SERBIA Monetary Policy Harald Hirschhofer IMF Resident Representative

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SERBIAMonetary Policy Harald Hirschhofer IMF
Resident Representative

• Economic Faculty
• Belgrade, May 23, 2007

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Serbia has a long history of high inflation
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Why is inflation bad?

• High inflation (gt8pct) has a powerful negative
  effect on growth. (Non Linear Effects of
  Inflation on Economic Growth by Michael Sarel)
• Transition economies that achieved low inflation
  had the fastest turn around in output growth.
• Inflation hurts the poor.

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NBS introduced new monetary policy framework in
September 2006

• Nominal anchor - core inflation (defined as a
  range)
• Main policy instrument 2w repo operations
• Decision making process based on macroeconomic
  analysis and mid-term forecasts
• Flexible foreign exchange rate indicator of
  monetary policy transmission
• Transparent communication of the central bank
  with the general public

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Inflation objective Focus on Core Inflation

• Accountability of NBS is key!
• But politically set prices (fuel, electricity,
  etc.) and agricultural goods cannot be influenced
  by NBS. Thus they are not in core concept.

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Inflation objective Focus on 12 months rates

• Eliminate seasonality
• Focus on longer-term performance
• But dont forget momentum measures in annualized
  AND seasonally adjusted monthly rates!

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Predictability, Accountability, and Learning to
Influence Expectations and Trust

• Inflation Report, published quarterly, explains
• How objectives are met
• Inflationary risks
• Future policy actions
• Press conference, held after each MPC decision
  meeting, to explain policy actions
• Predictable schedule of PC meetings.

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Inflation reports are available from the NBS web
page
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Contents of Inflation Report
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How are Policy Actions Prepared?

• Analysis first! Before each MPC meeting, the NBS
  staff analyses economic and inflation
  developments and trends.
• The role of models reduce complexity and add
  analytical discipline. Ex-post evaluation of
  decisions made easier.
• MPC carefully reviews staff analysis. If it
  concludes that significant risks of reaching the
  objectives exist under the current policy stance,
  it will adjust the rate upwards and vice versa.

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The 2w-REPO Influences the Economy

• The financial markets, banks, and other economic
  agents use it as benchmark.
• It affects allocation of resources between dinars
  and FX
• Raising key policy rates will temporarily push
  for fx rate appreciation, putting a further
  downward pressure on inflation
• This channel of monetary policy transmission is
  currently dominant

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NBS successfully managed to bring down inflation
during 2006
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Dinar appreciated, central banks interventions
on foreign exchange market are less frequent
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Market interest rates are less volatile, and
signaling function of the key policy rate is
improved
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Monetary policy still faces serious challenges

• Loose budget and structural and wage policies
  create inflationary and current account
  pressures.
• The central bank lacks independence

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If budget, wage and structural policies were not
corrected

• The reserve requirement and macro-prudential
  regulations will have to remain restrictive.
• Monetary policy can not achieve both inflation
  and current account targets.
• Efforts to contain inflation via the repo rate
  and hence a strong dinar- will deteriorate
  external deficits further.

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IMF recommendations

• Entrench low inflation Strengthen NBS
  independence, continue efforts to move towards
  inflation targeting.
• Back monetary policy with tight fiscal policy,
  adequate wage policy, and a strong commitment to
  structural reform.

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Additional Reading

• Threshold Effects in the Relationship Between
  Inflation and Growth by Khan, Mohsin S. and
  Senhadji Semlali, http//www.imf.org/external/pubs
  /ft/wp/2000/wp00110.pdf
• Nonlinear Effects of inflation on Economic Growth
  by Michael Saral http//www.imf.org/external/pubs/
  cat/longres.cfm?sk1873.0
• Macroeconomic Policy and Poverty Reductionby
  Brian Ames, Ward Brown, Shanta Devarajan and
  Alejandro Izquierdo http//www.imf.org/external/p
  ubs/ft/exrp/macropol/eng/index.htm2

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Office of the Resident Representative in Serbia

• Kralja Petra 12
• Belgrade
• www.imf.org
• hhirschhofer_at_imf.org