Over the last two years or so, inflation has reappeared in Romania. At first, it seemed that the rise in prices was temporary and caused exclusively by external reasons: tensions on the international market of raw materials and difficulties with supply in the conditions of active recovery of the world economy after the lifting of restrictions imposed by the pandemic. .[1] It was later discovered that inflation is persistent and is fueled, among other things, by internal factors acting on both the supply and demand sides.[2] In the short term, the last and perhaps the most important cause of inflation is the rise in energy prices, exacerbated by the war in Ukraine. In the medium and long term, inflationary pressures are likely to increase due to structural factors such as imbalances in the Romanian economy, stagnant investments, demographic decline, transition to green energy (more expensive), etc. The mode of action and combination of these factors is specific to the Romanian economy , and, as a result, a monetary policy adapted to local realities is needed. Monetary policy decisions made by the Fed, the ECB and other central banks in the region that are not part of the eurozone will also be particularly important. These external decisions are important from the point of view of the evolution of the interest rate differential and the orientation of international capital flows, in which the Romanian economy is included.

The main challenges that the National Bank of Romania (BNR) is currently facing are: to prevent too much deviation of the inflation rate from the target (2.5% ± 1 point); not be subject to requirements to lower interest rates to stimulate short-term economic growth; resist the pressure to indirectly finance the budget deficit.

Currently, the NDB is relatively well positioned to face all of these challenges, especially the economic and political pressures that typically arise as a result of monetary policy tightening. Its strength is the provisions of the law on organization and activity, which prohibit it from granting loans to the state (Articles 6.1 and 7.1 of law no. 312/2004), the external support it enjoys as a member of the “European system”. central banks” (SEBC) and institutional experience accumulated in the post-communist period.[3] This experience covers three important areas: managing supply-side shocks; budgetary capacity; a balance between established practice and new ideas and information.

Management of supply shocks

Supply-side shocks are usually caused not by monetary policy, but by causes in the real economy. This type of upheaval was strongly manifested in the first two decades after the fall of communism due to the disorganization of the production apparatus of the planned economy and the indecision of the authorities, which “descended” from the revolution, to carry out the reforms necessary to establish a market economy.[4] In the period 1992-2009, the author was a member of the Board of Directors of the NBR (CA) and tried, in accordance with his mandate, to contribute to the assessment of the impact of supply-side shocks on the understanding of the mechanisms by which their temporary and long-term effects are transmitted in economics and development of demand management methods. Many colleagues from the leadership of the BNR and its staff did the same.[5]

Part of the problem is that under conditions of high inflation, economic agents learn to index their prices and wages.

During the communist period, inflation was hidden because prices were set by the government regardless of supply and demand and remained unchanged for long periods of time. The imbalance between (higher) demand and (lower) supply manifested itself in the disappearance of goods from stores, queues, cards, etc., and not in the growth of prices. After the fall of communism, the imbalance between supply and demand increased, but prices were liberalized and, as a result, rose very quickly. As a result, a lot of talk and writing about inflation began, often ignoring it and with clear accents left over from communist propaganda.

Despite this, public awareness of the phenomenon of inflation means that if the central bank does not take timely action, pressures on prices and wages increase, inflationary expectations are quickly extinguished by monetary policy, and temporary situations end with long-lasting effects.

According to the textbooks, the optimal response to supply shocks is no response at all, since in a market economy the shock will dissipate by itself. However, Romanian society, traumatized by deficits of all kinds from the communist period and the upheavals of social positions caused by the transition period, has little tolerance for a decline in purchasing power and demands a strict indexation of wages and other nominal incomes. The consequence of this is that once it occurs, inflation perpetuates itself, becoming so-called “inertia inflation.” Therefore, monetary policy measures are often needed to deal with supply-side shocks, even if the amount of goods and services available for consumption in the long run depends on the real factors of production (capital, labor, technical knowledge and organizational, etc.). .), not an offer of money.

The NDB’s solution to lower inflation expectations was to adopt a monetary policy strategy called “direct inflation targeting.” The need for such an approach was determined by the high level of inflation in the previous period, which prompted economic actors to predict that prices would rise rather than remain stable. Thus, the level of inflation has become an important factor in decisions made by both the population and business, and this fact must be taken into account in the development and application of monetary policy. As in other emerging market economies, this strategy has worked relatively well and provided flexibility to monetary policy.

Budget viability

The second direction concerns the NBR’s mission, which is to ensure and maintain price stability. It found that the Romanian authorities’ monetary and fiscal policies often diverge, demonstrating what is called “fiscal dominance.” This phenomenon is illustrated by the purchase of government securities on the secondary market by the central bank, which, although it is an established instrument of monetary policy (operations open market), from an economic point of view, is equivalent to indirect monetary financing of the state. In fact, even when government securities are not purchased by the central bank in the secondary market, loans made by commercial banks to the government feed the process of credit and money supply expansion carried out within the commercial banking sector without central bank involvement. This process of multiplication causes the money supply to grow faster than the amount of goods and services available for exchange, thus driving up prices. That is why it is important that the mission of the NBR is not burdened by budgetary dominance either directly or indirectly.

In order to operate economically, a country needs an overall strategy that has several categories of positive effects, including budget viability. Without such a more comprehensive strategy, the central bank alone cannot ensure price stability.

A good example in this matter is Romania. In 2014-2016, the NBR was able to reduce inflation without harming economic growth and without causing the economy to fall into deflation, given the small budget deficit and public debt. Key elements of this outstanding performance were: a managed floating exchange rate (managed floating exchange rate), which freed the country from expensive and probably ineffective central bank interventions in the foreign exchange market; inflation targeting, which has led to low interest rates and stable prices; finally, especially, budgetary savings.

These factors helped Romania overcome the difficulties of the transition, but imposed fiscal discipline and prudence on it. As a result, the monetary policy did not receive a high rating, but caused numerous criticisms of the NBR.[6] Such an atmosphere undoubtedly contributed to the populist orientation of budget policy in subsequent periods, when the volume of public expenditures increased and their quality was almost completely neglected. The NBR maintained the anti-inflationary focus of monetary policy, but this factor proved to be insufficient due to the strengthening of macroeconomic imbalances and the slowdown of economic growth.

The path of balance

The third direction of NBR experience is the development and application of monetary policy in such a way as to ensure a balance between, on the one hand, standard instruments (operations on the money market; permanent credit institutions, minimum reserve requirements). ) and, on the other hand, openness to new ideas, information and practices.

In developed countries, especially in recent years, unity of authority has undoubtedly been a major problem of monetary policy. This is especially true for quantitative easing (Quantitative Easing), which was adopted by major central banks to stimulate economic recovery and which is now considered to be an important cause of inflation in these countries. The BNR does not publish the results of voting in the CA, but it can be assumed that in a situation where the issue of strengthening monetary policy is on the agenda, cases of unanimity are rare, especially regarding interest rate increases. accepted as such. After all, CA members are appointed by parliamentary parties and it is normal that, in addition to professional knowledge, they are inspired by different ideologies. In any case, the experience of the undersigned shows that the collegial governing body of the NBR does not lack diversity of opinion.

In our opinion, what Romania’s economic policymakers need now is a consensus on a general strategy and a plurality of opinions on tactical issues.

The mission of the BNR is to protect the value of the currency for the purpose of balanced and sustainable economic growth. While open discussions on various aspects of the central bank’s activities are welcome, this fundamental role of the NDB should not be constantly questioned and criticized. Diversity of opinion is normal, but it is not necessary to question everything. Read the whole article and comment on Contributors.ro