Download Is the Inflation in Albania so Low?

Is the Inflation in
Albania too Low?
Mimi KODHELI
Economics Dept-University of Verona
Is the Inflation in Albania too Low?
-Background-
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The fall of communism in late 1990 was followed by economic
collapse, social disorder and widespread emigration;
A one-year reform program began in 1992-target: “to reduce
annual inflation from over 300% to below 20%”. Monetary
policy was based on direct instruments of monetary control;
A two-tier banking system was established in April 1992;
The banking system, in first half of ’90s, was dominated by 3
state-owned banks which quickly accumulated debt problems;
The Rural Comm. Bank was liquidated in January 1998, the
National Comm. Bank was privatized to foreign investors in
2000, and the largest state-owned bank, the Savings was
privatized to Raiffeisen Bank of Austria in late 2003.
Is the Inflation in Albania too Low?
-Background-
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The performance of the Albanian economy during transition
has pleasantly surprised many people;
Albania has quickly moved to high GDP growth and falling
inflation, making serious efforts towards market reforms;
A bond and T Bill market started to emerge in 1995 which
helped public debt management and monetary policy;
In early 1996, some licenses where issued to several foreign
banks;
Nevertheless, BoA continued to impose ceilings on deposit
rates offered by state-owned banks;
New private banks have encouraged the use of indirect
instruments of monetary control and inter-bank competition;
Is the Inflation in Albania too Low?
-Background-
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These achievements were jeopardized, by a period of turmoil
and quite anarchy in early 1997;
Several large pyramid schemes, into which much of the
population had put their savings, collapsed;
Since then, Albanian economy has enjoyed high annual
growth rates and low inflation;
Nevertheless, financial sector development is still at an early
stage, and informal markets flourish;
Albania is paying attention to the role of monetary policy,
especially to the costs and benefits of new instruments and
moving to more explicit inflation targeting;
Is the Inflation in Albania too Low?
-The Environment-
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4 of the channels that operate in market economies are:
Interest rates,
Credit ceilings,
Exchange rate, and
Inflation expectations.
In case of Albania channels like equity prices or housing
market are less relevant;
During 90s, the exchange rate channel was the most
promising route for explaining inflationary developments;
This link of two variables is seen clearly during 1997, when
both the exchange and inflation rate jumped sharply (these
rates fell rapidly once the situation was under control);
Is the Inflation in Albania too Low?
-The Environment-
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Foreign currency circulates widely, both because of high inflow
of remittances and from contraband activities;
The stable exchange rate has played a key role in anchoring
inflationary expectations;
The independence of BoA was sanctioned through Law “On
the Central Bank” of December 1997;
BoA undertook many steps in order to reestablish an
environment in which prices would have a relative stability,
and public regained the confidence in Lek (local currency);
Deposits increase with an average of 6% of GDP during’03-04
The quantity of Lek outside of banks as a % of money at
large decrease from 32 to 27% during the same period;
Is the Inflation in Albania too Low?
-The Environment-
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Despite the last years’ achievements, the economists consider Lek as
an “over valuated” currency;
It is important to underline that BoA targets the inflation and not the
exchange rate;
During the recent years, the 12 month interest rate has dropped
towards the 2-4% floor, thus the monetary policy of a strong Lek is
considered by the economists “utterly tense”;
But, a strong Lek would not hurt the international competition for as
long as it reflects a result of the stable equilibrium caused by internal
factors of the Albanian economy;
Several economist reached the conclusion that: ”Albania may find
itself in facing the dilemma of holding the inflation at low levels, or
fulfilling the process of the market liberalization, but not both at the
same time”.
Is the Inflation in Albania too Low?
-The Inflation and the Economical Growth-
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The difficult challenge of today lays in obtaining “the invisible
profits” of a low inflation period which would explain the small
but constant effects on the economic growth;
The average growth of Albania’s GDP of 6% during 2000-’05
has passed that of every country in the region; while the
average increase in prices of 2.2% were lower that others;
An environment of low inflation seems to have been in favor
of that part of society with fix income. Some data: During ’95’98 (average inflation was 18.5%) the pensions in the city as a
% of GDP/capita were reduced annually by 4.8%, from 47.3%
in 1995 to 38.2% in 1998. On the contrary, during 2000-’03
(average inflation was 3.2%), the pensions increased by
0.5%-from 36.5% in 2000 to 37.4% in 2003;
Is the Inflation in Albania so Low?
-Expectation on Inflation-
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In the last 5-year period, the level of prices started to get
closer to that of other regional countries with ambitions to
join the EU. Here is an important question: Can the inflation
remain so low and stable in countries with an economy in
transition?
“The disaggregating” of the data on inflation shows that two
important factors have been:
1- the structural reforms in industries, where the tariffs were increased in order
to cover costs, and
2- the seasonal changes in the supply, especially in agricultural sector;
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Firstly, after the year 1998, the general interest rate started to
stabilize while prices in various sectors started to differentiate:
Is the Inflation in Albania too Low?
-Expectation on Inflation-
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Prices of import goods reflected the overpricing of Lek
dropped by an annual average of 2.5% during 2001-2005;
Prices of traditional public sectors (electric power, health,
education) have grown by an annual av. of more then 6%;
Prices of groups consisting of domestic products grew by an
annual average of 3% that was generally in line with overall
price growth (3.4%), during the same period;
In the banking system, the combination of low inflation,
consolidation of fiscal system, and additional liquidity provided
by the privatization of the Savings Bank (2003), resulted in
increased loans and reduced financial costs for investments;
As a result, the loan for the economy grew 30-40%;
Is the Inflation in Albania too Low?
-Expectation on Inflation-
180
160
140
120
100
ICP
Foods &non alcoholic drinks
80
Monthly Interest rate
Average monthley interest rate
Exchange rate Euro/Lek
60
40
20
0
99
99 l-99 t-99 -00 -00 l-00 t-00 -01 -01 l-01 t-01 -02 -02 l-02 t-02 -03 -03 l-03 t-03 -04 -04 l-04 t-04
r
r
r
r
r
n- pr n
n
n
n
n
Ju Oc
Ju Oc
Ju O c
Ju Oc
Ju O c
Ju O c
Ja
A
Ja
Ap
Ja
Ap
Ja
Ap
Ja
Ap
Ja
Ap
-20
Is the Inflation in Albania too Low?
-Expectation on Inflation-
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Secondly, prices have traditionally shown a stable seasonal
model. The monthly inflation rates observed in Sept. and Dec.
(respectively an av. of 0.8% and 3.6% during ’99-’05) are in
contrast with the average deflecting rate of 0.2% for all the
other months;
The seasonal influence reflects the importance of agriculture
in the domestic product (27% of GDP) as well as remittances
& income generated by tourism. The latter ones culminate in
summer and Dec. when Albanian emigrants visit their families
and bring money, mainly Euros.
In Dec. the Albanian families seem to pre-finance their
shopping for the end of the year, thus causing a constant
growth of prices in Dec. and lower exchange rate in January;
Is the Inflation in Albania too Low?
-What is the Explanation for the Valuation of Lek?-
From the macroeconomic point of view there are no indicators
of the efforts by the Albanian monetary authorities to
artificially increase the external value of the market;
 It seems there are two essential reasons that can explain the
strength of Lek:
1- a growth of the remittances and other money entries, and
2- improvement in the productivity of the sectors of tradable
goods that in line with the predictions of the BalassaSamuelson model, would have caused a valuation of the real
exchange rate;
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Is the Inflation in Albania too Low?
-Increased productivity & valuation of the (real) exchange rate-
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The highest growth rate of transitional economies as
compared to those of more advanced economies, must be
based in comparable growth (higher) in the ratio capital/work
and in the total factor of productivity, especially in commercial
sectors;
The available data in Albania on the development of the
average salaries in various industries are inaccurate, mainly
due to transactions in cash, fiscal evasion and a large informal
sector;
However, official data on the salaries may show the possibility
that the Balassa-Samuelson assumption may be true:
Is the Inflation in Albania too Low?
-Increased productivity & valuation of the (real) exchange rate-
1997
1998
1999
2000
2001
2002
Industry
9,411
10,792
12,203
13,230
14,839
15,882
Non-tradable Sector (average)
8,581
10,968
11,765
13,154
14,384
16,706
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Construction
8,340
10,617
10,936
12,489
13,416
15,014
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Transport & Communication
9,350
11,744
14,503
16,225
18,124
23,434
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Commerce
8,819
9,653
10,901
10,889
12,856
13,924
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Services
7,814
11,856
10,718
13,012
13,140
14,453
109.7
98.4
103.7
100.6
103.2
95.1
Industry /NT Sector salaries in %
Is the Inflation in Albania too Low?
-Increased productivity & valuation of the (real) exchange rate-
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Data shows that a correspondence between proportions in
ratios of relative prices with the ratios of the real exchange
rate, which implies that the valuation of lek is in proportion
with the growth in productivity, transmitted in the ICP through
transitory inflation;
Another phenomenon of the Albanian economy that might be
explain by B-S effect is the fact that the reduction of comm.
deficit from 26% of GDP in 2002 to 20% in 2005-06, is
consistent with the interpretation that the valuation of the
exchange rate was a result of the increased productivity
(Albanian export was part of world export at 0.011% in 2000
and 0.019% in 2005);
Is the Inflation in Albania too Low?
-Increased productivity & valuation of the (real) exchange rate-
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But, De Broek and Slok found clear evidence of the B-S effect
in the EU candidate countries, while such evidence is not so
strong in other transitional countries (including Albania)
because their majority has gone through long periods of
economic growth;
The results must be similar even for particular countries with
fixed exchange rates such as Estonia & Slovenia that joined
euro zone in mid ’04;
Contrary to countries with flexible exchange rates such as
Albania, the B-S effect in such cases is manifested through
high inflation rates and not through a valuation of the
exchange rate;
Is the Inflation in Albania too Low?
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In general terms, there are not indicators showing why
Albania cannot and must not keep an environment of low
inflation, while at the same time it completes the program of
structural reforms;
BoA, through its monetary policy has increased the credibility
of its policy for an inflation rate within the limits of 2-4%,
which is 2% higher then the band used by the Central
European Bank;
The theoretical and empirical problems for qualifying the
permanent effects of the low inflation rate on the economic
growth are multiplied because of the lack of data in Albania;
Recommendations:
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Due to a continuous low inflation rate, the BoA can and must
attenuate the monetary policy by supporting the commercial
bank sector, that is now completely privatized, in order to
increase loans for the economy by encouraging investments in
the private sector and by maintaining economic growth in the
same levels.
Balassa – Samuelson Model
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a)
b)
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The BS effect is either of two related things:
the observation that consumer price levels in wealthier
countries are systematically higher than in poorer ones (the
Penn effect);
An economic model predicting the above, based on the
assumption that productivity or productivity growth-rates
vary more by country in the traded goods’ sectors than in
other sectors (the BS hypothesis).
Every economy is presumed to manufacture two kind of
products, where the companies that max their profit
produce tradable and non-tradable goods. Both sectors
produce commodities according to a standard constant
function production:
Balassa – Samuelson Model
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↔ ↔ ↔ ↔
Yt = At x Ltα x Kt1-α, 0<α<1
^ ^ ^
^
Yt = At x Ltβ x Kt1-β, 0<β<1
where:
(A1)
(A2)
↔
^
 Yt = Yt + Yt ;
A= total factor of productivity; L= Work; K= Capital
(A1) – tradable goods (A2) – non tradable goods
Balassa – Samuelson Model
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Prices of tradable goods and interest rates are
determined at world trade market, and salaries are
determined by the highest productivity sector (in
general the tradable goods sector);
Assumptions of the B–S effect result in an internal
transmission mechanism: “The traded goods have a
higher productivity growth than the non-tradable
goods sector, leading to higher relative non-tradable
goods’ prices and inflation”.
…..to be continued