RAIFFEISEN BANK S.A.

 | 

IONUT DUMITRU

 | 

NICOLAE COVRIG

  |  25.03.2013

Inflation dynamics and monetary policy

Achieving and maintaining a low level for inflation rate is a key objective of macroeconomic policies given the negative consequences of a high inflation rate (arbitrary redistribution of wealth, distortions in market mechanisms and relative prices). In this context, central banks are formally charged to ensure price stability, which means to limit the increase in consumer prices at around 2% per year.

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RAIFFEISEN BANK S.A.

IONUT DUMITRU

IONUT DUMITRU

HEAD OF MACROECONOMIC RESEARCH at RAIFFEISEN BANK S.A.


NICOLAE COVRIG

NICOLAE COVRIG

RAIFFEISEN BANK S.A.

Documents

 

Achieving price stability - a difficult task
 
 
 
Ensuring and maintaining price stability is also the main objective of the National Bank of Romania (NBR). However, the inflation target fixed by the NBR is a bit higher (2.5% with a fluctuation band of +/-1%) compared with ones set by central banks in well developed economies and this in order to take into account the expected convergence in Romanian prices (lower) towards the  levels in the Euro Area (higher).
 
 
Given the subdued economic growth, central banks' concerns on inflation were low over the last few years. Major central banks in developed economies put in place non-standard quantitative easing policies, while many central banks in developing economies had also room to ease the monetary policy stance. Dynamics of inflation is another area were Romania remarks on the negative side (high inflation rates). In spite of a prolong recession during the past four years, Romania recorded the highest inflation rate among the EU member countries.  Implied average annual inflation rate between end-2008 and end-2012 amounted to 5.1%. Advance in prices was fuelled in some extent by hike in VAT from 19% to 24% (in July 2010) and by increase in excises (hike in their level and leu depreciation). When adjusting for taxes contribution, resulting inflation rate amounted to 3.2% per year between end-2008 and end-2012. This is still the highest level among the EU member countries and above the central bank's inflation target assumed for the next years.
 
 
Strong impact from supply side shocks
 
 
Changes in food prices and administered prices have a strong impact on inflation dynamics in Romania. Foods and non-alcoholic   beverages account for 32% of the HICP basket, which is the highest level among the EU member countries. Food prices, especially the ones for fruits and vegetables, depend in a large extent on weather conditions: a good agricultural year cause downward pressures in volatile food prices, while a bad agricultural year generate important upward pressures on volatile food prices. Over the last years, weather conditions were very volatile and this resulted in large swings in volatile food prices and in overall inflation rate. Administered prices have also a large share in consumption basket. Not only they increased much faster than most other prices in the past, but also their dynamics was also volatile at some times. While the impact of supply side shocks on short-term inflation dynamics is evident, they might have also impact on inflation dynamics in medium and long-term by limiting the speed of the disinflation process. Inflationary expectations might inflate each time the inflation rate climbs at a high level even though this is only a transitory development (i.e prices for fruits and vegetables increase in case of a bad agricultural year, but decrease subsequently). So, the failure to anchor public inflationary expectations to the central bank's inflation target or to the medium term trend in inflation rate might be a reason for the high persistence in inflation rate.
 
 
Adverse  weather conditions last year had a strong negative impact on agricultural output  and on volatile food prices (fruits, vegetables) which increased by 19.1% yoy as of end-February 2013 and had a contributions of 1.3 percentage points to inflation rate (5.7% yoy). When adjusting for their contribution, the remaining prices advanced by 4.7%. This is much closer to our estimates for medium-term trend in inflation rate (close to 4%). in fact, the annual inflation rate should decelerate towards 4% yoy by end-of the year when the adverse statistical base effect (stemming from increases in volatile food prices in H2 2012) will disappear.

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