Prices are rising. Can National Bank control inflation?

Author : Bohdan Danylyshyn

Source :

National Bank of Ukraine has a significant impact on the level of inflation, but it is not decisive. Money relations are not detached from the other sectors of economic life. Actions of the National Bank without other comprehensive measures will not give the proper effect
20:53, 16 January 2018

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On January 9, the State Statistics Service of Ukraine reported that consumer inflation in December 2017 compared with the previous month was 101%, for the year as a whole it was 13.7% (food - 17.7%). The prices of manufacturers of industrial products in December 2017 compared with the previous month increased by 1.7%, for the year as a whole - by 16.5%. The base consumer price index in December 2017 compared with the previous month was 100.8%, for the year as a whole - 109.5% (for 2016 - 5.8%). Thus, the actual inflation in 2017 exceeded the inflation target of the National Bank of Ukraine (8% with an allowable deviation range of ± 2%), and exceeded inflation in 2016 (12.4%). The probability of higher actual inflation compared to the forecast and the objectives of the National Bank was observed in the first half of last year. Therefore, the Council of the National Bank of Ukraine, in its decision No. 33-rd, analyzing the implementation of the Basic Principles of Monetary Policy for the first half of 2017, noted the need to actively apply the available monetary instruments to contain inflation within 8% ±2%.

However, the National Bank did not begin to pursue a more stringent monetary policy, given the need to balance the leveling of inflation risks and support for economic growth, but only refrained from mitigating this policy. Only in late October, the NBU raised its discount rate to 13.5% per annum. Such a step of the regulator can be partially justified by the need to maintain the existing rates of economic growth. Considering these circumstances and the implementation of the Basic Principles of Monetary Policy for January-September of 2017, the Council of the National Bank again insisted on the necessity of applying all means and methods of monetary and credit policy to achieve benchmarks on inflation.

The Council also recommended to the Board the following: "Take measures to concentrate the NBU actions on achieving goals regarding consumer inflation and to ensure priority in achieving and maintaining price stability in the state while the NBU performs its functions. To take into account the fact that during the establishment of targets for consumer inflation for the current year, a smooth trajectory of reducing inflation was expected, which was consistent with the rates of economic growth, that is already taking into account the need to support economic growth. Taking into account the above, it seems unnecessary to further balancing between leveling inflation risks and supporting economic growth, whereas taking into account current inflation, it is relevant to use all instruments to achieve inflationary goals. "

The fact that December 14 the Board of the National Bank again raised the discount rate (up to 14.5% per annum), demonstrating the Board's awareness of the available inflationary risks. Given that the effect of increasing the discount rate is felt with a certain delay in time, I believe that this step will help to reduce the rate of inflation in 2018. However, it should be noted that the dynamics of the consumer price index depends on a number of factors, and the NBU doesn’t have the influence on all of them.

Why did the actual consumer inflation exceed the forecast and target values? What is its nature?

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First of all, there was an increase in food prices higher than predicted, in particular for raw food products. This was reflected in the prices of food products with a high degree of processing. In addition, the prices for fuel grew at a faster rate. This, in turn, was due to a steady increase in world oil prices, which took place during the second half of 2017. Current inflation is supply inflation. It is connected with the fact that manufacturers raise prices for their products because of increased production costs, and not because consumer demand is growing. Although there is a reason to note a certain revival of consumer demand, in fact, last year the balances on loans to the population in the national currency increased substantially. They were largely aimed at buying cars and meeting other consumer needs. If we analyze in more detail the structure and dynamics of prices for goods and services that are part of the consumer price index, we can draw the following conclusions.

The main part of this list is food products. However, it is incorrect to think that the demand for food has increased, since a person, naturally, cannot significantly increase food intake. But demand can increase for services, for example, when the society becomes wealthier, or for durable goods (cars, furniture, household and computer equipment, photo equipment, etc.). However, the increase in prices for these goods in 2017 was significantly lower than, say, food, alcohol, tobacco products, fuel, goods, and services, which are administratively regulated (housing and communal services).

This does not give grounds to state the inflation of demand, which is the object of the indirect impact of monetary policy. Underestimation is the effect of transferring the growth of producer prices to the final price of goods. For a final confirmation of this thesis, it is necessary to study this question in more detail.

At the end, it should be noted that Ukraine is still experiencing supply inflation. Due to the deterioration of fixed production assets, low efficiency and labor productivity, an increase in the cost of equipment, raw materials, semi-finished products, high-interest rates on loans, the cost of manufactured products increases. Manufacturers are forced to raise prices due to increased costs. That is, the key factor in the dynamics of consumer prices is now an increase in the cost of production. At the end of 2016, the growth of producer price was 35.7%. With a delay of 6-9 months, this was reflected in the increase in consumer prices. In 2017, the producer price index (PPI) is 16.5%.

To improve the inflationary situation, it is clearly not enough just to raise the central bank's rate (the standard central bank practice of combating inflation). We can not deny the fact that domestic manufacturers will invest in the price of products, which in turn stimulates price increases, to increase the bank interest rates on loans that may occur as a result of the NBU rate increase. Therefore, the NBU is wary of using the discount rate as a tool to combat inflation.

If we talk about the competence of the National Bank and the effectiveness of its tools, it is worth noting the potential for regulating the supply of money, especially in the tactical plan. Despite the introduction of the monetary regime of inflation targeting in Ukraine, no one abolished the postulate of monetarism, according to which the inflation is effected by a change in the volume of funds in circulation. To ensure the stability of the national currency in Ukraine, one should not allow even short-term arbitrariness in the regulation of the hryvnia proposal, since this remains a significant factor in inflation, as is the exchange rate of the national currency.

At the same time, there is a need to further strengthen the coordination of state policy and various public authorities in overcoming inflation. In particular, the fact of significant budget expenditures in December, respectively, the transfer of the hryvnia from the treasury account at the National Bank to the monetary market, demonstrated the need for tight tactical coordination of monetary and fiscal policies.

The deviation of the current PPI indicators does not mean that the inflation targeting policy should be revised.

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Under the inflation targeting, the NBU implies the choice of the price guide as the main medium-term goal. It is important to understand here that the interpretation of inflation as an overflow of monetary circulation is incomplete. Inflation, though it manifests itself in the growth of consumer (commodity) prices, is not only a monetary phenomenon but also a social and economic phenomenon caused by imbalances in various spheres of the economy. Inflation is a multifactorial phenomenon. If its components are sorted into monetary and non-monetary, the second part would be bigger.

The situation was complicated by the fact that since July 1, according to the decision of the Cabinet, the regulation of food prices has been canceled. In the structure of a consumer basket in Ukraine a significant part is the cost of food, then the abolition of regulation of food prices has made a significant contribution to inflation.

To reduce inflation, it is necessary to coordinate the activities of the NBU, the Cabinet of Ministers and the Antimonopoly Committee. But AMC did not succeed to demonopolize markets. As of mid-2017, more than 40% of the market in our country was monopolized, 11% of the market was operating in an administrative or natural monopoly. Monopolies and oligopolies were formed in the fuel and energy complex (65%), in the transport and communications (82%). Monopolists abuse their position, they use tools that make it possible to maximize profits by inflating prices and tariffs. This is reflected in inflation.

It is necessary to pursue a policy aimed at increasing competition, reforming the housing and communal sector, preventing tariff increases, restructuring the economy in order to reduce its dependence on foreign markets. These measures will not only help to reduce inflation, but also provide conditions for long-term economic growth.

Analyzing the consequences of the decision to abolish the regulation of food prices, I consider it premature because in the conditions of the monopolized economy of Ukraine it led to an increase in the rate of inflation. In my opinion, the work of the State price administration should resume, which, at the stage of transition of the economy from recession to growth, could conduct control over price formation and consumer price growth.

The NBU has a significant impact on the level of inflation, but it is not decisive. Money relations are not far from other spheres of economic life. Actions of the NBU without other complex measures will not give the proper effect. The increase in the refinancing rate - and this is the main instrument of the NBU in the fight against inflation - will not ensure inflation reduction under the conditions of a monopolistic market structure. Producers-monopolists support the discrepancy between demand and supply in order to gain control over pricing.

Inflation in Ukraine is not exclusively a monetary phenomenon, it has many components. As mentioned above, the contribution of non-monetary components to price increases cannot be ignored. For example, the tariffs of natural monopolies and infrastructural monopolies affect the level of prices in our country. It influences the prices and cost of energy resources, which we mainly import.

Factors which the National Bank doesn’t control have the strong influence on the growth of consumer prices. Among them, apart from the abolition of regulation of food prices, the growth of administratively regulated tariffs for housing and communal services, an increase in the prices of industrial and agricultural products. That is why the NBU can control the price growth only in some limit. To reduce inflation, the National Bank is forced to raise the discount rate. However, during the period of economic recovery from the crisis, this may entail an increase in the cost of loans and a decrease in the volume of crediting of the economy. The positive impact of the increase in the discount rate on curbing inflation in terms of supply inflation is also limited.

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