Monetary policy. General information

The main objective of monetary policy in 2018 is curbing of inflation at the level of no more than 6% (December 2018 to December 2017). The medium-term goal - a gradual decline in the inflation to 5% in 2020.

Inflation is a general increase in consumer prices over a certain period of time. Inflation is measured using the consumer price index (CPI).

Figure 1. Increase in consumer prices
(month to the correspondent month of the previous year)

An important indicator of inflation is the core consumer price index (core inflation). Core inflation reflects the dynamics of change in prices, which are not influenced by factors of administrative and seasonal character.

Intermediate target of monetary policy is the increase in the average monthly broad money supply by 9-12% (December 2018 to December 2017)

Figure 2. Increase in the average monthly broad money supply
(month to the correspondent month of the previous year)

  • What is the macroeconomic stability, and why is it important?

    Macroeconomic stability - a situation where the national economy witnesses a sustainable long-term economic growth, inflation (price increase) is low and under control, and the economy itself has a high internal resistance to shocks (financial stability).

    The importance of macroeconomic stability can be explained using the example of its absence, when prices are not stable or the economy consumes more than it can afford. In this case, enterprises and people find it difficult to plan their future actions: to invest or save, to make purchases or not, to take or not to take a loan/credit.

    One of the most important components of the government's economic policy aimed at achieving macroeconomic stability is monetary policy.

  • What is monetary policy?

    Monetary policy is a set of activities that the central bank undertakes for the purpose of maintaining price stability in order to promote sustainable and balanced development of the economy.

    In this case, the price stability (stability of the national currency’s purchasing power) refers to a moderate increase in consumer prices, and not their rigidity.

  • Why price stability is necessary?

    Inflation reduces the purchasing power of money by decreasing the real value of monetary incomes and savings of the population and organizations, as in the course of time for the same amount of money one will be able to buy less goods and services than before.

    Under the conditions of an unstable and high inflation, the population tends to materialize as soon as possible its depreciating monetary funds into goods and services or transfer in the assets that serve as a haven against the inflation, especially in foreign currency. As a result, inflation is further strengthened, and the pressure on the exchange rate increases.

    Inflation stifle incentives to invest, reduces the ability of the economy to implement its production potential. High inflation hinders the realization of long-term investment projects, thereby enhancing the reduction in business activity, a decrease in output and volume of employment.

    As a result, a high and unstable inflation adversely affects the long-term economic growth and citizens' well-being.

    The absence of inflation and deflation (price cut) are also dangerous for the economy. When commodity prices are not rising or falling, consumers commence delaying purchases, hoping for further price reductions. In the end, manufacturers cease to grow, hire staff and maintain the previous level of wages. In view of this, consumers spend even less subsequently degrading opportunities for manufacturers. Reinforcing each other, these effects have a negative impact on long-term economic growth rates.

  • How does the central bank ensure price stability?

    For historical reasons, the central bank has been responsible for price stability. This is due to the emergence of the central banks’ right to issue money in the form of paper money. The central bank, as the issuer of money, is obliged to ensure the sustainability of their purchasing power or, in other words, low inflation.

    Thus, the growth in supply of the national currency issued by the central bank always stands for inflation as a phenomenon.

    With a view of achieving the goals on inflation the central bank uses one of the possible strategies (regimes) of monetary policy - a set of rules and procedures for conducting monetary policy by the central bank. A key feature of the monetary policy regime, taking into account the impossibility of direct influence of the central bank on the change in prices, is the choice of the intermediate target. General quality of the intermediate target in any monetary policy regime chosen by the central bank is the ability of the central bank to influence the regime using the bank’s instruments, its transparency and clarity.

    This is necessary since the relationship between the instruments of monetary regulation and the ultimate goal of monetary policy is complicated. The signals sent to the economy through operations and instruments of the central bank are shown in the dynamics of general price level with a lag (delay).

    The most popular monetary policy regimes in the world practice are the following:

    • regime of exchange rate targeting;
    • regime of monetary targeting;
    • regime of inflation targeting.
  • Strategy (regimes) of monetary policy

    Regime of exchange rate targeting means that the central bank pegs the value of the national currency to the rate of exchange (currency basket) of the country (countries) with low levels of inflation, ie. an intermediate guide of monetary policy is a certain level of or a change in the exchange rate. Based on the theory of relative purchasing power parity, this regime assumes that when fixing the exchange rate, inflation in the country should be close to the inflation in the country of the currency peg.

    Implementation of the national currency issue (withdrawal) is carried out in the exchange for foreign currency.

    With a view to efficient use of this regime, a country should own significant foreign exchange reserves to counter shocks in the foreign exchange market.

    Regime of monetary targeting uses one of the indicators of money supply as an intermediate target. Theoretically, based on the equation of exchange of I.Fisher, this regime assumes the availability in the country of close direct relationship between selected intermediate target and the consumer price index.

    Equation of Fisher (equation of exchange) is the equation that describes the ratio of money supply, velocity of money, price level, and the volume of output.


        M — money supply;
        V — velocity of money;
        P — price level;
        Q — volume of output.

    The American economist Irving Fisher justified the formula in his work "The Purchasing Power of Money" in 1911. It is clear from the equation of exchange, that the product of the amount of money and its velocity per year should be equal to the nominal income (ie. the nominal value of the purchased goods and services).

    The issue (withdrawal) of the national currency, as a rule, is carried out by means of banks’ refinancing instruments (liquidity withdrawal). The volume of issue (withdrawal) is determined based on the need to achieve the intermediate target.

    An important condition for the effective implementation of monetary targeting regime is the availability of a flexible exchange rate of the national currency against foreign currencies. This allows the central bank focusing on solving the problem of managing the money supply through refinancing instruments (withdrawal) and minimizing the impact of foreign exchange channel on the intermediate target.

    Regime of inflation targeting assumes that the central bank achieves its ultimate target by means of managing inflation expectations. The inflation forecast serves as an intermediate target. When the risk of inflation deviation from the announced target appears, the central bank uses the monetary policy instruments to bring it in line with the target value.

    The main impact of monetary policy is usually carried out through the interest rate channel. Accordingly, the volumes of issue (withdrawal) are determined by the market based on the money price set by the central bank.

    The use of this regime requires the availability of basic set of organizational and legal and macroeconomic conditions in the country:

    • availability of consensus in the society on the fact that the maintenance of price stability should be the main objective of monetary policy of the central bank;
    • availability of sufficiently well-functioning financial institutions and markets;
    • reaching an agreement with the Government on the quantitative parameter of the inflation target or independent determination of the target by the central bank;
    • absence of fiscal dominance over the monetary policy;
    • central bank’s independence in the choice of monetary policy instruments;
    • transparent pricing system;
    • availability of a close relationship between the level of short-term interest rate in the money market and inflation.