Download Remarks by Mr. Ivan Iskrov, Governor of the BNB, at the EastEuro

Remarks by Mr. Ivan Iskrov, Governor of the BNB, at the EastEuro
Link’s
Conference
Growth
Toward
Synergy:
Restructuring
Macroeconomics and Finance in Central and South East Europe, Sofia, 30
January 2004
STRATEGIES AND PRIORITIES OF THE
CENTRAL AND SOUTH EAST EUROPE’S CENTRAL BANKS
It is a pleasure for me to take part in this conference and to open the discussion within which various
views on the priorities of Central and Southeast Europe's central banks1 and the strategies for attaining
them can be shared.
Money and the various approaches to its management appeared as early as the initial stages of
development of civilization. From this long-term perspective, central banks are relatively new
institutions. By way of example, I will mention that the first central bank - the Swedish Riksbank - was
established as late as 1668. In 1900 there were only 18 central banks worldwide, and one of them was
the Bulgarian National Bank, whose 125th anniversary we are to commemorate this year. Today central
banks are 174.
This relatively short period of existence of central banks, evidenced all through a continuing process
of change of priorities in the policies pursued and the strategies for their achievement. The scope and
focus of this Conference do not allow for an exhaustive overview of this development. So in this short
speech, I will focus on the goals, and the strategies for their attainment, of the Central and Southeast
Europe's central banks in the period after 1990, trying also to outline the challenges we presently face.
With the start of the transition from a command to a market economy, in the countries in Central and
Southeast Europe, governments and central banks were faced with the challenge of formulating the
central bank goals and the strategy for their attainment. Of course, this process in the countries of
Central and Southeast Europe could not develop in isolation from the global monetary policy and
central banking trends.
The 1990ies were a period when the developed countries' central banks redefined their ultimate
objectives and strategies. The experience from the 1970ies and 1980ies has indicated that higher rates
of growth and employment cannot be achieved by allowing higher rates of inflation. Furthermore,
historic experience has proven that high and unstable inflation rates result in low and fluctuating rates
of economic growth and employment (see Figure 1).
Chart 1. Inflation and GDP growth in G-7 economies2
(annual percentage change)
1
The group of the countries from Central and Southeast Europe includes: Albania, Bosnia & Herzegovina, Bulgaria, Croatia, Czech Rep., Estonia,
Hungary, Latvia, Lithuania, Macedonia, Poland, Romania, Serbia & Montenegro, Slovak Rep. and Slovenia.
2
All the data for the year 2004 is forecast data
This experience was underlying the change that led to redefining the interrelation between the central
bank and the government, the ultimate objectives of its policies, and the strategies for attaining these
objectives. The view that central banks should have a high degree of independence, combined with
transparency and accountability was generally accepted. They should set maintaining price and
financial stability as their main goal, with monetary policy strategies based either on a floating
exchange rate and direct inflation targeting, or on pegging the exchange rate and convergence of the
inflation rate towards the inflation rate of the country (or area) of its reserve currency.
In establishing their central banks and defining their priorities and strategies, the countries of Central
and Southeast Europe proceeded from the conventional view of the central bank's role in society,
established in the developed countries. To what extent did countries in our region adopt this
conventional view and what could they achieve?
Central Bank Independence
Empirical data and research indicate that today almost all central banks of countries in Central and
Southeast Europe enjoy a degree of statutory independence higher, on the average, than the one
existing in the early 1990ies in most of the developed countries3. Of course, we should note the
importance of real compliance with the law, which practically determines the degree of actual central
bank independence. It is a well-known fact, that the law is applied in a varying degree in different
countries, which determines the degree of actual independence of the respective central bank.
Main Objectives
As regards the legally set main objectives, the central banks in Central and Southeast Europe have to
a very great extent come close to the generally accepted principle that central banks should be
responsible for maintaining price and financial stability in their country. In almost all countries4 in our
region, the main objective provided for in the central bank legislation is ensuring price stability, or any
other type of stability of the national currency5. To what extent do central banks manage to control
inflation and ensure price stability? Since the beginning of the transition, inflation in the countries of
Central and Southeast Europe dropped from 140 % in 1990 to 4 % in 2003 (see Figure 2).
Undoubtedly, considerable part of this significant reduction in the inflation rates is accounted for by the
considerable continuous improvement of the practices of monetary policy implementation, the
accumulation of expertise and experience, and the institutional strengthening of the central banks in the
region. Of course, central banks could not reap alone the ovations for the successful inflation rate
reduction. Balancing the fiscal policies of national governments, as well as the continuous process of
opening of national economies, market globalization, and the increasing competition also contributed to
the reduction of inflation rates6. Low inflation rates were made possible because the societies realized
the high price of inflation and had the will to take actions ensuring price stability.
See Cukierman, A., Miller, G., & Neyapti, B., (2002). ‘Central bank reform, liberalization and inflation in transition countries – an international
perspective’, Journal of Monetary Economics 49, pp.237-264.
4
Except Albania, Serbia and Montenegro, for which we have no data. For an indepth presentation see ‘Objectives of the central bank as set out in
legislation’, Bank for International Settlements, 2001.
5
See BIS, pp. 13-14.
6
See Rogoff, K., (2003). ‘Globalization and global disinflation’, FRB of Kansas City Economic Review, pp.45-78.
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Chart 2. Inflation in Central and Southeast Europe economies and G-7 economies
(annual percentage change)
Individual central banks in the region have managed to a different extent to achieve control of
inflation rates. At the end of 2002, a prevailing part of the countries from Central and Southeast Europe
(with the exception of Romania, Serbia and Montenegro) have one-digit inflation rates of consumer
prices7. This stabilization of inflation at one-digit levels is a considerable achievement, given the
comprehensiveness of the reforms that our countries had to implement for a relatively short period of
time. At the same time, we know these countries are characterized by an endogeneous trend of
increasing price levels due to the continuing process of convergence of real incomes to the income
levels in the developed countries (see Figure 4). Later in my speech, I will provide more detailed
observations on the effect of the real convergence process on the inflation rates in the Central and
South East Europe countries.
Monetary Policy Strategies
The monetary policy strategies of the banks in the region developed in time depending on the
transition stage their economies had reached. Presently, we can define two main groups of countries with a floating exchange rate and direct inflation targeting and countries with fixed exchange rate and
focusing central bank policy on maintaining a fixed exchange rate. The discussion on the choice of an
exchange rate regime and a monetary policy strategy is very enormous and sophisticated to be
described in detail in such a short speech. Our countries’ experience proved that both floating and fixed
exchange rates can ensure price and financial stability and a favourable environment for economic
growth. I believe that in the countries with less stable or more temperamental political environment,
currency boards act as a stabilizing factor.
The issue, Central and South East Europe’s central banks should find an answer to, is to what extent
the presently existing monetary policy strategies will allow them to perform their main tasks. The
development of the economy and society is accompanied by a high degree of uncertainty. This faces
central banks with the incessant need to adapt to the changing economic environment. Which is the
major challenge that our central banks will have to face in the medium-term perspective and how will
this impact their priorities and strategies?
The Challenges
It is a fact that 8 countries from the region will join the European Union (ЕU) in May this year.
Bulgaria and Romania are looking forward to accession in 2007, and the remaining countries in the
region - as a longer-term prospect. The EU accession presupposes joining the Economic and Monetary
7
See EBRD Transition Report 2003, ‘Integration and regional cooperation’, pp. 108-212.
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Union as a next step, as the new EU member-countries cannot exercise an opt-out clause as regards
EMU membership.
The accession of Central and South East Europe countries to the EMU and of the national central
banks to the European System of Central Banks (ESCB) is the major challenge for us in a mediumterm perspective. The requirement of achieving real and nominal convergence of the national
economies prior to each country's accession to the EMU, assign to the central banks the task to define
and implement a monetary policy strategy, which would ensure both price stability and real
convergence.
The nominal convergence criteria (known as the Maastricht criteria) set five preliminary conditions
that each country should comply with before joining the EMU.

Achieving an inflation rate, which should not exceed by more than 1.5 percent the average
inflation rate in the three Euro area countries with the lowest inflation;

Achieving a nominal long-term interest rate, which should not exceed by more than 2 percent
the one in the three countries in the Euro area with the lowest inflation;

Achieving a budget deficit below 3 percent of the GDP;

Achieving a level of the gross sovereign debt to GDP ratio below 60 per cent;

Supporting a fixed exchange rate to the euro for a period of at least two years.
Inflation
Among the nominal convergence criteria, the criterion of achieving an inflation rate equal to the
average rate in the three EMU countries featuring the lowest inflation plus 1.5 % is a direct
responsibility of the central bank. As already mentioned, the central banks in the region have to a great
extent managed to formulate a monetary policy strategy allowing them to ensure price stability. (see
Figure 3). To what extent, however, will the existing strategies permit central banks to additionally
reduce the inflation rates to a level compliant with the inflation criterion, will depend on some changes
in the structure of the respective economies. These changes are beyond the direct control of the central
bank, but it should take them into consideration in formulating and pursuing the monetary policy.
Long-Term Nominal Interest Rate
The convergence of the long-term nominal interest rate is partially a function of the central bank's
policy. As we are well aware, central banks can exercise control only on the short-term interest rates.
The long-term interest rates are a function of multiple factors, most of which beyond the central bank's
control. Since the long-term nominal interest rate incorporates the long-term inflation expectations,
managing inflation rates and inflation expectations in the economy is the contribution, which the
central bank is able to provide for the compliance with the interest rate convergence criterion.
Exchange Rate
The countries practicing floating exchange rate and directly targeting inflation will have to adapt
their monetary policy strategy in a way allowing them to participate in ERM II. In other words, they
will have to fix their exchange rate to the Euro, preserving the possibility to pursue an independent
monetary policy to the extent this is compatible with supporting the fixed exchange rate. The countries
with a fixed exchange rate of their national currency to the Euro (including the ones practicing a
currency board) will not have to make any significant changes in their monetary policy strategy. The
ECB's position on the in-principle compatibility of currency board regimes with ERM II, provided that
the regime is sustainable in a long-term perspective, does not require from central banks operating
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under such a regime to change their monetary policy regime in the transition period before their EMU
accession8.
Chart 3. Inflation in Central and Eastern Europe economies and Euro area
(annual percentage change)
Nominal and Real Convergence
As I mentioned earlier, one of the main criteria of nominal convergence is maintaining an inflation
rate not exceeding by more than 1.5 % the average rate for the three countries in the Euro area with the
lowest inflation rate. I find this as one of the greatest challenges for the national central banks, as to a
certain extent this goal comes in contradiction with the goal of achieving real convergence.
It is well known that there is a strong correlation between the price level and the incomes in the
economy. The incomes increase in the economy goes along with a rise in prices (see Chart 4). The
countries joining the EU this year have per capita income that is 47% of the income in the EU and a
price level that is 52% of the level in the EU9. This contradiction between the requirement for
achieving nominal and real convergence before the actual membership in the EMU is one of the most
important challenges for national central banks, and they must find an adequate solution by adapting
their monetary policy strategies.
Chart 4. GDP per head and price level in
Acceding and Candidate countries
EU15=100 (in PPS)
See European Central Bank ‘Policy position of the Governing Council of the European Central Bank on exchange rate issues relating to the Acceding
countries’, 18 December 2003.
9
See Eurostat 'Purchasing power parities and related economic indicators for EU, Acceding and Candidate Countries and EFTA' 9 December 2003.
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As I already said, the uncertainties about the development of the political and economic life in the
individual countries faces central banks with many challenges and they must find the best possible
solution to these challenges. In this short speech I could not, and I do not intend to, make an extensive
review of the evolution of central banks’ strategies and priorities in Central and Southeast Europe and
the challenges before these banks. I rather hope that what I have shared with you today would be a
good basis for holding productive and useful discussions during this forum.
Thank you very much for your attention.
I wish you constructive and useful discussions.
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