The Main Objective of Monetary Policy is Price Stability

In accordance with the Statute of the National Bank, approved by Edict of the President of the Republic of Belarus No. 231 dated June 29, 2017 (National Legal Internet Portal of the Republic of Belarus, July 1, 2017, 1/17138), the main objective of monetary policy is price stability.

In this case, the price stability (stability of the purchasing power of the national currency) means a moderate increase in consumer prices, and not the rigidity thereof.

Inflation decreases the purchasing power of money, reducing the real value of monetary incomes and savings of the households and organizations, because over time for the same amount of money you can buy less goods and services than before.

Under the conditions of unstable and high inflation, households tend to materialize their depreciating monetary resources in goods and services as soon as possible or to transfer them in assets, primarily in foreign currency, which serve as a “shelter” from inflation. As a result, the pressure on the exchange rate increases and inflation further intensifies.

Inflation suppresses incentives for investment, reduces the ability of the economy to implement its production potential. High inflation impedes the implementation of long-term investment projects, thereby increasing the decline in business activity, as well as the reduction in production and volume of employment.

As a result, high and unstable inflation negatively affects the long-term growth of the economy and the well-being of citizens.

The absence of inflation and deflation (price reduction) are also dangerous for the economy. When commodity prices are steadily declining, consumers begin to postpone purchases hoping for further price reductions. As a result, producers stop developing, hiring personnel and maintaining the same level of salaries. Therefore, consumers spend even less, further worsening the opportunities for producers. Strengthening each other, these effects have a negative impact on the long-term growth rates of the economy.

Medium-term objective

In line with the Program of Social and Economic Development of the Republic of Belarus for 2016-2020, approved by Edict of the President of the Republic of Belarus No. 406 of December 15, 2016, the main goal of monetary policy is to reduce inflation up to 5% by the end of 2020.

The optimal value of inflation reflects those price conditions that do not violate the positive dynamics of economic growth and do not create macroeconomic and financial imbalances.

Research results show that, depending on the country, the average annual inflation parameters in the range of 1–5% ensure better conditions for economic growth. Lower inflation will restrain structural changes in the economy and reduce the flexibility of wages, while a higher inflation will increase the costs of ensuring the well-being of citizens.

The majority of modern scientists and practitioners agree that such inflation rates correspond to price stability. The target level must be above zero. A positive target reduces the likelihood of reaching the lower zero level by nominal interest rates and makes it possible to avoid the risk of deflation, which incurs greater costs than inflation.

In developed countries with a fairly long period of price stability, high confidence in monetary authorities and low inflation expectations, the medium-term objective is set at 1-3%.

The level of inflation in developing countries and emerging markets is usually higher than in developed countries. This is due to a number of factors: the Balassa-Samuelson effect, unfinished transformation of prices in these countries, optimization of the mechanism for allocating resources, high inflationary expectations. Based on these effects, inflation targets in emerging markets may differ by 1-2 percentage points.

The inflation target is established annually in Monetary Policy Guidelines, approved by President of the Republic of Belarus.

Central banks are responsible for price stability, since inflation has a monetary nature, and in the long run, the growth of the money supply is to the full extent transformed into the price growth.

Source: King, M. No money, no inflation – the role of money in the economy / M.King // Bank of England Quarterly Bulletin. – 2002.

In the long run the inflation rates are determined by the growth rate of money supply. The interrelation of money and inflation over a long-term period is close to 1.

It is the central banks that have a monopoly on the issue of money in the economy and the ability to control the money supply.

Despite the fact that certain outbursts of price growth may be caused by external shocks or administrative influence, the overall control over the money supply in the long term allows controlling inflation, which is the reason for the worldwide trend of transferring the function of ensuring price stability to the area of responsibility of central banks. Ensuring price stability is the goal of monetary policy in many countries of the world (European Central Bank, Central Bank of the Russian Federation, National Bank of Kazakhstan, etc.).

The inflation target is established annually in Monetary Policy Guidelines, approved by President of the Republic of Belarus.