Monetary policy and global inflation Jlia Kirly Deputy

Monetary policy and global inflation Júlia Király Deputy Governor Magyar Nemzeti Bank Based on the joint work of Julia Kiraly - Tóth Máté Barnabás

Outline 1. Global outlook – hiking prices 2. What does happen in the EU new member states 3. A special case study: Hungary – déja vue?

What we see? • Oil, food and commodity price increases are pushing up inflation all over the world • But we are not anywhere near to the inflation rates of the ’ 70 s or ’ 80 s • However, there is no reason for central banks to be complacent

Global inflation

Three competing stories • Temporary spike in oil/food/commodity prices – Due to bad weather, capacity bottlenecks, speculation etc. • Permanent relative price change, driven by structural factors – increasing demand from China and India, subsidies for bio-fuel production • Global inflationary pressure – monetary conditions are too loose at the global level – commodity prices are leading headline inflation

How to respond? (in a small and open economy) • Temporary spike – Accommodate the short run inflationary impact – Ensure that inflation expectations remain well anchored and no second round effects occur • Permanent relative price change – Ensure that it takes place in a low inflationary environment – Exchange rate appreciation and a temporarily negative output gap may be necessary – But keep an eye on potential output and second round effects • Global inflation – Aggregate, nominal phenomenon: no change in relative prices needed – Offset imported inflation by engineering exchange rate appreciation

But… • The above three stories are not mutually exclusive… • … and we don’t know which is the most likely one • Policy responses should take this uncertainty into account

New member states • Floaters are more able to cope with imported price pressures – A credible inflation target coupled with the appropriate policy response helps • Countries with fixed exchange rate regimes are in trouble – Imported inflation + imported monetary conditions

Hungary - déja vu? • The fiscal adjustment measures introduced in 2006 created a very similar environment – Inflationary shock due to one off increases in indirect taxes and regulated prices – Slowdown in activity negative output gap – Possible decline in potential (or long run trend) output due to intensifying distortive taxation • Monetary policy decided not to offset the short run impact (see story 1) concentrated on 2 nd round effects instead – Lags in the transmission mechanism – The edge of the exchange rate band limited the room for manoeuvre – The output gap will help to disinflate

Hungary - déja vu? (2) • Just when the inflationary impact of the fiscal adjustment started to fade the oil/food price shock hit • This time we would be ill advised to accommodate – Risks of second round effects and inflation expectations becoming unanchored are higher – We are not sure whether we are facing a one-off rise in inflation or something more permanent – We abandoned the exchange rate band – Reaching our medium term target during 2009 is still within reach • Therefore we tightened by 100 basis points in the first half of the year