Strategies for Developing Monetary Policy in Emerging Countries

Strategies for Developing Monetary Policy in Emerging Countries Associate professor Cristian DUMITRESCU1 Abstract Monetary policy is a primary element of economic policy, as with its help central banks can act and influence both the demand and supply of money in the economy. The main purpose of monetary policy measures is to ensure price stability, effective control over inflation, as well as the stability of the national currency. A very important aspect to highlight about the European Central Bank is that the objective of monetary policy aims at the strategy of maintaining price stability and the inflation rate at lower levels. Any decision is the product of a procedure that involves the assembly of a large number of primary information. The monetary policy decision is also subordinated to these procedures, but simple information, regardless of its degree of organization and hierarchical processing, does not seem to be sufficient to be able to make a decision. Keywords: monetary policy, European monetary integration, financial stability, price stability, inflation targeting, emerging economy, European Central Bank (ECB), convergence process. JEL Classification: K22, K34 1. Introduction An infallible monetary policy should be supported by appropriate monetary policies, since, at least in emerging economies, due to real and nominal shocks that cause imbalances in financial markets and implicitly cause unpredictable price variations, inflation control is of paramount importance2. In other words, ‘economic policy is a deliberate state intervention in the economic field in order to achieve certain structural or conjunctural objectives’3. The particularities of economies in transition determine considerable inflows of direct investments, either independent or through the process of transferring some assets from the state’s patrimony to the patrimony of private entities, or portfolio investments, which have been generated by the higher interest that made these markets extremely attractive. These aspects can generate two relevant consequences at macroeconomic level: the first would be an appreciation of the exchange rate, which would reduce inflationary pressure in the short term, the second consequence would essentially be generated by the appreciation of the national currency which would implicitly disfavor exports and generate an external imbalance; the boomerang effect would continue with currency depreciation, high inflation and a vulnerability of the economy associated with changes in foreign markets 4 . 2. In monetary theory and particularly in monetary practice In monetary theory and particularly in monetary practice, there are three monetary policy strategies that have generated an effective nominal anchor, namely: targeting monetary aggregates, targeting the exchange rate and targeting inflation. An alternative to these strategies would be the nominal income strategy, which however is a purely theoretical strategy, not yet applied in real monetary policy. Currently, in the emerging economies of Central and Eastern Europe, exchange rate targeting policies and inflation targeting policies are used, while the policy of targeting monetary aggregates loses its importance due to the disintegration of the relationship between monetary aggregates and inflation, against the background of liberalization of capital flows and a reduced inflation and 1 Cristian Dumitrescu - Hyperion University of Bucharest, Romania, . Isărescu, Mugur, Probleme ale politicii monetare într-o ţară emergentă. Cazul României, 2008, p. 27, (https://www.bnr.ro/files/d/ Noutati/Prezentari%20si%20interviuri/Probleme_PM_tara_emergenta.pdf). 3 Basno, Cezar and Dardac, Nicolae, Currency, Credit, Banks, Didactic and Pedagogical Publishing House, Bucharest, 1999. 4 Isărescu, Mugur, op. cit, 2008, p. 28. 2 Perspectives of Law and Public Administration Volume 11, Issue 4, December 2022 567 implicitly an accelerated remonetisation5. In the approach of the European Central Bank there is a strategy that takes into account the rhythm of the monetary mass, structured into 2 pillars: a) economic analysis - carried out by analyzing short- and medium-term price determinants, focused on the evolution of the economy and financial conditions b) monetary analysis - carried out by capitalizing on the long-term connection between money and prices; thus, by analyzing the evolution of the monetary mass, the authorities can make forecasts on inflation However, monetary policies differ from state to state, depending on its size and the specifics of the economy; therefore, monetary practice shows us with the following types of monetary policies related to the exchange rate: ‘monetary council’ regime (Bulgaria, Estonia, Lithuania), hard peg regime (Latvia), freely floating exchange rate regime (Poland), managed floating exchange rate regime (Czech Republic, Romania). Regarding an inflation targeting approach, the central banks of the states that adopt such a strategy must pay more attention to loss functions, through complex measures adopted in order to minimize them6. Emerging economies present certain specific characteristics which, combined with the criteria for joining the euro zone, generate difficulties in the elaboration of monetary policy. Thus, the shocks on the supply side, the expansion of the monetary substitution phenomenon, the fragility of fiscal institutions, the shallow financial markets, the vulnerability to the sudden interruption of capital inflows and labor migration generate a high degree of complexity in the development of price stability. Based on the above, we can say that price stability is the fundamental objective of an effective monetary policy. The main reason would be that, in addition to the inflationary balance it determines, price stability also allows the regulation of other macroeconomic imbalances and thus this policy becomes the best measure that can be taken in order to ensure a state of social welfare and an increasing standard of living. This idea is supported by the Treaty on European Union, according to which ‘the primary objective of the European System of Central Banks (ESCB) is to maintain price stability’. Despite these facts, the effectiveness of monetary policy is constrained in the absence of a viable and stable financial system. The efficient operation of the interest rate and credit channel is hindered by shallow financial markets, therefore a fine-tuning operation by the European Central Bank is limited and an excessive dependence on the exchange rate channel in the aggregate demand management process may be generated.7 The independence of the Central Bank is reflected by its ability to ensure the achievement of the macroeconomic policy objective established by the government. Therefore, the Central Bank does not have the independence in establishing the objective of monetary policy, but it does have the independence regarding the choice of the instruments used to achi (...truncated)