Price stability is the condition in which the domestic currency retains its purchasing power by maintaining low and stable inflation as measured by the Consumer Price Index over the medium term (from 3 to 5 years). Price stability does not imply that prices do not change; it means that prices grow at a moderate pace.
High inflation reduces the incomes and savings of businesses, households, and the state, and drives an increase in production costs, the cost of credit, and interest rates as a result of uncertainty over future prices.
Large inflation fluctuations create an unfavorable environment for long-term investment in the economy, as investors focus on short-term transactions. Thus, high and unstable inflation affects economic growth.
Taking that into account, creating an environment with low and stable inflation is the NBU’s main contribution to sustainable economic growth. This type of environment implies that:
- inflation is no longer a concern for households and businesses
- trust in the domestic currency grows and the currency becomes more widely used
- the real value of household incomes and savings is maintained
- economic agents do not use foreign currency as the medium of exchange, store of value, and unit of account
- low nominal interest rates support investment activity and economic growth
- households and businesses adequately assess FX risks and are prepared for potential large fluctuations of the exchange rate, which cause a change in the value of savings and liabilities in foreign currency.
In recent decades, the Ukrainian economy suffered from volatile and unpredictable inflation, which undermined trust in the hryvnia, thus causing high interest rates on loans and deposits and a high level of dollarization. This produced an unstable economic environment that hampered economic growth.
That situation was a product of the fixed exchange rate policy that led to an accumulation of macroeconomic imbalances and which was incapable of maintaining stable and low inflation and of supporting economic growth. Moreover, the pegged exchange rate made the public’s expectations susceptible to exchange rate fluctuations. This pushed economic agents to take excessive risks, which limited the use of the exchange rate as a buffer against external shocks.
The NBU’s task is to gradually shift the public’s focus away from exchange rate fluctuations, to focus on inflation. The only way to achieve that is to conduct a consistent and transparent monetary policy aimed at delivering price stability.
The NBU’s focus on price stability requires a commitment to a floating exchange rate, which makes exchange rate fluctuations the main buffer against external shocks to Ukraine’s economy. In the event of negative external shocks (e.g., a decline in demand for Ukrainian exports or a deterioration in the terms of trade), a moderate depreciation of the hryvnia would maintain the competitiveness of Ukrainian exports and mitigate the adverse effect on output and employment. In the event of positive external shocks, a strengthening of the hryvnia would prevent the economy from overheating and inflation from accelerating too rapidly.