Sustaining Low Inflation in Ukraine

Abstract

This publication presents the collection of papers written in 2004 within the project that aimed to broaden the knowledge about sources of inflation in Ukraine and indicate policies that can support low inflation in the future. While working on analyses of monetary policies and inflation, the authors used the experience of other transitional countries, Polish in particular. The project team1 hopes that the research gathered in this volume will contribute to the understanding of the sources of inflation in Ukraine and to the influence of monetary policy instruments on other variables.Over the last years, situation in Ukraine improved considerably. The country started to grow in 2000, and the rates of economic development have been impressive since then. It is enough to mention that the economy expanded by 12% in 2004 only. The end of the year 2004 was also marked by important political change, which became possible due to the mass protests, the so called Orange Revolution. The new president and the new government of Ukraine declared their pro-market orientation and the will to adhere to the needed economic reforms, while at the same time working on closer integration with the global economy. One of the macroeconomic challenges that Ukraine faces at the moment is to lower and stabilise the rates of price changes. After some years of relative stability - and even months of deflation in 2002 - consumer prices were rising by over 10% in annual terms in the second half of 2004 already, and recorded 15% y/y growth in the first half of 2005. Certainly, the reversal to the high and unstable inflation rates threatens sustainable economic development. With the perception of macroeconomic instability - which is often signalled by unstable and high inflation - the authorities are less able to conduct economic policies, as the trust of economic agents is limited and their behaviour hard to predict. The proposition that the monetary policy turns gradually away from the exchange rate-based stabilisation to inflation targeting was communicated by the National Bank of Ukraine in 2003 already, and released in fundamentals of the monetary policy for the following year. To date, however, the exchange rate peg to the US dollar have remained the nominal anchor of the monetary authority. Some new solutions in the functioning of the monetary policy are necessary if the current monetary regime in Ukraine is to be replaced by direct inflation targeting. Among them are: the necessity for the central bank to act independently and be credible, developed financial market with stable banking system, and the ability to conduct comprehensive and systematic analytical work in order to better understand the underlying reasons of price changes, as well as the speed at which the economy reacts to the changes in monetary policy. The authors of the research gathered in this volume carried out analytical work related to these subjects. Relevant transitional experience was used to illustrate possible effects and necessary conditions for moving to inflation target, and detailed calculations of inflation measures and estimates of monetary policy transmission in Ukraine were explored.