Nick Rowe on Canadian monetary policy

I don’t have time for a new post, so I’ll just comment on this portion of a recent Nick Rowe post:

7. In the “short run” the Bank of Canada ignores Y and P and makes the money supply function perfectly interest-elastic. It targets (what it thinks is) the short-term natural (“neutral”) rate of interest. It makes the LM curve horizontal (and the AD curve vertical). This would be a big problem if the IS (or SRAS and LRAS) curves shifted around. But they usually don’t shift much in 6 weeks.

8. In the “medium run” the Bank of Canada ignores r and P and makes the money supply function perfectly negatively income-elastic. It targets (what it thinks is) potential output. It makes the LM curve vertical (and the AD curve vertical too). Shifts in the IS curve don’t shift the AD curve. (The vertical AD curve would be a problem if the price level adjusted quickly, but it doesn’t seem to.)

9. In the “long run” the Bank of Canada ignores r and Y and makes the money supply perfectly negatively price level-elastic. The LM curve is now a very thick line that covers the whole of {r,Y} space, and the AD curve is horizontal. (I invite students to think in 3D, with P a third axis coming out of the chalkboard, and hold a sheet of paper parallel to the board and tell them it’s the LM curve.)

How would things be different if the central bank used its (discretionary) approach to target NGDP, level targeting?  The first step would still be an interest rate peg (up to six weeks) but the medium and long run would now be the identical—NGDPLT in both cases.

Now assume the central bank adopts a policy of targeting NGDP futures (or even uses an aggressive Svenssonian “target the internal forecast” approach, updated hourly.) In that case all three steps would be combined.  The central bank would target the level of future expected NGDP in the short, medium, and long run.

Now think about all the ways Fed policy can (and has!!) screwed up trying to seamlessly shift from the short to the medium to the long run target.  Especially when rates are near zero.  Wouldn’t targeting NGDP futures prices be much easier?  Of course there are hundreds of very prestigious Federal Reserve jobs whose existence depends on me, Scott Sumner, being wrong.  Robin Hanson has lots to say about this problem.


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45 Responses to “Nick Rowe on Canadian monetary policy”

  1. Gravatar of George Selgin George Selgin
    11. April 2012 at 06:33

    Scott, can you provide a link to Hanson’s discussion to which you refer?

  2. Gravatar of Major_Freedom Major_Freedom
    11. April 2012 at 06:38

    Wouldn’t targeting NGDP futures prices be much easier?

    What if prices were bid above the NGDP target when NGDP is actually on target? Prices can deviate from their “fundamentals”, as the recent MBS debacle has amply shown.

    What if some rogue central banker makes some off hand remarks about worrying over inflation, which drives NGDP futures price downward, which drives down NGDP expectations and thus actual NGDP?

    If the Fed has shown itself capable of failing to fulfil its existing mandate, then wouldn’t the Fed fail to fulfil any other mandate like NGDP targeting?

    I’m still trying to figure out whether you believe easy money from the Fed increases or decreases short term interest rates. When you base things on NGDP, you say easy money from the Fed raises interest rates. But then you say things like this:

    “The anticipation of Fed easing will immediately reduce future expected short term rates, and will immediately reduce long term rates. The market does the Fed’s work before the Fed even realizes there is a problem.”

    Of course there are hundreds of very prestigious Federal Reserve jobs whose existence depends on me, Scott Sumner, being wrong. Robin Hanson has lots to say about this problem.

    The same thing is true for NGDP advocates whose careers would be over if they became free market advocates.

    Imagine up and coming economists at Harvard and Yale and Princeton becoming free market advocates in money production, or anarchists.

  3. Gravatar of dwb dwb
    11. April 2012 at 06:38

    lets not target the forecast:
    http://www.voxeu.org/index.php?q=node/7616

    in some sense, I think the Fed is already doing that (or thinks it is, anyway) and its not working.

  4. Gravatar of Morgan Warstler Morgan Warstler
    11. April 2012 at 06:47

    you need to be meaner, noah clearly said you make sweeping cultural stereotypes and then dog whistle to racists

    eventually, you will be a real problem for the left, they will see where this is taking them.

    gird your loins

  5. Gravatar of Mike Sax Mike Sax
    11. April 2012 at 07:28

    See Morgan you’re always talking about what a master strategist Scott is. Yet he probably wouldn’t be if he took your advice. He handled the Noah post pretty well I must say.

    You want him to come out like Rush or Breitbart or Cantor hyper-partisan and souped up. Then Money Illusion becomes like Red State America.

    Triangulation is what Clinton’s strategy was called. I think your trouble is you hate subtlety you feel it almost unmanly or immoral or something. Most Right wingers do which is why most of them are not so bright.

  6. Gravatar of calmrevolt calmrevolt
    11. April 2012 at 08:26

    I have a possibly dumb question which is entirely unrelated to this post. I would welcome other informed commenters to answer. I read in previous posts about the author being a vocal advocate of a progressive payroll tax in lieu of an income tax. But if individuals have a marginal propensity to consume less than 0.5 of their payroll income then isn’t it (a progressive payroll tax) still more of a tax on saving than consumption? If we truly want a more equitable and direct consumption tax wouldn’t it be more optimal to just design a less regressive sales tax? Say by taxing goods we reliably know higher-income individuals are more likely to consume (e.g. tax Mercedes/BMWs higher than Honda/Fords, lobster higher than ramen noodles, etc)?

    Sorry for any derailment of the discussion but who knows when the next tax related post will be (except for Mr. Sumner maybe).

  7. Gravatar of To To
    11. April 2012 at 08:32

    One thing has been bugging me about NGDP futures markets: efficient markets mean that all available information is included in the price. The fact that the CB is targeting NGDP seems like a very relevant information. In other words, the futures price is a measure of the failure of the CB.

    You cannot have at the same time (1) efficient markets (2) successful control of NGDP by the CB and (3) information in the NGDP futures price that is useful to the CB.

    Am I missing something ?

  8. Gravatar of Morgan Warstler Morgan Warstler
    11. April 2012 at 08:52

    Mike, subtlety obfuscates and assumes people are too emotional to hear things.

    We don’t have to be mean to one another, but life is in fact brutish and short, bad things happen to good people, and we must assume that all players are opportunists.

    Then we hold these truths to be self-evident…

    Rhetoric is the science of making the weaker argument the stronger.

    So if you flip that over, the opposite of rhetoric, saying everything without any artifice or verbal shading, you can more clearly see which argument is stronger.

    You in fact LIKE that I tell you this stuff to your face.

    My goal is actually, not the political argument, my goal is to show the most likely path of policy attainment.

    As in, I think Scott’s idea will happen, it is almost inevitable, so let’s all think through the new political environs that will put us in.

    Thats the discussion I want to have.

    But instead I have to sit and watch everybody play out a very long chess match.

  9. Gravatar of Morgan Warstler Morgan Warstler
    11. April 2012 at 09:12

    “Of course there are hundreds of very prestigious Federal Reserve jobs whose existence depends on me, Scott Sumner, being wrong.”

    This is not just a natural fact, this a TRAGIC thing, it is also a Tea Party sales pitch.

    Fed economists hate Sumner’s plan because they will all be fired, who wants to do Sumner’s plan?!?

  10. Gravatar of D.Gibson D.Gibson
    11. April 2012 at 10:02

    Here’s a bloomberg article that calls for NGDP targeting (sort of).

    http://www.bloomberg.com/news/2012-04-10/the-fed-needs-a-new-simpler-mandate.html

    Is any country officially using NGDP targeting?

  11. Gravatar of bill woolsey bill woolsey
    11. April 2012 at 10:56

    To:

    If you treat the market as homogenous, that pretty much covers it.

    But rather than think about the price of the future, think of the central bank’s position on the contract.

    If it has one, then it shows in what direction the market thinks the central bank is in error.

    Any speculator’s position on the contract tells you in what direction he or she thinks the central bank is wrong. If the central bank has no position on the contract, then any speculators position tells you in what direction he or she thinks the other speculators are wrong.

    If there were only one speculator, there would be no position on the contract.

  12. Gravatar of bill woolsey bill woolsey
    11. April 2012 at 11:15

    Scott:

    Suppose current nominal GDP is pegged.

    Short run aggregate supply detemines the price level and real output.

    Real output and IS determine the real interest rate.

    The current price level and the expected future price level determine the expected inflation rate.

    The expected inflation rate plus the real interest rate determines the nominal interest rate.

    The nominal interest rate, real income, and the price level determine the demand to hold money.

    The demand to hold money determines the quantity of money.

    In reality, no one knows “IS” but have guess, and no one can observe the demand for money. So, the quantity of money and the nominal interest rate both adjust together. They could move in the same or opposite directions, but they are jointly determined.

    Also, nominal GDP isn’t fixed now. It’s expected future level is fixed. So, we have actual nominal GDP, an actual price level, and actual real GDP. They are influenced very much by the expected future level. Can’t get too far out of line with that. Still, the current price level and real income determines the demand for money. What determines the real interest rate? Presumably both the current and expected future level of real GDP. And, the current price level and the expected future price level still determine expected inflation and the nominal interest rate.

    And the quantity of money and nominal interest rate are still jointly determined.

    Messy.

  13. Gravatar of Mike Sax Mike Sax
    11. April 2012 at 14:59

    Morgan what I like about you is you don’t pretend to be somethiing your not. I mean if you tell Rush Limbaugh he wants to see public sector workers get screwed he’ll play like that’s just a myth of the “liberal media”

    You say yeah that’swhat you want.

    I’d be shocked if any tea parier other than you of course have heard of Sumner.

    I get that you are interested in policy attainment and I agree that’s what matters. For that end I’d say Sumner has been pretty shrewd. Of course the game aint over yet.

  14. Gravatar of edeast edeast
    11. April 2012 at 15:00

    This is offtopic. If I were to create a competitive currency, that captured a significant subset of the economy so that it is used exclusively as MOE/MOA within the subset, would an NGDP target make sense. How does it benefit me, through my banking system within the subset?, less defaults?

    Say all I care about is seignorage, does an NGDP target add users, does a futures target add more.
    NGDP and the value of money depends on the size of the economy. If I have my NGDP target,5% how do I entice any rgdp to join my MOE/MOA zone at all?
    or do I as the issuer have to ensure some exchange takes place,(base rgdp/backing theory) eg Nick Rowe’s previous post.

  15. Gravatar of Mike Sax Mike Sax
    11. April 2012 at 15:06

    Part of what I don’t like about most Right wingers I guess is lack of honesty about what they realy want-even to themselves maybe. You do bring clarity. I will give you that.

  16. Gravatar of dwb dwb
    11. April 2012 at 15:12

    DEAR BEN BERNANKE,

    PLEASE STOP TARGETING SUPPLY-SIDE INFLATION, THESE THINGS WORK THEMSELVES OUT IN DUE COURSE.

    http://www.ft.com/intl/cms/s/0/6a365a54-71c5-11e1-8497-00144feab49a.html#axzz1rmBWrjsA

    yours truly,
    dwb

  17. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    11. April 2012 at 15:17

    ‘Part of what I don’t like about most Right wingers I guess is lack of honesty about what they realy want-even to themselves maybe.’

    In contrast to your scrupulous even-handedness, you mean?

  18. Gravatar of Lorenzo from Oz Lorenzo from Oz
    11. April 2012 at 17:33

    Mike Sax: Be careful, Jonathan Haidt’s suggests that someone on the left is less likely to be correct about how rightwingers morally reason than vice versa.

    Haidt summarises his research here.

  19. Gravatar of ssumner ssumner
    11. April 2012 at 18:44

    George, I can’t find the link I recall, but this has some of his cynicism about policy:

    http://www.overcomingbias.com/2008/09/bank-politics-i.html

    And this Lars Christensen post links to his “futarchy” papers (“we should vote on values and bet on beliefs.”)

    http://marketmonetarist.com/2012/02/02/robin-hansons-brilliant-idea-for-central-bank-decision-making/

    Maybe someone else can help me out.

    MF, NGDP futures prices could never deviate from target under NGDP futures targeting.

    dwb, They aren’t targeting the forecast, and they certainly aren’t doing level targeting.

    Morgan, Or you need to be less mean.

    Calmrevolt. Actually a payroll tax and a VAT have identical effects on saving and investment–both are pure consumption taxes. But you may be right that taxing at the goods level is more effective, as it’s hard for the rich to evade those taxes.

    To, Yup, you are missing something. Under NGDP targeting it’s the market controlling monetary policy, not the Fed. So the same people setting the money supply are also forecasting its impact on NGDP.

    D. Gibson, Great article.

    Bill, Yes, messy, especially with the indeterminacy issue.

    edeast, I suppose you’d want to target the NGDP of the zone that uses that currency.

  20. Gravatar of Major_Freedom Major_Freedom
    11. April 2012 at 19:03

    ssumner:

    MF, NGDP futures prices could never deviate from target under NGDP futures targeting.

    Oh. My. God.

    Do you realize the implications of what you just said? If this is your actual belief, then you just completely demolished your own NGDP futures targeting scheme.

    If the prices can never deviate from target, then there is no point of even having NGDP futures “market” in the first place. For what function is the market actually performing if NGDP futures “prices” cannot deviate from target?

    If you say the market should price NGDP futures, then because pricing contains an element of subjectivity, you have to accept the possibility that people can make mistakes in their pricing.

    The more you write, the more it is clear just how utterly empty the whole NGDP targeting scheme really is.

  21. Gravatar of edeast edeast
    11. April 2012 at 19:49

    I was assuming I was targeting the NGDP of my zone, but I was wondering why?

    Why would I as a non gov entity care if monetary recession hit, unless it hit my pocket book somehow.

    This was just a mental exercise, as a new MMO(massively multiplayer online game) is coming out, and I was wondering about what it would take to launch a competitive currency.

  22. Gravatar of Steve Steve
    11. April 2012 at 20:02

    “ssumner: MF, NGDP futures prices could never deviate from target under NGDP futures targeting.
    Oh. My. God. Do you realize the implications of what you just said? If this is your actual belief, then you just completely demolished your own NGDP futures targeting scheme.”

    This is one of the reasons why I’ve argued we need a big liquid market in NGDP-index debt, rather than a futures market. It would be just like the TIPs market, except that the coupon would likely be NGDP *minus*.

    Then, as a thought experiment, imagine if the Fed got rid of the fed funds target and simply pegged the NGDP breakevens at 5% (or maybe 4.75% to 5.25%, the way a central bank might enforce a fixed exchange rate regime). It would implement this technically by buying ordinary treasuries whenever the NGDP breakeven fell to 4.75%, and selling treasuries whenever the NGDP breakeven rose to 5.25%. The balance sheet would be the transmission mechanism, and the fed funds rate would go away.

  23. Gravatar of Steve Steve
    11. April 2012 at 20:14

    In practice their might be some timespread issues as well, i.e., higher or lower NGDP breakevens at different durations. These could be due to seasonal, statistical, or real business artifacts. The Fed should address this by pegging the belly of the NGDP curve, the 3 to 7 year breakevens, at 5%. This would implement level targeting effectively, while allowing small short-term fluctuations.

    In practice, the Fed is already doing something like this with medium-term TIPs breakevens, except that it’s not transparent, and the Fed is obsessed with inertia and face saving.

  24. Gravatar of Saturos Saturos
    11. April 2012 at 21:06

    Scott, I’ll ask you the same thing I asked Nick, see who replies first: If the BoC is targeting the neutral rate in the short run, why peg it at all? Why not let it float? Does it have to peg it somewhere? I’m probably missing something obvious here.

  25. Gravatar of Morgan Warstler Morgan Warstler
    11. April 2012 at 21:40

    Scott, it’s not really part of our Nov2012 bet (wherein you dedicate your book to me), but it feeds into it.

    The question is whether your ideas could be farther along than they are right now.

    Is your meme moving at mach speed? Or is this going to to take another ten years? Other countries are already there.

  26. Gravatar of Saturos Saturos
    11. April 2012 at 22:20

    Scott,

    What do you think about the new Arnold Kling post:
    http://econlog.econlib.org/archives/2012/04/the_liquidity_c.html

  27. Gravatar of Becky Hargrove Becky Hargrove
    11. April 2012 at 23:32

    Mike,
    Here’s a low income/no income version of libertarianism:
    I want this group to have sets of flexible social guidelines that work well for creating self-sufficiency and autonomy, and the prosperity that is possible from one’s own skill, just as the middle to upper classes would have clearly defined sets of guidelines that allow money to work for them. Of course, no class has ways to create prosperity efficiently in the present, and we all have too many inflexible rules.

    As for the lower classes, we’re not asking for the same kinds of material perks. In fact, the environments we would create, even cities, would often look very natural compared to the wealth of the upper classes. But we do want the right to use knowledge of all kinds to teach and heal each other….it’s not that we want to make money with the knowledge of others, but we don’t want to have to constantly rely on those who have more money than we do and whose time is already stretched thin. We would not want the government to provide healthcare, education or retirement for us because we can do these things far better by enlisting every single person in economic endeavour that is also freely chosen. Government would receive from us a one in five hour ‘tax’ that is our choice who to help in community, who can no longer help themselves or is too young to do so. That way, government could go back to more basic functions, and no individual would have to be solely tied to the burdens of family.

  28. Gravatar of TGGP TGGP
    11. April 2012 at 23:34

    I don’t remember the bet Morgan refers to above, but I recall making a bet with him that Rick Perry would not gain the GOP nomination. I went back to copy the link, and found that Morgan had actually accepted my bet. I had forgotten that.

  29. Gravatar of TGGP TGGP
    11. April 2012 at 23:46

    George, I don’t know if there’s a specific Hanson post Scott is referring to rather than his overall ouvre, but Hanson did once propose assigning the government a bunch of money to make bets with as a check against bubbles. But he did that as an alternative to other kinds of regulation, and he didn’t expect it to be taken seriously because it would make officials too accountable (we can see after the fact their bets were wrong, hence they can’t detect bubbles).

  30. Gravatar of Bonnie Bonnie
    12. April 2012 at 01:35

    Mike Sax:

    “Part of what I don’t like about most Right wingers I guess is lack of honesty about what they realy want-even to themselves maybe.”

    I want a society of self-sufficiency. I want to be left alone so I can take care of myself in the way I see fit instead of being forced to throw money I should be saving and investing myself down a rat hole for all kinds of government largesse. I want SSI and Medicare to be voluntary programs. I want the government to keep its hands off my health care – there is absolutely no need to usurp the whole thing to help the needy.

    Need any more honesty?

  31. Gravatar of Morgan Warstler Morgan Warstler
    12. April 2012 at 05:49

    Bonnie, what Sax can’t say honestly back is that he wants to be the boss of other people.

    Instead he’ll say he wants to help the poor etc.

    But deep inside he’s far more concerned not with the folks he is above, he just doesn’t like anyone over him.

    This is why almost all progressives lie.

    Indeed a TRUE progressive would care so much about the poor they would work like dogs to make sure govt. delivered the same kind of productivity gains as the private sector.

    Real progressives would be so greedy for the poor, so determined to help them, that they would NEVER accept public employees blocking reform that would provide more services for less pay per hour.

  32. Gravatar of Morgan Warstler Morgan Warstler
    12. April 2012 at 06:15

    I need Greenwalds address

  33. Gravatar of Morgan Warstler Morgan Warstler
    12. April 2012 at 06:18

    sending here, unless there is some other progressive cause you prefer to give the $10:

    101 Spear Street, Suite 203
    San Francisco, CA 94105

  34. Gravatar of Bill Woolsey Bill Woolsey
    12. April 2012 at 09:24

    Steve:

    The price of the nominal GDP future doesn’t change. But the central bank’s position on the contract changes.

    If the central bank kept its position at zero, then each speculator is betting against the other speculators.

    I don’t like these fixed interest rates schemes.

  35. Gravatar of ssumner ssumner
    12. April 2012 at 10:48

    MF, You said;

    “The more you write, the more it is clear just how utterly empty the whole NGDP targeting scheme really is.”

    Something is utterly empty, but more likely that you don’t understand that the point of the scheme is to set the monetary base, not to predict NGDP.

    edeast, I meant the government part. You are right, it’s not obvious why the private sector would want to stablize NGDP in their zone.

    Steve, Bernanke and Woodford (1997, JMCB) discuss a “circularity problem” with the plan you just outlined.

    Saturos, I agree, there is no reason to target rates at all, or indeed any other intermediate target.

    Morgan, I’m slowed from Mach speed by having to address so many comments that don’t get to the meat of the post.

  36. Gravatar of To To
    12. April 2012 at 10:52

    ssumner: Mmmmkay. I think I get it (and Major_Freedom doesn’t :^). I was stuck halfway between the current system and your proposal; so, there is only one way to use such a futures (or bond) market.

    Note that, at a time when people are grumbling about accountability of central banks, proposing to give the control of monetary policy directly to the market seems like a recipe for one hell of a sh*tstorm. Politically speaking, you’d better stick to the general principle of an NGDP level target. Just my 2c…

    Also, triple-check for any market failure, i.e. ways of making money by screwing with the system.

  37. Gravatar of ssumner ssumner
    12. April 2012 at 11:16

    Saturos, Arnold’s post seems reasonable to me, but I’m no expert on banking. I do think that government subsidies had caused banking to grow excessively large prior to the crisis.

    To, I’ve published 6 papers on futures targeting—the first was presented at the AEA 25 years ago. I’m pretty sure I’ve got the bugs worked out. But I agree that it won’t happen for quite a while.

  38. Gravatar of Major_Freedom Major_Freedom
    12. April 2012 at 11:34

    ssumner:

    you don’t understand that the point of the scheme is to set the monetary base, not to predict NGDP.

    I don’t think it’s a matter of predicting NGDP, since the Fed would be targeting it.

    My point is that if the Fed is going to target NGDP futures “prices”, then that means the market process isn’t pricing NGDP futures, the same way the Fed targeting the fed funds rate would mean that the market process isn’t pricing the fed funds rate.

  39. Gravatar of Major_Freedom Major_Freedom
    12. April 2012 at 11:43

    In other words, if you say the market will price NGDP futures, then there is a chance the market will price the futures incorrectly. Their forecasts might be off, like they were with the housing market, and the Nasdaq market prior.

  40. Gravatar of Saturos Saturos
    13. April 2012 at 03:50

    MF:

    Scott wants the Fed to set the monetary base such that the free market equilibrium price in the NGDP futures market forecasts levels of NGDP which are equal to those being targeted by the Fed.

  41. Gravatar of Saturos Saturos
    13. April 2012 at 03:58

    Though I’m sure you’ll find a way to object to this too.

  42. Gravatar of Major_Freedom Major_Freedom
    13. April 2012 at 05:43

    Saturos:

    Scott wants the Fed to set the monetary base such that the free market equilibrium price in the NGDP futures market forecasts levels of NGDP which are equal to those being targeted by the Fed.

    I know the mechanics. My points are A. these won’t be free market prices for NGDP futures, no more than the fed funds rate, despite the rate being directly set by banks, is the free market fed funds rate, and B. Market participants can be incorrect in their forecast of NGDP. NGDP is not like an individual firm’s forecasted sales revenues. NGDP is everyone’s sales revenues. Just because the Fed can print money to make NGDP whatever they want, it doesn’t mean that individual market participants can accurately predict it, and finally C. Most important of all, no investor invests into and no seller sells into aggregate demand or nominal GDP. Nominal GDP is not like a lump sum of sales revenues that investors and sellers can invest and sell into to earn a profit. Nominal GDP includes expenditures on input factors. Investors and sellers invest and sell into price spreads, input prices and output prices, not price levels or aggregate spending.

  43. Gravatar of ssumner ssumner
    13. April 2012 at 09:07

    MF, You said;

    “these won’t be free market prices for NGDP futures’

    Anyone will be able to buy or sell as many contracts as they wish at that price. You are free to call it free market or not, that’s just semantics.

  44. Gravatar of Saturos Saturos
    13. April 2012 at 09:24

    MF, It doesn’t matter if an NGDP futures contract isn’t like a stock option – markets can be used to forecast anything, from IBM’s future profitability to the future temperature of the Earth’s surface (http://econmodels.com/upload7282/efae68d98251d757b48dfaef0295c28e.pdf). And why yes, markets can be wrong, but they’re the best aggregators of social knowledge known to man – much better than central planners like the FOMC. I’d have thought an Austrian like yourself would have understood that. Given that we are going to have a central bank determining the money supply, how much more free-market can you get? What do you propose instead, Major Freedom, a gold standard?

  45. Gravatar of Major_Freedom Major_Freedom
    18. April 2012 at 05:48

    MF, You said;

    “these won’t be free market prices for NGDP futures’

    Anyone will be able to buy or sell as many contracts as they wish at that price. You are free to call it free market or not, that’s just semantics.

    That is not the minimum requirement for a free market price to exist. The price is artificial, meaning it is not market driven. The price is targeted by the central bank.

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