto instrument independence = Yes; primacy of inflation objective de jure = Yes; de facto = Yes.
  - Georgia: de jure instrument independence = Yes; de facto instrument independence = No; primacy of inflation objective de jure = No; de facto = No.
  - Recommendations: Georgia should examine legal framework consistency with primacy of price stability and consider a public declaration that price stability is overriding goal. Armenia should modify central bank law to accommodate new regime focusing on policy interest rates.
- Central bank financial strength
  - Armenia: government recapitalized the CBA in 2006 using nonmarketable securities at market-based rates when a capital shortfall arose.
  - Georgia: no shortfalls recorded; long-dated low-interest non-marketable NBG claims on government booked at face value rather than present value.
  - Short-term recommendations: enforce IFRS and clarify profit distribution formulas.
  - Medium-term: future recapitalization if warranted via dated government securities bearing market interest rates; securitize remaining central bank claims on government.
- Formal accountability mechanisms
  - Both central banks legally accountable to parliament, but no formal penalties for non-compliance with targets.
  - Recommendation: reporting requirements should reflect primacy of inflation objective and legal consequences for non-compliance should be formalized.

### Fiscal coordination and treasury management
- Fiscal dominance: current debt levels moderate; no direct central bank deficit financing in either country.
- Coordination shortcomings:
  - (i) size of annual fiscal impulses not coordinated with monetary objectives;
  - (ii) central banks limited in liquidity forecasting and day-to-day liquidity management due to lack of timely treasury information.
- Country specifics
  - Armenia: government increasingly relies on an MTEF and set up monetary and budget coordination committee; committee faces consensus difficulties.
  - Georgia: frequent annual budget revisions; MTEF not binding; NBG and ministry began preparing one- and three-month liquidity forecasts but treasury may lack spending-plan information.
- Short-term recommendations: improve coordination via consistent MTEF implementation; approve and implement quarterly and monthly public expenditure programs; strengthen coordination committees.

### Monetary instruments, market development, and liquidity management
- Constraint: shallow government securities and interbank markets constrain interest-rate based operating targets.
- Market features
  - Armenia: central bank securities (maturities 3, 6 and 12 months), regular issuance, multi-price auctions; standing deposit and credit facilities used; interbank rates within a corridor since 2006.
  - Georgia: central bank securities issuance started in September 2006 (1- and 3-month certificates); standing credit facility not used since July 2004; interbank corridor not in place.
- Excess liquidity: frequent incidences driven by unsterilized FX purchases, remittance inflows, and government deposit volatility.
- Short-term policy recommendations:
  - Establish (Georgia) or maintain (Armenia) an interbank interest rate corridor using standing facilities.
  - Use fixed or variable rate repo/reverse repo operations to steer short-term rates within the corridor.
- Medium-term market development recommendations:
  - Auction securities at regular pre-announced intervals irrespective of immediate treasury shortfalls.
  - Eliminate overlap in maturity between central bank and government securities: central banks focus on short maturities (up to 6 months); treasuries on longer maturities (more than 6 months).
  - Treasuries to issue longer-term securities in greater quantities to build a benchmark yield curve.

### Financial system stability: diagnostics and recommendations
- Obstacles: insufficient competition and large "grey" economy; many banks operate in niche markets.
- Interest rate spreads: averaging over 10 percent at end-2005 in Armenia and Georgia (compared with around 2 percent in Estonia and 8 percent in Russia at end-2005).
- Banking soundness indicators (selected, 2003–05)
  - Armenia: Capital adequacy 33.8, 32.3, 33.7; Liquidity 47.5, 47.1, 44.2; ROA 2.7, 3.2, 3.1; Nonperforming loans 5.4, 2.1, 1.9; Provisions to NPLs 34.3, 77.0, 70.7.
  - Georgia: Capital adequacy 20.3, 18.8, 17.5; Liquidity 43.3, 45.0, 33.3; ROA 4.0, 2.4, 3.2; Nonperforming loans 7.5, 6.2, 3.8.
- Supervisory concerns: weak corporate governance (especially Georgia), connected lending, rapid credit growth raising loan quality concerns, patchy enforcement in Georgia due to limited staff.
- Short-term recommendations: tighten asset classification and provisioning rules; enhance supervisory coverage to include interest rate and market risk; Georgia to adopt fit and proper requirements for bank owners and improve enforcement.
- Medium-term recommendation: foster competition in the banking system.

### Foreign exchange market and derivatives
- Current state: retail and interbank FX markets in Georgia and Armenia are reasonably competitive and liquid with a significant number of well-established market-makers.
- Medium-term recommendation: develop foreign currency derivatives markets once an appropriate supervisory framework has been established.

### Operational design issues: CPI, targets, forecasting, transparency
- Inflation index
  - Both countries attach highest importance to headline inflation.
  - CBA targets headline CPI and compiles/publishes a 15 percent trimmed mean core CPI; NBG publishes headline CPI forecasts and core CPI measures historically.
  - Recommendation: national statistics offices should improve CPI compilation methodologies and take over production of core inflation indices; Georgia should strengthen de facto independence of its statistics office.
- Numerical targets and horizon
  - Both central banks target inflation ranges within a 12-month horizon and set relatively narrow target bands in 2006.
  - Recommendation: set a medium-term path for inflation target together with annual target; set inflation targets at least 12 months in advance and aim to be near the center of the target range; extend target horizon beyond 12 months.
- Forecasting
  - Forecast horizon: 4 quarters (12 months).
  - Current models often exclude interest rates from money demand and forecasting equations.
  - Armenia specifics (Table 11a): CBA publishes 15 percent trimmed mean CPI; money demand ADL-type model uses real GDP but not interest rates; inflation forecasting uses unit labor costs, agriculture growth, exchange rate, broad money.
  - Georgia specifics (Table 11b): three core CPI measures (median, 20 percent trimmed, weighted); money demand estimated by error correction model; inflation forecasting uses GDP, M2 (M3), Oil prices, CPI, GEL/US$ exchange rate, agriculture prices.
  - Recommendations:
    - Short term: extend forecast horizon of leading indicators models and compile more reliable monthly indicators of real activity.
    - Medium term: develop structural VARs and GEMs; calibrate GEMs using parameters from similar FFIT countries; integrate forecasting closely with decision making.
- Transparency and communications
  - Both central banks have increased transparency: publish inflation objectives, risks, monetary and exchange rate policies, financial standing, and 12-month inflation forecasts with models.
  - NBG needs to improve communication regarding monetary and exchange rate policy framework.
  - Table 12 summary: Armenia — monthly monetary report, quarterly inflation report, one-year fan-charts with discussion, publishes research/models, minutes within 10 days; Georgia — monthly monetary report, quarterly inflation report, one-year fan-charts, publishes some model material, no published minutes.

### Prioritized short- and medium-term recommendations (Section V)
- Short-term key measures
  - Central bank legislation: Georgia to align legal framework with primacy of price stability; Armenia to modify law to focus on policy interest rates.
  - Central bank financial strength: enforce IFRS and clarify profit distribution.
  - Fiscal coordination: adhere to MTEFs and set up effective coordination committees.
  - Monetary instruments: establish (Georgia) and maintain (Armenia) an interbank rate corridor using standing facilities.
  - Banking supervision: Georgia to improve enforcement and adopt fit and proper ownership requirements.
  - CPI data: statistics offices to improve compilation and produce core measures.
  - Forecasting capacity: extend forecasting horizon and incorporate more real sector information.
  - Communication: NBG to increase transparency on objectives and instruments.
- Medium-term measures
  - NBG to obtain de facto independence.
  - Deepen securities and interbank markets: increase marketable securities and improve auctioning and secondary market trading.
  - Increase competition in the banking system.
  - Introduce foreign exchange derivatives after supervisory framework established.
  - Georgia: make statistics office more independent.
  - Improve forecasting capabilities to include structural models.
  - Extend target horizon beyond 12 months.

### VAR annex: data, variables, and identification details
- Sample and frequency: monthly data; baseline focuses on post-Russian crisis years. Table A1 sample periods: Armenia Jan. 2001–Dec. 2005; Georgia Jan. 2000–Mar. 2006.
- Endogenous ordering: real GDP; CPI; an interest rate; nominal effective exchange rate; cash in circulation (CIC). Rationale: exchange rate placed before CIC due to high dollarization.
- Exogenous variables
  - Armenia: U.S. federal funds rate (explains opportunity cost of remittances).
  - Georgia: oil price index and U.S. federal funds rate.
- Data treatment: all variables except interest rates seasonally adjusted and taken in logarithms; almost all variables I(1); first-differencing not conducted to avoid filtering dynamic interactions.
- Modeling limitations: cointegration analysis not conducted due to short time series; ordering of exchange rate and monetary aggregate makes little difference because of low residual correlation; exogenous variables help mitigate price puzzle.
- Baseline model listings (Table A1)
  - Armenia endogenous: Real GDP; CPI; REPO rate; Nominal effective exchange rate; Cash in circulation. Exogenous: U.S. federal funds rate. Sample Jan. 2001–Dec. 2005.
  - Georgia endogenous: Real GDP; CPI; Lending rate; Nominal effective exchange rate; Cash in circulation. Exogenous: Oil price index; U.S. federal funds rate. Sample Jan. 2000–Mar. 2006.

*Source: IMF staff background paper (based on information available as of September 30, 2006).*

### 1. Exchange Rate Developments vis-à-vis the U.S. Dollar, 1998–2006 ..............................4

### 1. Exchange Rate Developments vis-à-vis the U.S. Dollar, 1998–2006

### Introduction and context
- Armenia and Georgia (South Caucasus) faced similar monetary and exchange rate policy challenges despite relatively favorable recent inflation performance.
- Key challenges: sizable foreign exchange inflows, shifts in money demand amid high dollarization, and relatively shallow and unsophisticated securities markets, which complicated choosing a credible nominal anchor.
- Several developing and transition economies have adopted full-fledged inflation targeting (FFIT) as their main monetary anchor; at adoption these countries had medium to high policy credibility, a clear commitment to their inflation target, and institutionalized transparent frameworks fostering central bank accountability.
- Recent empirical evidence for emerging market countries suggests that FFIT outperforms other monetary regimes on inflation, inflation expectations, and volatility in the output gap, exchange rate, interest rate and international reserves (Batini and Laxton, 2005).
- FFIT was judged not feasible in Armenia or Georgia in the short term given:
  - vulnerability to economic shocks,
  - poor fiscal–monetary coordination,
  - underdeveloped financial systems,
  - institutional weaknesses,
  - limited central bank technical capacity.
- An implicit or “lite” inflation targeting (IT) framework can be a transitional regime where countries announce a clear inflation objective and commitment to a target even if FFIT is not yet feasible (Stone, 2003).

### Purpose and organization of the paper
- Reviews experiences of Armenia and Georgia with current monetary and exchange rate policy frameworks and highlights key challenges of transition toward FFIT.
- Relevance:
  - Armenia: has established IT lite and aspires to adopt FFIT in the medium term.
  - Georgia: has not yet decided on moving toward IT lite or FFIT.
- Structure:
  - Section II: main issues in existing monetary and exchange rate frameworks.
  - Section III: empirical analysis of monetary policy transmission mechanisms and implications for operating frameworks.
  - Section IV: gaps relative to macroeconomic and institutional prerequisites for FFIT and recommendations to close gaps.
  - Section V: conclusions and recommendation to pursue improvements and meet prerequisites for FFIT in the medium term.
- Paper based on information available as of September 30, 2006.

### Historical overview (1998–2006)
- In late 1990s both countries relied on IMF-supported programs to reduce inflation to single digits.
- Early 2000s: low inflation and exchange rates allowed to fluctuate around smooth trends; focus on base money operating targets.
- During 2003–05, both economies experienced large shocks: sizable increases in remittances, FDI and export-related foreign exchange inflows (partly due to improved conditions in Russia and other CIS countries), and relaxed fiscal policies financed largely by external resources (foreign aid and privatization proceeds from nonresidents).
- Central Bank responses:
  - Both central banks increased exchange rate flexibility to different extents to absorb shocks and maintain single-digit inflation while relying on base money operating targets.
- Observed data sources referenced: IFS; country authorities; Fund staff estimates and projections.

### Current monetary and exchange rate policy regimes (end-June 2006)
- Central Bank of Armenia (CBA):
  - Announced adoption of IT lite in 2005 and move to FFIT in the medium term.
  - Set inflation target at 0–3 percent for 2006 and confirmed consistency with the 2006 budget in the parliamentary-approved monetary program.
  - Relies on government securities repurchase agreement (“repo”) rate as primary operating target.
  - Continues to pay attention to local currency base money growth as a secondary operating target, reflected in its monetary program.
- National Bank of Georgia (NBG):
  - Announces an end-of-year forecast (not a formal target); 2006 forecast: 5–6 percent.
  - 2006 monetary program approved by parliament listed key objectives: maintain external purchasing power of the currency and price stability.
  - In practice, since late 2004 the NBG has limited exchange rate flexibility and the exchange rate band operates as the de facto primary operating target.
  - Numerous 2006 budget revisions with limited NBG consultation undermined credibility of the initial monetary program.
  - NBG delayed a needed revision of the original base money path when inflation began to exceed forecast in May 2006, seemingly to avoid nominal exchange rate appreciation outside a +/-2 percent band.
- Table 1 (summary, end-June 2006)
  - Armenia:
    - Inflation target announced: Yes
    - Time horizon: Calendar year
    - Who determines the target: Central bank and government
    - Type of inflation target: End-year CPI
    - Specificity: Less than 3 percent
    - Public commitment to transition to FFIT: Yes
    - Primary intermediate target: Inflation forecast
    - Secondary intermediate target: No
    - Primary operating target: Repo interest rate
    - Secondary operating target: Local currency base money
  - Georgia:
    - Inflation target announced: Yes (NBG announces an end-of-year forecast not a target)
    - Time horizon: Calendar year
    - Who determines the target: Parliament approves central bank suggestion
    - Type of inflation target: End-year CPI
    - Specificity: Varies; 2006: 5–6 percent
    - Public commitment to transition to FFIT: No
    - Primary intermediate target: De facto, an exchange rate band
    - Secondary intermediate target: Inflation forecast
    - Primary operating target: De facto, exchange rate band
    - Secondary operating target: Local currency base money

### Exchange rate flexibility and inflation outcomes
- Armenia:
  - Greater exchange rate flexibility throughout the period supported absorption of shocks and helped keep inflation close to the target.
  - Strong public commitment to low inflation in IT lite, progress in developing indirect monetary policy instruments, and increased exchange rate flexibility contributed to inflation performance.
  - Minor target overshooting since mid-2006 mainly explained by supply-side shocks.
- Georgia:
  - Limited exchange rate flexibility since late 2004 contributed to sharply rising inflation since early 2006.
- Political pressures affecting exchange rate flexibility in both countries include:
  - Desire to maintain competitiveness by resisting real exchange rate appreciation pressures.
  - Intent to preserve local currency value of significant dollar-denominated remittance inflows and largely foreign currency-denominated savings.

### The choice of operating targets: conceptual criteria
- Operating targets under IT should be:
  - under the control of the central bank;
  - strongly related to inflation;
  - easily quantified with little discretion or ambiguity in measurement;
  - relatively easy to forecast;
  - easy to observe and understand by policy makers and the public.
- Developed FFIT countries use interest rates as operating targets; some emerging market FFIT adopters used exchange rates or narrow monetary aggregates during early stages.
- Choice in emerging markets typically based on empirical analysis of monetary policy transmission mechanisms.

### Empirical analysis: transmission mechanisms and VAR overview
- A VAR analysis was undertaken for 2000–06 to quantify importance of monetary policy variables (exchange rates, interest rates, and cash in circulation (CIC)) for CPI dynamics.
- Methods:
  - Granger causality tests to assess predictive significance of policy variables for CPI.
  - Variance decomposition and impulse response analyses to measure exchange rate pass-through and roles of other policy variables.
  - Innovations identified using Choleski decomposition with causal ordering: real GDP, the CPI, an interest rate, an exchange rate, and the CIC.
- Caveat: VAR results should be interpreted with caution given inherent data weaknesses (Annex).

### Empirical findings (Granger causality and transmission)
- Granger causality tests indicate:
  - Joint significance of policy variables overall; bivariate tests give mixed results.
  - Armenia:
    - The exchange rate and the key policy interest rate have high predictive power for the CPI.
    - CIC is insignificant for CPI dynamics.
  - Georgia:
    - Only the CIC "Granger" causes the CPI in bivariate terms.
- Implication: The significance of different policy variables as predictors of CPI differs across the two economies, suggesting that appropriate operating targets may differ as well (e.g., repo interest rate in Armenia vs. exchange rate in Georgia), depending on empirical support from transmission analysis.

### Policy implications and recommendations (as emphasized in the analysis)
- For Armenia:
  - IT lite with a strong public commitment and use of the repo rate as primary operating target appears consistent with observed transmission mechanisms and inflation performance.
  - Continued development of indirect monetary instruments and maintenance of exchange rate flexibility are important.
- For Georgia:
  - Limited exchange rate flexibility and de facto use of an exchange rate band as primary operating target have been associated with rising inflation; the exchange rate band has become the practical primary operating target.
  - Many IT-related improvements would strengthen Georgia’s existing monetary policy framework even if the authorities do not pursue FFIT in the foreseeable future.
  - A gradual transition toward IT lite and ultimately FFIT is proposed as a possible option, contingent on addressing key gaps (macroeconomic, institutional, and technical).
- General recommendation:
  - Both countries should continue improving monetary and exchange rate policy frameworks and work toward meeting institutional and other prerequisites for FFIT in the medium term.

*Source: IMF staff background paper (based on information available as of September 30, 2006).*

### Annex for details on data and variables used).

### References

### _wp07133 - References

### Literature on Inflation Targeting and Policy Frameworks
- Batini, N., and D. Laxton, 2005, “Under What Conditions Can Inflation Targeting be Adopted? The Experience of Emerging Markets,” forthcoming in Monetary Policy Under Inflation Targeting ed. by Schmidt-Hebel and Mishkin, (Santiago: Banco Central de Chile).
- Berg, C., 2005, “Experience of Inflation Targeting in 20 Countries,” Riksbank Quarterly Review, 1, pages 20-47.
- Dabla-Norris, E., 2006, “Recent Experiences with Inflation Targeting in Developing and Transition Countries,” mimeo, International Monetary Fund.
- Freedman, C., and I. Otker-Robe, 2005, “Conditions for Successful Implementation of Inflation Targeting,” presentation for seminar on Inflation Targeting: Policy and Implementation Issues, Istanbul, Turkey.
- Jonas, J., and F. Mishkin, 2005, “Inflation Targeting in Transition Countries: Experiences and Prospects,” in The Inflation Targeting Debate, Studies in Business Cycles, No. 32, Part III, ed. by Bernanke and Woodford (Chicago: University of Chicago Press).
- Landerretche, O., F. Morandé, and K. Schmidt-Hebel, 2000, “Inflation Targets and Stabilization in Chile,” in Monetary Policy Frameworks in a Global Context, ed. by L. Mahadeva and G. Sterne (London: Routledge).
- Masson, P., M. Savastano, and S. Sharma, 1997, “The Scope for Inflation Targeting in Developing Countries,” IMF Working Paper No. 97/130 (Washington: International Monetary Fund).
- Mishkin, F., 2000, “Inflation Targeting in Emerging-Market Countries,” American Economic Review, Vol. 90(2), pages 105-109.
- Mishkin, F., 2003, “Comments on Fraga, Goldfajn, and Minella,” on Inflation Targeting in Emerging Market Economies, mimeo.
- Roger, S., and M. Stone, 2005, “On Target? The International Experience with Achieving Inflation Targets,” IMF Working Paper No. 05/163 (Washington: International Monetary Fund).
- Schmidt-Hebel, K., and M. Tapia, 2002, “Monetary Policy Implementation and Results in 20 Inflation Targeting Countries,” Central Bank of Chile, Working Paper No. 166.
- Stone, M., 2003, “Inflation Targeting Lite,” IMF Working Paper No. 03/12 (Washington: International Monetary Fund).
- Truman, E., 2003, Inflation Targeting in the World Economy (Washington: Institute for International Economics).

### Country- and Region-Specific Studies and Case Analyses
- Bakradze, G., and A. Billmeier, 2007, “Inflation Targeting in Georgia: Are We There Yet?” mimeo, National Bank of Georgia and International Monetary Fund.
- Dabla-Norris, E., and H. Floerkemeier, 2006, “Transmission Mechanisms of Monetary Policy in Armenia: Evidence from VAR Analysis,” IMF Working Paper No. 06/248 (Washington: International Monetary Fund).
- Duttagupta, R., Gilda Fernandez, Cem Karacadag, 2004, “From Fixed to Float: Operational Aspects of Moving Towards Exchange Rate Flexibility,” IMF Working Paper No. 04/126 (Washington: International Monetary Fund).
- Leiderman, L., Rodolfo Maino, and Eric Parrado, 2006, “Inflation Targeting in Dollarized Economies,” IMF Working Paper No. 03/12 (Washington: International Monetary Fund).
- Landerretche, O., F. Morandé, and K. Schmidt-Hebel, 2000, “Inflation Targets and Stabilization in Chile,” in Monetary Policy Frameworks in a Global Context, ed. by L. Mahadeva and G. Sterne (London: Routledge).

### Monetary Policy Implementation, Instruments, and Financial Market Structure
- Carare, A., A. Schaechter, and M. Stone, 2002, “Establishing Initial Conditions in Support of Inflation Targeting,” IMF Working Paper No. 02/102 (Washington: International Monetary Fund).
- Laurens, B. and others, 2005, “Monetary Policy Implementation at Different Stages of Market Development,” IMF Occasional Paper No. 244 (Washington: International Monetary Fund).
- Khan, M., 2003, “Current Issues in the Design and Conduct of Monetary Policy,” IMF Working Paper No. 03/56 (Washington: International Monetary Fund).
- Khan, M., and A. Senhadji, 2001, “Inflation and Financial Depth,” IMF Working Paper No. 01/44 (Washington: International Monetary Fund).
- Sarr, A., and Tonny Lybek, 2002, “Measuring Liquidity in Financial Markets,” IMF Working Paper No. 02/232 (Washington: International Monetary Fund).
- Silver, Mark, 2006, “Core Inflation Measures and Statistical Issues in Choosing Among Them,” IMF Working Paper No. 06/97 (Washington: International Monetary Fund).
- Williams, M., 2004, “Government Cash Management: Good and Bad Practice,” World Bank Technical Note.

### Communication, Transparency, and Central Bank Credibility
- Fracasso, A., H. Genberg, and C. Wyplosz, 2003, “How do Central Banks Write? An Evaluation of Inflation Reports by Inflation Targeting Central Banks,” CEPR/Geneva Reports on the World Economy, Special Report No. 2.
- Freedman, C., and I. Otker-Robe, 2005, “Conditions for Successful Implementation of Inflation Targeting,” presentation for seminar on Inflation Targeting: Policy and Implementation Issues, Istanbul, Turkey.
- Mishkin, F., 2003, “Comments on Fraga, Goldfajn, and Minella,” on Inflation Targeting in Emerging Market Economies, mimeo.
- Stella, P., 2005, “Central Bank Financial Strength, Transparency, and Policy Credibility,” Staff Papers, International Monetary Fund, Vol. 52(2), pages 335–365.

### Theoretical and Methodological Contributions
- Calvo, G., and C. Reinhart, 2000, “Fear of Floating,” NBER Working Paper No. 7993 (Cambridge, Massachusetts: National Bureau of Economic Research).
- Sargent, T., and Neil Wallace, 1981, “Some Unpleasant Monetarist Arithmetic,” Federal Reserve Bank of Minneapolis Quarterly Review, vol. 5(3), pages 1-17.
- Sims, C., 2003, “Limits to Inflation Targeting,” (unpublished; Princeton, New Jersey: Princeton University).
- Fracasso, A., H. Genberg, and C. Wyplosz, 2003, “How do Central Banks Write? An Evaluation of Inflation Reports by Inflation Targeting Central Banks,” CEPR/Geneva Reports on the World Economy, Special Report No. 2.

### General IMF and Global Economy References
- IMF, 2005, World Economic Outlook, September 2005 (Washington: International Monetary Fund).

*Source: _wp07133 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2007/_wp07133.pdf_