Good morning,
It is my great pleasure to welcome you to the Second Annual Research Conference organized by the National Bank of Ukraine in cooperation with Narodowy Bank Polski with the assistance of the Government of Canada and the Kyiv School of Economics.
Leading economists, scholars and researchers from different countries gathered together for two days to discuss the role of the central bank in economic development, a topic that has always garnered a keen interest. This topic will be central on the conference agenda today since the issue of post-crisis economic recovery is relevant not only for Ukraine, but also for most other countries across the world.
Last year our country, and particularly the NBU, focused its efforts on curbing inflation. Economic growth, although expanding at the fastest pace in the past five years, remained modest. This year inflation continues to trend downwards.
In this light, promoting faster economic growth is at the forefront of our efforts. This being said, the question arises as to who should be responsible for this?
The role of central banks has changed over the past three centuries since they came into existence. This role has been evolving and changing, affected by the crises that have accompanied the economic development. For operational purposes, most central banks use the term “stability”. It is not surprising because central banks were established to pursue currency stability, with money being the liability of the central bank before each citizen of the country. The instability inherent in the monetary system brought into focus the need for the independence of central banks from government authorities since the latter tend to pursue shorter-term objectives.
The need for the central bank to play a stabilizing role is questioned. It is logical. Hardly anybody likes crises and their repercussions.
At the same time, stability as an objective often imposes constraints, including constraints on economic growth. It is this issue that has caused divisions in opinions about the central bank's policy.
Finding a balance and a compromise between stabilization and growth objectives is a major stumbling point in discussions about the role of the central bank.
The NBU has recently followed a short but eventful path toward economic stabilization. The Ukrainian society is of tired of the crises that, although varying in intensity, have persistently ravaged the country’s economy.
Therefore, we quickly reached a consensus within our central bank as to the NBU’s policy in different areas.
We came to understanding and worked out a common vision on a long-term policy that we will be consistently implementing.
To achieve this goal, this policy should be proactive and forward looking. Furthermore, all the objectives of the central bank, notably price and financial stability objectives, have to be achieved simultaneously and in the most efficient manner.
How should they be achieved?
I would like to start with a priority objective for most central banks — ensuring currency stability.
The economic literature uses the term “anchoring expectations” to assess the central bank’s performance. In simple words, this means that the public has confidence in the ability of the central bank to ensure currency stability and money enjoys public trust. If a central bank has managed to anchor expectations, it has succeeded in performing its function.
The exchange rate has long served as the anchor of stability in Ukraine. However, it failed to meet expectations. After periods of relative and delusive stability, the hryvnia, our national currency, depreciated significantly, affected by the crises. At this, periods of stability became shorter and shorter. Of course, under these conditions, the domestic currency did not enjoy credibility, which was manifested in high interest rates and a high level of dollarization.
It was necessary to search for a new anchor for expectations, which should ensure confidence in the domestic currency. Only low and stable inflation could become an anchor that met this condition.
Therefore, we came to understanding that there was no alternative to inflation targeting
This regime has proved to be efficient in other countries. This is primarily because inflation ceased to be a problem. This paved the way for long-term planning, and thus opened the door to making long-term savings and investments.
Opponents of this monetary regime argue that its implementation has failed to shield some economies from the global crisis. However, they leave out of account the fact that despite the crisis expectations remain well anchored in most economies that have long maintained price stability. Therefore, the central bank and its currency remain credible. This makes it easier for the central bank to nurse the post-crisis economy back to health.
Inflation targeting is also blamed for ignoring economic growth objectives. In fact, this is not true
First, the process of achieving price stability entails economic growth losses mainly in the short term. Indeed, the central bank has initially to convince the public of its intent to achieve inflation targets. And this requires rather tight monetary policy. However, this is a short-term price for long-term stability. In fact, there is no alternative. If this price is left unpaid, the economy will be constantly exposed to crisis in the absence of confidence in the money.
Moreover, the central bank is able to make the process as less painful as possible. For instance, the NBU managed to minimize economic growth losses even during the announcement of quantitative inflation targets in the summer of 2015. For this reason, the path towards achieving the medium-term inflation target, which envisages a gradual rather than sharp decline in inflation, was defined over a three-year horizon.
We have already reaped the first positive results: the NBU successfully met its first quantitative inflation target in 2016, with the economy starting to recover.
Second, implementation of inflation targeting allows making economic growth more sustainable. Anchored expectations and confidence contribute to a more flexible adjustment of the economy to shocks and help mitigate exchange rate and interest rates volatility. The experience of many countries and their numerous researches have proved it.
Indeed, strong economic growth does not mean rapid economic growth. There is no clear evidence that countries with inflation targeting grow at a faster pace. However, any monetary regime itself cannot be a "magic pill" capable of boosting economic growth. The potential for economic development is unleashed primarily owing to a favorable climate for investment and innovation. However, the central bank alone cannot and should not be the driver of such changes.
However, the central bank can only achieve its price stability goals only if the financial system is healthy. And here we come to another key objective of central banks: ensuring financial stability
The problem of financial stability is important for most central banks. After all, if before crisis in 2008 two thirds of central banks had a mandate to facilitate financial stability, after the crisis four out of five banks have it.
Finding the balance between stability and development is also evident in this aspect of the central banking.
On the one hand, banking regulation should reduce the risks of financial crisis and, thus, prevent economic growth losses. On the other hand, the regulation limits opportunities for the financial system development and, thus, economic development potential. Finding the right balance in this case requires a thorough analytical work.
These efforts, if proved successful, will result in the delivery of sustainable, safe, but quite strong economic growth. According to the Basel Committee on Banking Supervision, a one percentage point reduction in the annual probability of the financial crisis leads to GDP growth of 0.6%. At the same time, the loss caused by the regulation as estimated by the Committee is relatively moderate. For example, each one percentage point increase in the capital adequacy requirements over a four-year horizon leads to a GDP drop of 0.19%.
Unfortunately, Ukraine has a long history of financial instability, having suffered losses from the banking crises
After another episode of the crisis, it was clear that the banking system in its pre-crisis state only undermined economic growth. It was weak due to both risky activities performed by banks as a result of reckless regulatory forbearance, and banks’ involvement in sham banking operations conducted in parallel with classic banking operations.
Under such conditions, effective reallocation of resources in the economy was out of the question. On the contrary, the financial system was constantly generating losses. After all, banks shifted their losses to the state. Therefore, bringing the banking system back to health was one of the main components of the package of reforms that were supported by international financial institutions.
Since the beginning of reforms, half of Ukrainian banks left the market. However, this led the banking system to become more stable and healthier. It can now enjoy the confidence and properly perform its functions.
Of course, the NBU not only removed insolvent banks from the market. Also, new risk-based approaches to banking supervision and regulation were introduced. Intensive efforts are underway to develop and design macroprudential tools. We stay strong in the pursuit of our goals and plan long-term financial stability policy.
The NBU has many problems to address to better facilitate economic development. As you know, it is possible to reach a consensus on difficult issues only through broad professional discussions.
We invite you to a discussion, dear participants and guests of the conference!