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The Warsaw Voice » Special Sections » November 30, 2010
Monetary Policy: Keeping Inflation in Check
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Monetary Policy: Keeping Inflation in Check
November 30, 2010   
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The main goal of Poland’s monetary policy next year will be keeping inflation at 2.5 percent in the medium term, the Monetary Policy Council has decided. At the same time, monetary policy is to support sustainable economic growth.

In developed economies, monetary policy pursued by central banks is focused on preventing excessive fluctuations in economic growth associated with the business cycle. But the ultimate goal of monetary policy is always to ensure price stability. Central bank interest rates and communication with the banking environment are the main monetary policy tools used by central banks.

It is worth noting that these instruments are the most relevant in direct inflation targeting regimes. Other regimes apply different instruments. The most important strategies, apart from inflation targeting strategies, include exchange rate control and eclectic strategies. In the case of direct inflation-targeting strategy, the official goal of a central bank is to achieve the declared inflation rate in the medium term.

Monetary policy decisions, especially decisions on central bank interest rates, have a major impact on the economy. They determine the short-term price of credit on the banking market. A very important factor in pursuing an inflation target is communication between the central bank and the banking environment. It aims to shape inflation expectations, which are one of the factors fueling price growth. In Poland, the Monetary Policy Council presents its assessment of the existing economic situation and economic trends expected in the future. The most important communication instruments are reports published after Monetary Policy Council meetings, news conferences, minutes of discussions held at the Council’s decision meetings, and inflation reports.

Since April 2000 the zloty has been a free-floating currency and has been subject to no restrictions. The central bank does not set the exchange rate of the zloty to other currencies, but reserves the right to intervene if it decides that intervention is necessary to defend the inflation target.

Monetary policy has the strongest influence on the level of inflation and the buying power of money. If money is expensive – that is, if interest rates are high – demand for credit drops. Borrowers, both businesses and households, are more cautious about taking bank loans because they are discouraged by high debt service costs. As a result, the supply of money on the market falls.

Decisions of the central bank are only one of many factors which influence inflation. The other factors include changes in prices of oil and other raw materials on global markets, harvests in agriculture, and decisions on regulated prices taken by a country’s authorities.

Direct inflation targeting
The strategy of direct inflation targeting has been pursued in Poland’s monetary policy since 1998. The Monetary Policy Council adopts an inflation target and then adjusts the level of basic interest rates of the National Bank of Poland (NBP) so as to maximize the likelihood that the target will be achieved. Since the beginning of 2004, the continuous inflation target has been set at 2.5 percent, with a deviation band of 1 percentage point up and down. The NBP keeps interest rates at a level consistent with its inflation target and influences nominal short-term interest rates on the money market.

The NBP uses modern monetary policy instruments, including open-market operations, standing facilities and reserve requirement, to shape short-term interest rates on the money market. Open-market operations are transactions conducted with commercial banks on the initiative of the central bank. They include the conditional and unconditional sale or purchase of securities or foreign currencies as well as issues of the central bank’s own debt securities.

In the case of basic open-market operations with a seven-day maturity, there may be significant fluctuations in the shortest interbank interest rates, especially overnight rates. These fluctuations are eased through standing facilities, that is, lending and deposit facilities available to commercial banks on their initiative: Lombard credit and term deposits. The facilities determine the level of interest rates on the money market, with the upper limit being the interest rate on Lombard credit and the lower limit being the interest rate on deposits in the central bank.

The central bank also requires that banks hold minimum reserves on accounts with the NBP. The reserve requirement is designed to mitigate the impact of current changes in banking sector liquidity on interest rates on the interbank market. Its aim is also to reduce overliquidity. It is profitable for banks which have surplus liquidity to lend to banks which have insufficient liquidity because leaving the money on accounts in the central bank means the loss of an opportunity to generate interest. But the interest rate the lending banks will demand will be higher than the NBP’s reference rate. Banks which want to borrow have an opportunity to ask for a loan from many different banks which have excess liquidity. Secondly, due to the averaging rule in the reserve requirement system, banks are not in a situation where it is absolutely necessary for them to take a loan. Additionally, banks do not have full knowledge about the liquidity position of their competitors. A minimum reserve, denominated in the zloty, is part of the money held on a bank’s accounts and acquired from the sale of securities and other refundable means received by the bank, except for means received from another Polish bank or acquired from abroad for at least two years. The minimum reserves are kept on accounts with the NBP.

Monetary Policy Council Sets Goals
Under the Monetary Policy Guidelines for 2011 adopted by the Monetary Policy Council at the end of October, the main goal next year will be to keep inflation at 2.5 percent in the medium term.

As in previous years, monetary policy parameters, including NBP interest rates, will be adjusted according to the changing economic situation and the assessment of the probability of inflation overshooting or undershooting the inflation target in the medium term. “Economic conditions in Poland, the situation on the labor market, fiscal policy and lending activity will be important internal determinants of monetary policy in 2011,” the Council has reported. “These factors may have a significant impact on the development of inflationary processes in 2011 and in the next years.”

The Council also believes that in 2011, the situation in the external environment will remain a major factor influencing the Polish economy. It is projected that the global economic revival will persist in 2011. The economic situation in the eurozone will be an important determinant of Poland’s economic growth because of its strong trade and financial ties with eurozone countries. Projections indicate that a slight acceleration of GDP growth may be expected in the eurozone in 2011, with major differences in the level of economic activity among individual countries.

However, the Council has cautioned that predictions for 2011 are very tentative owing to the scale, range and length of the global crisis. Among the risk factors, the Council points to economic conditions in other countries, prices of raw materials on global markets and, domestically, the impact of economic growth on incomes of the public finance sector.

For the time being, most forecasts are optimistic. According to the latest GDP projection for Poland presented at the end of October in the Inflation Report prepared by the NBP’s Economic Institute, the Polish economy will grow by 3.5 percent in 2010, 4.3 percent next year and 4.2 percent in 2012. The expected drop in the unemployment rate from 9.6 percent this year to 9.4 percent in 2011 and 8.9 percent in 2012 is also good news. The central path of the inflation projection, or the most likely inflation scenario, indicates that CPI inflation will be under control and will reach this year the NBP inflation target of 2.5 percent. And although in the next two years inflation may grow to 3 percent, it will remain within the inflation target band of 2.5 percent plus/minus 1 percentage point.

The projection is relatively optimistic, but experts of the NBP’s Economic Institute have outlined numerous risks that may change the expected trends. The risks to inflation cancel each other out but the risks to GDP growth are largely on the downside. Economic activity in other countries and the exchange rate of the zloty are the main sources of uncertainty.

Monetary Policy Council
Under article 12 of the Law on the National Bank of Poland, the Monetary Policy Council:
- adopts annual monetary policy guidelines, which are then submitted to the parliament together with the government-proposed budget bill,
- submits a report on the implementation of monetary policy guidelines to the parliament no later than five months after the end of the budget year,
- sets central bank interest rates,
- sets minimum reserve rules and the required reserve ratio,
- sets the upper limit on obligations resulting from loans taken by the NBP from foreign banking and financial institutions,
- approves the NBP’s financial plan and report on its activity,
- approves the NBP’s annual financial statement,
- sets the rules for open market operations.

Composition of the Monetary Policy Council
President of the Monetary Policy Council: Prof. Marek Belka, professor of economics, former prime minister and ex-finance minister

Members of the Monetary Policy Council:
Andrzej Bratkowski, economist, former deputy governor of the Polish central bank
Elżbieta Chojna-Duch, former deputy minister of finance, an expert on parliamentary committees and for the offices of the lower house of parliament and Senate
Prof. Zyta Gilowska, professor of economics, former deputy prime minister for economic affairs and ex-finance minister
Adam Glapiński, economist, former minister of foreign economic relations
Prof. Jerzy Hausner, professor of economics, former deputy prime minister and economy and labor minister; designed a plan to repair public finances, known as the Hausner Plan
Prof. Andrzej KaĽmierczak, member of the Scientific Council of the Collegium of Management and Finance and the Finance Science Committee, Polish Academy of Sciences
Andrzej Rzońca, economist, former advisor to the central bank governor
Prof. Jan Winiecki, former executive director of the European Bank for Reconstruction and Development (EBRD) in London
Prof. Anna Zielińska-Głębocka, author of numerous reports for central and regional authorities, including the Lower House Analysis Bureau
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