Monetary Policy Objectives for 2005
The highest contribution that monetary policy can make to economy consists in low, stable and predictable inflation. However, in the conditions of high dollarization (euroization) of economy, monetary policy has limited scope for achieving this objective. Key components of monetary policy in Serbia are the following: (a) managed floating exchange rate and (b) controlled inflation.
Monetary policy objectives are set out in Article 3 of the Law on the National Bank of Serbia (“RS Official Gazette”, no. 72/03 and 55/04). The NBS is expected to maintain price stability . Without prejudice to its primary objective, the NBS also lends support to the Government’s economic policy promoting sustainable economic growth.
In the largest number of market economies, central banks have similar objectives. The objective to maintain price stability (the improvement of the climate conducive for entrepreneurship development, for instance) indicates that the central bank is responsible for sustainable economic growth. Central bank’s independence is an important condition for the implementation of a monetary policy resulting in price stability. The independence of the NBS is provided for by Articles 2, 75 and 76 of the Law on the National Bank of Serbia (“RS Official Gazette”, no. 72/03 and 55/04) and Article 55 of the Law on the Budget System (“RS Official Gazette”, nos. 9/02, 87/02, 61/05 and 66/05): (a) election of the governor does not coincide with parliamentary elections in order to ensure independence from politics, (b) the NBS is financially independent, and (c) fiscal dominance has been avoided by limiting budget deficit financing and introducing the requirement to repay such financing in the course of the calendar year.
Similarly to other central banks, the NBS focuses on the stability of retail prices. Empirically, core inflation is a better indicator but it is also one that is difficult to communicate to the public and the press. Price stability does not mean that prices never change, but rather involves moderate price growth. The planned inflation level should leave sufficient room for changes in relative prices which occur all the time in every economy. Price stability in the Serbian economy means a long-term net (core) inflation rate ranging from 5% to 10%. In order to accomplish this objective, the NBS uses adequate monetary instruments.
Costs of Inflation
High and unstable inflation adversely affects economic growth. This is easily proven by means of a comparative analysis of years of world economic experience. High inflation makes deep inroads in income and savings, resulting in high nominal (and real) interest rates. As a rule, high inflation is accompanied by inflationary instability which sizably increases costs. High inflation also feeds insecurity as regards future relative prices and price levels. Thus, domestic and foreign financial markets demand higher risk premiums as compensation for increased insecurity. When inflation is high in the long-term, inflation and depreciation expectations are incorporated in economic entities’ business decision making. High inflationary instability prompts investors to focus more on short-term investments (speculations) and on safeguarding against inflation rather than long-term investment projects in real economy. Unpredictably high inflation sparks off numerous other disturbances which dampen potential economic growth. Revenues are then reallocated from creditors to debtors, tax system suffers disturbances, insidious tax is imposed on savings depositors who are unable to protect the purchasing power of their income and savings. Another downside to high inflation is embodied in high interest rates. This acts to stimulate the inflow of short-term risky capital leading to an array of negative direct and indirect effects.
Monetary Policy Objectives for 2005
Reduction of the inflation rate is the principal monetary policy objective for 2005. Additional monetary policy objective is the preservation of the financial system stability¹.
Every year the NBS draws up a monetary policy programme in which it assesses money and lending growth dynamics necessary for achieving the inflation rate projected for that year. In the course of the year, the NBS monitors actual developments, compares them with the projected ones, and revises its forecasts in contingency situations.
Projections of monetary aggregates are based on economic policy objectives and relevant assumptions on macroeconomic environment contained in the existing economic policy documents². It has accordingly been assumed that real GDP growth in 2005 will amount to 4.5% and that foreign trade deficit will be narrowed. In accordance with the country’s balance of payments position sustainable over the medium term, it has been estimated that net foreign exchange reserves of the banking system will increase by USD 395 million.
Monetary aggregates and current account, growth rates in %,
|NBS net foreign assets (in USD million) ¹||427.0||171.0||395.0|
|Money supply M1||13.1||8.0||11.0|
|Money supply M2||11.4||13.1||12.0|
|Money supply M3 ²||23.6||12.1||15.0|
|Current account (in USD million)||-1928.0||-2922.0||-2277.0|
|(in % GDP)||10.0||13.2||9.5|
¹ Calculated at the exchange rate as of the end of the previous year.
² Constant exchange rate as of the end of the previous year was applied to foreign exchange deposits.
Under the above economic policy assumptions, the NBS estimates that reserve money growth in 2005 will equal 6.5%. The process of mild remonetization coupled with a moderate deceleration of velocity of money circulation will continue, leading to an increase in money supply M2 by around 12%, whereas the broadly defined money supply M3, with foreign exchange components calculated applying the constant exchange rate, is expected to increase by around 15%. This projection is based on the assumption of faster growth of savings deposits relative to transaction deposits.
With a view to curbing inflation and strengthening public confidence in the dinar, the National Bank of Serbia will continue to implement the monetary policy of linking the growth of reserve money and money supply to NFA movements³ and the policy of managed floating exchange rate of the dinar over the medium term. Based on such assumptions, average annual growth of retail prices has been projected at 7% for the period 2006 - 2008.
¹ Monetary Policy Programme of the National Bank of Serbia for the Year 2005.
² Memorandum of Budget, Economic and Fiscal Policy for 2005, with projections for 2006 and 2007.
³ This criteria specification is based on the conceptual framework of the financial programme, the theoretical concept known as the monetary approach to balance of payments developed by the International Monetary Fund.
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