What better says about Ukraine's economy: dollar rate or inflation?

Author : Oleksiy Kushch

Source : 112 Ukraine

Ukraine's authorities are often remembered not by the level of real incomes, but by the rate of the hryvnia to the US dollar.
14:15, 23 March 2018

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Inflation targeting, which the National Bank (NBU) has been actively using in recent years, could be described with a famous joke: “Can you see the gopher? No? Neither can I. But he's here!” Despite the norms of the Constitution and the special laws, the NBU, like a petulant child, chose the "favorite" toy in the form of inflation from the huge heap of our problems. In fact, we have faced another absolutization of an abstract notion; previously, we have absolutized the course, now we absolutize the inflation index.

For many years, Ukrainians were accustomed to thinking about the stability of the national currency, which turned into a kind of fetish, a universal symbol of stability. The authorities were remembered not by the level of real incomes, but by the rate of the hryvnia to the US dollar. In our history, there were several such periods: 5.05, 8, or more precisely 7.95. But then Ukraine still had the industry with its long production cycles. And for this a stable exchange rate is required; otherwise, it is simply impossible to produce sophisticated equipment.

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In the conditions of total de-industrialization of the economy in recent years, the country has switched to simple commodity cycles. Everything leads to the fact that in five years we will have sparsely populated rural areas, focused on monocropping (sunflower, corn, canola, soy), and depressive cities with high unemployment, crime rate, and demographic decline.

It would seem, what does inflation targeting have to do with this? The task of the monetary body is to single out an issue from the whole spectrum of existing problems, which is the most relevant for this type of economy, and to develop a model for overcoming the crisis.

At one time, the world regulators went through various methods of regulation. This is the policy of fixed rates when the goal was to preserve the stability of the national currency. The downside of this model was the loss of a substantial part of the sovereign monetary policy of the central bank. In fact, the role of the NBU was reduced only to the redemption of surplus currency in the event of a revaluation of the exchange rate and the sale of currency on the domestic market in the face of devaluation. Money supply was bloated. NBU, professing the fixed hryvnia rate, have done it three times: in 1998, 2008, and 2014.

In 2014, it became obvious that the fixed-rate model was no longer working and it was necessary to find the new mechanisms for achieving macroeconomic stability.

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In the years 2014-2016, in accordance with the requirements of the International Monetary Fund, very stringent monetary beacons were set for Ukraine, related to the management of such key indicators as net domestic assets (rate of hryvnia mass) and net foreign currency reserves (gross reserves of the NBU minus liabilities).

In 2014, our country abandoned the policy of a fixed exchange rate and began carelessly applying the entire prescription prescribed by the IMF. On the one hand, the situation was hopeless: the reserves of the National Bank were reduced to the minimum levels by the end of that year. They were even selling the gold reserve: out 1.36 million troy ounces at the beginning of January 2014, 0.6 million were left by December, or 44% of the gold reserves were sold. That is, an extremely uncomfortable situation has arisen: the hands of the regulator were actually bounded – they had to keep the falling pants and any embarrassing movement threatened with public embarrassment.


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The implementation of the IMF demands in the period from 2014 to 2016 can be called a period of informal targeting of the money supply. In practice, this led to severe financial hypoxia of the national economy, reduction of real incomes of the population, "burning" of deposits for tens of billions of dollars and washing out of current assets. As a result, even the most zealous adherents of the Fund's policy realized that it was still risky to continue this way.

Strict control of the monetary aggregates led to a sharp slowdown in the pace of economic recovery: in 2014-2015, 15% of GDP was lost, and in the last two years, no more than 4% were turned back.

At one time, many transition economies faced a similar choice. For example, after the 2008 crisis, Kazakhstan abandoned the model of a permanent devaluation of the national currency and proceeded to create diversified channels of money supply to the economy. A special role is played by the so-called Marshall coefficients, which show the level of monetization of a particular economy, and they are calculated as the ratio of money supply to GDP.

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If you take Asian countries, many of which have a primary specialization and are transitional, you can see a clear relationship between the level of monetization and economic development. As a rule, the richest countries have a very high level of monetization and quite low inflation rates. Thus, in economies with a GDP level of 10-50 thousand dollars per capita, the money supply exceeds GDP (the level of monetization is more than 130%), and inflation is in the range of 0-3%. Developing countries (GDP per capita from 2.6 to 10 thousand dollars) are characterized by an average level of monetization (50-60% ) and inflation up to 8%. The poorest countries (GDP per capita up to $ 2,600) have a low level of monetization (35-40%) and inflation above 8%. This is usually a commodity economy with a high level of labor migration and corruption.

As a result of the strict limitation of the level of monetization of the economy, Ukraine fell into the basket of the poorest countries: GDP per capita is below $ 2,500, inflation is 12 to 44% in recent years. One of the reasons for the persistence of poverty is precisely the low level of monetization of our economy.

Since 2013, this indicator in Ukraine has decreased from 62% (the level of countries with average economic development) to 40% (the level of the poorest economies in Africa, Asia, and Oceania).

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One might consider that the problem could be solved with the help of a printing press. But still, it is very dangerous to completely satisfy its appetites. After filling the corrupt institutional environment with a large amount of money is fraught with only an increase in inflation and an inevitable reduction in the level of monetization, because this indicator "falls into the cowards" after each new inflationary wave.

In this situation, the central bank must also make the right goal setting. NBU has chosen control of the consumer inflation, having declared the basic goal at a rate of 6% +/- 2%. Last year this interval was significantly exceeded: at the upper lath of 8%, the actual level of inflation reached 14%. This year, the NBU has already revised its forecast in the direction of increasing it to almost 9%, although even now it is quite obvious that inflation in the current year will not be measured by an unambiguous number.

Inflation targeting is a sufficiently effective tool for developed countries that have solved the basic tasks of their economic development, and the only thing they need now is moderate price dynamics and macroeconomic stability.

The problem is that Ukraine needs macroeconomic development. Dynamic development. With growth rates of 2-3%, we are doomed to the progressive erosion of the domestic potential and complete annihilation of the industrial core of the economy, because at such rates Ukraine will not be able to provide competitive conditions for the development of labor resources or, environment for the formation of human capital, and the renewal of the system infrastructure.

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NBU is led by several tough failures of the fixed exchange rate of the national currency policy, but this does not mean that one unproductive instrument of monetary regulation needs to be changed to another, counterproductive.

Such economies, like Ukrainian one, are excessively dependent on the conjuncture of external commodity markets, mainly raw materials, energy prices, and supply shocks. Recall last year, when the freezing in the cold spring of early vegetables led to a significant increase in consumer prices. Nobody will give a guarantee that this will not happen again. Moreover, according to the "Murphy's laws", if something can happen, then it will necessarily happen.

That is why Ukraine needs to move to targeting a nominal gross domestic product and set a target for reaching the pre-crisis level of GDP. It is precisely this task that the instruments of the NBU monetary policy should serve. For many years, there have been disputes on the "useful" level of inflation - 0%, up to 10%, 10-15%. But the economy itself must answer this question. And targeting nominal GDP will facilitate this. That is, the task of the central bank is to promote economic growth and the economy's exit to the pre-crisis level with the help of monetary instruments, and the economy itself will decide what optimal level of consumer inflation it needs for this.

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The mechanism of targeting nominal GDP will allow to respond to supply shocks and deterioration of the conjuncture of external commodity markets, because this model allows to redistribute the crisis load on both prices and output of goods (economic growth), that is, to reduce the level of crisis pressure due to its redistribution to various shock absorbers. Speaking about the inflation targeting, the whole impact of the crisis is precisely on the dynamics of economic growth, which becomes a hostage to the price tight policy.

Most of the developed countries have solved the problems of sustainable growth 30 years ago. For us, dynamic economic growth is a priority task, achievable in case of using all the monetary potential that the National Bank has. Paraphrasing Churchill, if the central bank chooses inflation when choosing between economic growth and inflation, it will receive high prices and low GDP growth.

This column does not necessarily reflect the opinion of the editorial board or 112.International and its owners.

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