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GOALS AND REGIMES OF THE MONETARY POLICY

29.09.2022 21:01

[1. Економічні науки]

Автор: Nikishyna Mariia, State University of Trade and Economics; Savchuk Yelyzaveta, State University of Trade and Economics


Liberalization of capital accounts raises many controversial issues in the field of macroeconomic management, particularly in monetary policy. According to generally accepted economic theory, it is impossible to simultaneously conduct an independent monetary policy, control the exchange rate, and keep the capital account open. Each of these three options alone is potentially possible, but only two of them can be chosen as actual policy.

Monetary policy is one of the tools for ensuring economic growth, in particular through the regulation of inflation and the establishment of the key interest rate of the central bank.

Monetary goals ensure monetary stability of the country.

There are 3 types of monetary goals:

1. strategic - long run goals and also is the economic policy of the state. It includes: production growth, employment growth, balance of payments normalization, price stability. These goals can`t be achieved at the same time because of the limited monetary resources and also these goals are interchangeable - the growth of one can cause the decline of another one.

2. intermediate goals - changes in economic processes that will contribute to the achievements of strategic goals. It includes: restraint of the situation on commodity and money markets (changings of the level of interest rate and the mass of money).

3. tactical (current) goals - short term goals that will contribute to the achievements of intermediate goals. It includes: change in discount rate, interest on refinancing loans, interest of interbank loans, volumes of refinancing loans, volumes of mandatory reserves and exchange rates.

Most central banks conduct monetary policy within some sort of monetary policy regime. Such a regime provides a structure for monetary policy decision-making. In addition to facilitating the decision-making itself, this structure enables the decisions to be communicated more easily to the public.

The basic monetary regimes are:

1. exchange rate targeting;

2. monetary targeting;

3. inflation targeting.

Under the exchange rate targeting regime, the central bank tries to ensure nominal exchange rate stability vis-à-vis the currency of a so-called anchor country via interest rate changes and direct foreign exchange interventions, thereby "importing" price stability from the country.

The benefits of exchange rate targeting regime are:

1. the exchange rate is the most obvious and easily monitored by the public on the commitment of the monetary authorities;

2. ensuring the stability of prices and the exchange rate of national currency;

3. if the rate is tied to the currency of a country with low and stable inflation, then such a monetary regime will reduce inflationary expectations for inflation in the country of anchor currency;

4. reducing transaction costs and uncertainty in international trade, stimulating the latter;

5. in the short term, the central bank can easily control the exchange rate through direct foreign exchange interventions;

6. a nominal anchor is established that binds the domestic inflation rate to the rate of price growth and thus holds back inflation.

The monetary targeting regime focuses on the growth rate of a chosen monetary aggregate. It is based on the finding that in the long term, price growth is affected by money supply growth. A problem, however, lies in the choice of an appropriate monetary aggregate to target.

The main benefits of monetary targeting regime are:

1. supreme power of the central bank that gives the high level of control;

2. quick measurement of monetary aggregates;

3. close connection to monetary policy instruments.

Under inflation targeting, the central bank publicly pre-announces an inflation target (or a succession of targets) that it is determined to achieve. This involves active and direct shaping of inflation expectations. This regime's decision-making scheme involves the use of much more information than merely the exchange rate or monetary aggregates, covering the labour market, import prices, producer prices, the output gap, nominal and real interest rates, the nominal and real exchange rate, public budgets, etc. 

The benefits of inflation targeting regime:

1. the central bank has the flexibility to select and apply monetary policy instruments;

2. concentration of monetary policy on the domestic situation and respond to internal shocks;

3. setting a clear inflation target increases the responsibility of the central bank and avoids fiscal domination;

4. creation of foreseeable conditions for balanced development of all sectors and branches of economy;

5. when determining the nominal anchor, the consequences of its achievement will be clear to the public;

6. a sufficiently high level of public confidence in the central bank policy is ensured, resulting in lowering inflation expectations;

7. in the event of a failure of monetary policy, economic costs for the inflation targeting regime are lower than for other regimes.

Let's consider the impact of monetary policy directly on economic growth in Ukraine.

The study is based on the neo-Keynesian theory of economic growth and the IS-LM model. According to this theory, we assume that GDP is a function of monetary factors: the amount of money, the exchange rate, the interest rate, and inflation (Equation 1).




Equation 1 can be explicitly represented in the form of equation 2:





GDP – real GDP.

МЗ – money supply (monetary aggregate M3);

EXR – exchange rate;

IR – NBU discount rate;

INF – inflation rate;

β0,β1…- parameter coefficients;

εi – is the standard error of the model.

Quarterly data for the period 1996–2021 obtained from the official website of the NBU and the UNCTAD database were used for the model. The obtained results are shown in the table. 1.

Table 1

Indicators of the model of the influence of monetary factors on GDP






Table data 1 show that the money supply (M3) has a positive and statistically significant effect on economic growth. The exchange rate (EXR) also has a significant effect on GDP growth in Ukraine. This means that an increase in the money supply by 1% leads to an increase in GDP by 0.37%. Accordingly, a one percent increase in the exchange rate leads to an increase in GDP by 0.38%. In contrast, inflation (INF) and interest rate (IR) have a negative impact on GDP. A one-percent increase in inflation and the NBU interest rate leads to a decrease in GDP by 0.24% and 0.07%, respectively. 

The data also suggest that inflation and the interest ratenegatively affect economic growth, and the effect of the NBU interest rate is statistically insignificant.

According to the obtained results, we can state that monetary policy in Ukraine does not contribute to economic growth and is not an effective tool for stimulating economic activity in the period 1996–2021. It is the interest rate, not the money supply, that should ensure economic growth. The experience of Ukraine shows that the NBU did not use the discount rate for its main purpose. At the same time, in the current period of monetary policy, the NBU uses the discount rate to achieve the goals of inflation targeting, which gives hope for the stabilization of the macroeconomic situation and improvement of macroeconomic stability trends.

References:

1. National Bank of Ukraine [Electronic resource] - Resource access mode: https://bank.gov.ua/.

2. Aram Eisenschitz & Jamie Gough (1996) The contradictions of neo‐Keynesian local economic strategy, Review of International Political Economy. [Electronic resource] - Resource access mode: https://www.tandfonline.com/doi/abs/10.1080/09692299608434364 .

3. Carl E. Walsh. Monetary Theory and Policy / Carl E. Walsh. – Cambridge: Massachusetts Institute of Technology, 2010. – (3rd ed.).







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