POLAND S EXPERIENCE WITH INFLATION TARGETING

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1 POLAND S EXPERIENCE WITH INFLATION TARGETING Abstract Prof. Zbigniew Polanski After several years of gradual disinflation, the National Bank of Poland (NBP) officially adopted an inflation targeting strategy since the beginning of This was preceded by the introduction of new central bank legislation (effective since 1998) which gave considerable independence to NBP. The two years ( ) of explicit inflation targeting show, however, that proper central bank institutional framework is not enough to conduct a successful anti-inflationary strategy. While there is no doubt that it is a good thing to have a public institution entirely committed to inflation control (in particular in a country with a history of high inflation rates), Polish experience suggests that inflation control cannot be achieved only by central bank means. 85

2 I. INTRODUCTION since the beginning of 1999 National Bank of Poland (NBP) officially conducts an inflation targeting strategy in Poland inflation was targeted by the central bank prior to 1999 ( eclectic strategy) in the presentation I concentrate on the experience, but I will return to some aspects of the earlier experience (for more see the paper on Polish monetary policy during ) structure of presentation: (i) defining inflation targeting (ii) central bank legislation issues and NBP Medium-term Strategy of Monetary Policy ( ) (iii) monetary policy targets in the 1990s (iv) factors affecting the efficiency of inflation targeting in Poland (v) final remarks (vi) II. WHAT IS INFLATION TARGETING? Mishkin (1999, 2000): Inflation targeting encompasses: (i) public announcement of medium-term numerical targets for inflation (ii) institutional commitment to price stability as the primary goal of monetary policy, to which other goals are subordinated (iii) an information inclusive strategy in which many variables, and not just monetary aggregates or the exchange rate, are used for deciding the setting of policy instruments (...inflation targeting necessarily requires nominal exchange rate flexibility... (Mishkin 2000: 6)) (iv) increased transparency of the monetary policy strategy through communication with the public and the markets about the plans, objectives, and decisions of the monetary authorities (v) increased accountability of the central bank for attaining its inflation objectives IMF (2000): when discussing practical issues concerning inflation targeting 4 aspects should be taken into account: (i) institutional framework (ii) transition issues (iii) operational issues (iv) organizational implications for central banks 86

3 III. THE ADOPTION OF INFLATION TARGETING IN POLAND 1997: new legal framework for the conduct of monetary policy The Constitution of the Republic of Poland of 2 April 1997 Chapter X. Public Finances: It shall be neither permissible to contract loans nor provide guarantees and financial sureties which would engender a national public debt exceeding three-fifths of the value of the annual gross domestic product. (Article 216, 5) The budget shall not provide for covering a budget deficit by way of contracting credit obligations to the State s central bank. (Article 220, 2) Article 227: 1. (...) The NBP shall be responsible for the value of Polish currency. 2. The organs of the NBP shall be: the President of the NBP, the Monetary Policy Council (MPC) and the Board of NBP. 3. The Sejm, on request of the President of the Republic, shall appoint the President of the NBP for a period of 6 years. (...) 5. The MPC shall be composed of the President of the NBP, who shall preside over it, as well as persons (...) appointed, in equal numbers, by the President of the Republic, the Sejm and the Senate for the period of 6 years. 6. The MPC shall annually formulate the monetary policy guidelines and present them to the Sejm at the same time as the submission of the Council of Ministers draft Budget. Within 5 months following the end of the fiscal year, the MPC shall submit to the Sejm a report on the achievement of the purposes of monetary policy. (...) The Act on The National Bank of Poland of August 29, 1997 The basic objective of NBP activity shall be to maintain price stability, and it shall at the same time act in support of Government economic policies, insofar as this does not constrain pursuit of the basic objective of the NBP. (Article 3, 1) The President of the NBP may be recalled where: 1) he/she has been unable to fulfil his/her duties due to prolonged illness, 2) he/she has been convicted of a criminal offence under a final and 87

4 conclusive court verdict, 3) the Tribunal of State has prohibited him/her from occupying managerial positions or holding posts of particular responsibility in state institutions. (Article 9, 5) Article 13, 5: basically the same recalling conditions concerning remaining MPC members A representative of the Council of Ministers may participate in meetings of the MPC without voting rights; this representative may submit motions for the consideration of the MPC. (Article 15; to be amended soon) Article 16: 1. Meetings of the MPC shall be convened by the Chairperson at least once a month. (...) 3. The MPC shall rule in the form of resolutions adopted by majority vote, in the presence of at least five members, including the Chairperson. In the event of a tied vote, the Chairperson of the MPC shall have a casting vote. 4. The positions taken by MPC members during votes shall be published in Monitor Sądowy i Gospodarczy (the Court and Commercial Gazette - trans.) after a period of six weeks, yet no later than three months from the date the resolution is adopted. Article 24: 1. The NBP shall carry out the foreign exchange policy established by the Council of Ministers in consultation with the MPC. (...) Summing up the 1997 central bank legal framework issues: (i) clearly specified the objective of monetary policy (price stability) (ii) considerably increased the autonomy of the central bank: widened personal independence of the President, gave NBP explicit goal and instrument independence, prohibited central bank financing of government spending (iii) improved accountability and transparency in the decision making process (iv) legal framework proper for the conduct of an inflation target strategy became effective since the beginning of

5 2003) 1998: transition period : (i) February: the MPC is being formed (ii) June: MPC press communiqué: inflation targeting to be NBP s strategy (iii) September: Medium-term Strategy of Monetary Policy ( ) is adopted (iv) September 1998: Medium-Term Strategy of Monetary Policy (1999- Direct inflation targeting (DIT) - the underlying precept of monetary policy for Quantitative goal: to reduce inflation to below 4% by the year NBP will react to any available information on factors which could jeopardize reaching the inflation target set for a given year. Inflation targets will focus on the CPI (...) and not on a core inflation index. The inflationary target for any given year will be defined as a range and...the time span for which targets will be set is to be one year. modification of the NBP public information policy: The main analytical document for the Council will be the Inflation Report. Moving toward the floating exchange rate One of the conditions of Poland s accession to the EMU will be the inclusion of the zloty in the ERM2 system for at least two years. This should be preceded by a period of freely floating exchange rate.(...) The floating exchange rate system will be introduced following a period of the gradual expansion of the band of permitted exchange rate fluctuations and the gradual reduction of the crawling devaluation within the framework of the present exchange rate system....the NBP will maintain the right to intervene in foreign exchange markets when it recognizes a need to do so for monetary policy reasons. 89

6 Summing up The Medium-term Strategy...: (i) two target horizons: short-term (annual target) and strategic/medium-term (2003 target) (ii) headline CPI (December to December) as inflation target (iii) target range (iv) flotation of the exchange rate announced (v) commitment to publish Inflation Reports on a quarterly basis final conclusion: since 1999 NBP conducts basically a full-fledged inflation targeting strategy major exception: quantitative inflation forecasts not published in the course of the year I. ACHIEVING MONETARY POLICY TARGETS IN THE 1990S consistently matching of words and deeds is crucial to central bank s credibility inflation developments Table 1. NBP Inflation a Targets: Years Target Actual Difference (percentage points) b approx. 9.0 c approx a Consumer Price Index, December to December percent change. b Initially set at percent. c NBP forecast. Source: National Bank of Poland and Central Statistical Office. 90

7 CPI gradually picking up since March 1999 July 2000 (YoY): 11.6% August 2000 (YoY): 10.7% September 2000 (YoY): 10.3% inflation targeting strategy did not prevent the rise of inflation despite improving monetary conditions and the tough stance of monetary policy money supply developments Table 2. NBP and the Money Supply: Years Target a (bn PLN) Actual (bn PLN) Difference (%) b a Reference values since b Forecast (September). Source: NBP. Tough stance of monetary policy NBP intervention rate increased: 13% (I-IX 1999) 19% (VIII 2000) 91

8 Graph 1. Average interest rates on one-year business loans and households deposits, Graph 2. Monetary conditions index, real effective exchange rate and real interest rate change,

9 Exchange rate policy: 12 April 2000 Poland moved officially towards a free floating exchange rate regime Graph 3. Zloty Basket Exchange Rate, July 1998: direct interventions stopped June 1999: indirect interventions stopped (transaction fixing procedure abolished) GDP) : large balance of payments current account deficits (7-8% of IMF (2000: 86): Poland s short experience with inflation targeting has been somewhat mixed. V. WHY POLAND S INFLATION TARGETING EXPERIENCE IS PROBLEMATIC? institutional (legal) requirements for inflation targeting are basically fulfilled 93

10 what factors affect the efficiency of inflation targeting in Poland? 3 issues: (i) cognition problem: without an in-depth knowledge of the monetary transmission mechanism it is difficult to conduct a full-fledged inflation targeting (Haldane 1997: 16) statistical data problems distorted signals from monetary policy actions Christoffersen, R.F. Wescott (1998), Polański (1998a, 1998b) questioning the viability of inflation targeting in Poland (ii) timing problem: suitable timing from the point of view of legal framework adoption and lowering inflation ( ) (see Table 1) unsuitable timing as concerns the evolution in the macroeconomic framework: external shocks protective policy with respect to the agricultural sector tensions in the fiscal sector: indirect and excise taxes increases and changes in the size of the fiscal imbalance 4 important public sector reforms started in 1999 Table 3. Fiscal imbalances in Poland, (% of GDP) Item a 1. Total fiscal sector balance State budget balance Note: privatization revenues are excluded. a Ministry of Finance forecast. Source: Ministry of Finance. 94

11 (iii) design problem is CPI a suitable target? A core inflation index? 4 core inflation indices computed at NBP: Graphs 4-7 coordination of monetary policy decisions with other economic policy actions: Polish experience suggests that the central bank cannot be at least in the short and medium run the only responsible for inflation control 95

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13 VI. CONCLUSION proper institutional framework (scope and degree of central bank independence) is not enough to secure a successful inflation targeting strategy for a successful implementation of inflation targeting other important conditions must be fulfilled (especially on the fiscal policy side) it is a good thing to have a public institution entirely committed to inflation control (price stability), i.e. an inflation targeting central bank. Polish case shows, however, that inflation control might not be achieved by such an institution alone, i.e. without support from other governmental institutions. 97

14 VII. REFERENCES The Act on the National Bank of Poland (1997), NBP, Warsaw. Christoffersen, P.F., R.F. Wescott (1998) Is Poland Ready for Inflation Targeting?, IMF Working Paper, Washngton, D.C., October. Constitution of the Republic of Poland (1997), Warsaw. Haldane A. (1997) Some Issues in Inflation Targeting, Bank of England, Working Paper Series No. 74, London, December. IMF (2000): A. Schachter, M.R. Stone. M. Zelmer Practical Issues in the Adoption of Inflation Targeting by Emerging Market Countries, Forthcoming as IMF Occasional Paper. Mishkin, F.S. (1999) International Experiences with Different Monetary Regimes, Journal of Monetary Economics, vol. 43, pp Mishkin, F.S. (2000) Inflation Targeting in Emerging Market Countries, NBER Working Paper 7618, March. NBP (1998) Medium-term Strategy of Monetary Policy ( ), Warsaw, September. Polański, Z. (1998a) Polityka pieniężna w Polsce w drugiej połowie lat 90.: Bieżące problemy i strategiczne wyzwania (Polish monetary policy in the second half of the 1990s: Current problems and strategic considerations), NBP, Materiały i Studia, Warsaw, February. Polański, Z. (1998b) Wiarygodność banku centralnego a cele polityki pieniężnej (Central bank credibility and monetary policy goals), Bank i Kredyt, Warsaw, June, pp