National Bank of Kazakhstan: outdated song about the main things

Date: 12:01, 12-01-2015.

Almaty. January 12. Silkroadnews - At the end of December 2014 was issued a joint statement by the Government and the National Bank for the main directions of economic policy in 2015. The document has once again highlighted the goal of economic growth and inflation, as well as designated methods of credit policy.

"In monetary policy will be created a basis for the transition to inflation targeting in the medium term. Inflation targeting will increase the real yield savings in tenge and lead to lower inflation expectations", - stated in the document. A the same time planned to achieve more or less stable GDP growth rates of 4-5%.

Leaving aside the question of low oil prices, contry is to focus on inflation.


This has already been heard, but did not work


"The main focus of monetary policy of the National Bank of Kazakhstan in the next 3 years will be the preparation and transition to the principles of inflation targeting, which implies a gradual shift away from targets for the monetary base and foreign currency reserves to the inflation target", - said the main directions of the monetary credit policy of the National Bank for 2002-2004.

Inflation targeting is actually spelled out in the mandate of the National Bank since 2004. Then the main goal of the National Bank was changed to ensure internal and external stability of the national currency to ensure price stability. In the following years, members of the regulator mechanism tried to create inflation targeting itself and formed mathematical model of monetary policy in the country.

The main directions of monetary policy for 2007-2009 stated: "The inflation forecast is made on the basis of the Phillips curve, which reflects the theoretical relationship between the deviation of GDP from its potential level, inflation expectations and wages. Recent indicators, in turn, are determined by credit to the economy, exchange rate, money supply and other factors". That is, the end of the formulation of a mathematical model.

At the same time, as we recall, the tenge strengthened against the dollar due to the rising of oil prices. That was quite natural depreciation of the US currency against the backdrop of increasing revenue from petrodollars coming into the country. Created a kind of attempt, or maybe illusion of functioning flexible exchange rate. Inflation targeting did not happened.


Repetition - the mother of learning 


The fact is that inflation targeting, as a process, is closely tied to the active monetary policy or the management of interest rates. That is, for a correct and effective inflation targeting is required to ensure the independence of monetary policy. It is appropriate to recall the trilemma of monetary policy, which states that the Central Bank (CB) can achieve only two of the three goals: a stable exchange rate, independent monetary policy and capital market integration.

Most countries in this issue donate a stable exchange rate and send it to float freely. Since foreign capital market is important to us, and an independent monetary policy is needed for the problem of inflation targeting, it is required to let the tenge exchange rate. There is little doubt in which direction it will go when released now.

Hardly anyone knows the level where the course will decide to stop. Since the free floating tenge is nothing more than a myth, the implementation of inflation targeting in the medium term is likely to just escape from the realities in the country of dreams and fantasies.

To ensure the independence of monetary policy interest rate, appointed by the National Bank - the refinancing rate - should effectively regulate economic activity in the country. In other words, in the end, all questions of commercial lending and deposit money must end at this rate.

For now it did not happen. For the world of deposits there is a market rate, bit rate correctable recommended by KDIF (Kazakhstan Deposit Insurance Fund), but in the world of commercial loans the amount of benchmark to index interest rate is sufficiently large. At least, a few years ago the rate of KazPrime, rather than refinancing rate, was more popular as a basis for pricing a loan. That is, the refinancing rate has a limited effect on economic activity in the country.


Let us remember all and how it was


In theory, the Central Bank to lower inflation expectations regulates refinancing. With its increasing consumption becomes less profitable, and the gap between potential and actual GDP is reduced. At lower current, consumption becomes more advantageous for people (they get a lower interest rate on deposits and spend more money today), and the actual GDP is growing.

With a positive gap in GDP (when the actual is more than potential) there is a growth in inflation expectations, while a negative gap - reduction. Zero gap - a rare event, and is unlikely to be achieved in the long period of time. For theoretical CB’s main goal is to stable inflation, to stable economic growth is the goal number two. See Picture 1.

This chart denotes the quarterly dynamics of the refinancing rate, inflation and the gap between potential and actual GDP. Regime change in the National Bank began in around 2000, but as has been said, in 2004, the regime finally changed in the direction of inflation targeting.

Shall be noted steady, but weak growth of inflation and refinancing rate. Everything went according to plan during 2004-2005, when "like" increase in interest rates offset the gap between actual and potential GDP. But then there was an abrupt increase in the GDP, which is fully in line with economic theory results in a spike in inflation.

In this case, the National Bank would have to raise the refinancing rate to heaven. Here are a few different scenarios of behavior of the refinancing rate, depending on how much weight to assign CB component of inflation or economic growth in comparison with the current interest rate. See Picture 2.

In this case, the most important is the time period when the Central Bank sought to inflation targeting - the period of 2002-2007. The black line represents the actual interest rate, and color - different models. As you can see, the classic economic model recommended in this period the greater rate than the actual.

It is interesting that a similar situation at the same time took place in the United States. The author of this method John Taylor criticized the FRS (Federal Reserve System) for too soft monetary policy, which led to the housing bubble in the United States. By an unfortunate coincidence, the same thing happened in Kazakhstan. This graph shows that the policy of the Central Bank, despite the fact stated inflation targeting was too soft and contributed to the expansion of the speculative bubble in the market of Real property estate and inflation expectations. Maybe all these happened due to the lack of independence of the Central Bank?


It was considered very important


The results of mathematical modeling and analysis of the data are valid and strong, if they rely on high-quality and accurate statistics. We are considering the 2002-2007 period when the National Bank could cause big issues to the Statistics Agency (now the Committee on Statistics of the Republic of Kazakhstan, Ministry of National Economy) on the settlement of important statistical indicators.

First of all, nobody in the country counts explicitly gap between potential and actual GDP, although for the purposes of monetary policy and inflation targeting, this figure is the key. Of course, you can find yourself having sufficient knowledge, but no one can do it better than the Statistics Committee.

Secondly, "likely" the correct management of interest rate on the background of the "likely" floating exchange rate regime should not lead to a sharp positive jumps, except in cases where a significant part of the economy is not covered by official statistics. This has a place to be, as the assessment of the shadow economy in the country from year to year is constant at around 20%. Apparently, this estimate is somewhere in the middle between the maximum of what can count Statistics Committee, and the least of what it actually is. It is likely that at some point the shadow economy in the country has grown so much that has led to a very strong rise in inflation expectations. And we should not leave without attention the rising of food prices in the world.

Finally, the accountability of the National Bank and all other departments of the presidential administration, means that the policy of the National Bank and the approach to inflation targeting will not be independent. This will lead to searching for compromises in the decisions and not enough hard policies, and at the same time disclaimer. However, if the direction toward inflation targeting - not fiction, and it looks that way, in the near future we will see a kind of half-hearted resolve in the exchange rate.


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