How much have we as a country learned from past mistakes? To what extent were the governor’s repeated recommendations heeded by the leaders to whom they were addressed? Central banks are currently facing a perhaps unprecedented challenge to preserve their most important asset: TRUST.

Confidence shaken by unhealthy close ties between political central banks and financial markets

Trust is shaken:

• A. the unhealthy close ties established between central banks, politics, and financial markets. A situation that, in my opinion, surpasses the paradigm proposed by the governor at one point in time, under which politics is discussed throughout history. Muge Iserescu said: “Neither subordination to BC was complete, nor complete independence”

• B. Failure of the Central Bank to correctly predict the long-term impact of quantitative easing, and I mean primarily inflation

The prevailing philosophy that led to this is captured very well in the collection with a reference to Jeremy Powell’s Jackson Hole 2019 speech: “The problem is low inflation. In the event of an increase in BC, they have the necessary tools.”

But here, everything is not as simple as it seemed at the time, and the Governor’s remark is extremely relevant: “The independence-trust ratio is important in order to bring inflation under control.”

The return of independence and trust to the fore was reflected in the remarkably strong messages sent today by major central banks, after an initial period of vacillation, on getting inflation under control. At any cost. There is no more room for multiple goals and compromises.

The risk of an inflationary spiral caused by a lack of confidence in central banks is too great

The sometimes unexpected reaction of the US stock market, unconvinced by the firmness of the Fed’s approach, is a mirror of the challenges facing BC. Likewise, changes in consumer and business behavior that are undermining inflationary expectations are also a source of concern for BC, suggesting the need for consistent messaging and approaches.

Mugur Isarescu’s crucial question: “If confidence in central banks has been damaged by successive attacks on it, can confidence in central banks re-establish inflation expectations?”

In the case of a country like Romania, the challenges are even greater under a discrepancies between monetary and economic policy which over time led to the repeated failure of the inflation target.

For almost all of this time, we could state the absence of “the necessary division of labor in order not to burden monetary policy with goals that in the short term contradict price stability.”

In addition to this fundamental problem, there is an original problem: Lack of firm political commitment to an inflation targeting regime. In the textbook No. 10/2002, it is stated: “As long as monetary policy operates in an environment where the first-mover advantage belongs to fiscal policy, the field of action of the central bank is significantly narrowed (Niepelt, 2001). Its independence is complete only under the conditions under which the operating structure ensures the preference of the inflation target over the fiscal target. In such a context, fiscal policy must adjust its behavior in such a way as not to jeopardize the inflation target, which is equivalent to the absence of any symptoms of fiscal dominance.

Unfortunately, this was not the case in Romania, where pro-cyclical fiscal policy was a constant.

The big mistake of economic policy was the inversion of priorities: prioritizing the restoration of the gap in living standards, ignoring the fact that this can only be a CONSEQUENCE of the restoration of the development gap.

In Romania, for decades it was believed that fiscal policy stimulates aggregate demand, not potential GDP.

The development of Romania was purely opportunistic and, to a very small extent, planned.

Hence the permanence of the shortage of twins.

Practically, the business environment could not adapt to the coordinates of the growing demand without supporting strategies for the development of infrastructure, education, labor force mobilization, stimulation of innovation, capitalization of natural resources, etc.). That is, everything that could increase the potential GDP of Romania.

Fiscal policies that cause deficits and debt to build up, with no commitment to reduce them in the future, are likely to lead to inflation and further burden monetary policy.

Time and again, those who have been called upon to think about economic policies that would reduce the burden on monetary policy have been more concerned with suggestions about what the BNR should do (lower the interest rate, protect the exchange rate) than what the institutions should do , which they coordinate.

The truth the Governor reminds us is that there is no alternative to a balanced and coherent mix of macroeconomic policies.

Romania’s problem is that all fiscal consolidations were carried out under pressure from the IMF and/or the EU in a pro-cyclical approach due to their delay.

The incoherence of domestic policies has created the need for “trust imports” (IM) by the EU and the IMF, as was the case during the 2008 crisis.

In practice, the inability of local institutions to carry out a controlled adjustment of internal imbalances leads to their discredit before external financiers (important for financing the deficit), which requires the intervention of external institutions with a solid capital of trust.

An extremely important question being asked today: Will Romania, FOR THE FIRST TIME, be able to carry out fiscal consolidation without being under the constraints of an agreement concluded with multilateral institutions?

The repeated failure to meet the inflation targets, even if this can be justified, among other things, by the lack of support for economic policy, has undermined the confidence capital of the BNR in the ability to target inflation.

It is no coincidence that in the collective consciousness, the main merit of the NBR is connected primarily with the stability of the exchange rate, and not with the stability of prices.

I think it’s time for BNR to take credit for price stability. ONLY the merit of price stability.

In fact, the governor himself, in a list of theoretically possible economic events and reactions that the Central Bank would like to have, mentions that in a potential scenario of recession and inflation (supply-driven), faced with inflationary expectations, the Central Bank Banks are obliged to intervene to limit the consequences of the second round.

In conclusion, I would like to open a topic for reflection:

Hasn’t the decision-making by central banks not only regarding monetary policy, but also the excess of some elements of economic policy created a moral hazard that prompts the political world to take a rather contemplative attitude?

N. Red: Radu Krachun is the president of BCR Pensii. The above text was delivered on Wednesday, at the presentation of the volume “Central Banks and Calibration of Monetary Policy” by the Governor of the BNR