Clarification statement to the media on inflation issue

Recent comments state that inflation rate in Albania must be higher, since the present range of 2-4 per cent is impeding the further development of business and economy. Although there have no reasonable arguments why this inflation rate is impeding economic development, or why inflation rate would provide stronger grounds for a higher gross domestic product, the Bank of Albania (BoA) being open and transparent with the public is sending its technical stance regarding arguments why inflation is/should be 2-4 per cent, and what effects a higher inflation rate would bear.

In addition, the Governor and experts from the BoA will organize shortly a seminar in the form of a debate with journalists/analysts on the future stance of monetary policy, inflation targeting, etc.

However, bearing in mind the sensitivity of the issue and from the request of the TVA television, please find below some thesis from Dr. Erjon Luçi, Head of the Research Department at the BoA.

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Recently, various analysts have brought forth the idea that inflation in Albania is being at such levels that it is adding costs to the economy in real terms. The targeted inflation from the BoA comprises an important issue to be discussed; therefore all discussions on the issue are welcomed. However, the discussions, up to now, lack strong arguments in support of a higher inflation rate. With this, we want to underline that keeping a low inflation rate is a much broader and complex issue than what has been treated in the press.

The BoA is committed to keeping the level of prices within the range of 2-4 per cent within the year. The inflation target set by the BoA has been grounded on several factors. Important is the "nature" of inflation. Although inflation is defined as a general increase of prices in transitional countries, often there are relative shifts of prices, in response to deep structural changes and lost balances. This pushes on a higher inflation. Since price shifts are positive for a market economy development, the BoA has been trying to adopt inflation rate to such developments and focus rather on monetary-driven inflation. The answer to the question whether it is the case for the targeted range of 2-4 per cent to be reviewed will be provided by facing potential benefits against the costs put forward earlier.

A possible benefit from a higher inflation is related to a relatively outdated economic concept of the Philips curve. According to this concept, the abrupt rise of inflation can lead to a fall of unemployment rate. Unexpected inflation causes a fall in real salaries, since nominal salaries are fixed in one-year or longer contracts. The fall of the real salaries makes employers hire more people. Nevertheless, the Philips curve has been contested for a long time now, and currently it plays no significant role in drafting economic policies. It also is contradiction with the central bank independence. Hence, the argument for a higher inflation would be quite difficult to find support in such a concept. In the case of Albania, the Philips curve is less contested, since structural changes make it shift continuously, and consequently, the outcome of the above policy becomes quite indefinite. Also, there has been no clear-cut evidence that keeping a low inflation brings additional costs to the domestic product. On the contrary, from some studies it resulted that macroeconomic stability, assed during a low inflation period, plays a positive role in expanding lending to economy and production.

If the growth of competition in Albania is related to lek appreciation, and this latter requires a higher inflation, we would say that this is just a short way leading to a longer one for several reasons.
First, the BoA does not keep the lek appreciated because it applies the free rate regime. Such a regime is kept to make the rate perform as to the developments in economy, too and not in inflation only.

Second, rise of inflation because of lek depreciation is similar to a direct intervention of the bank in the foreign exchange market, which conflicts with the first point.

Third, in various discussions and according to some researches, it has been concluded that the assessment of the real exchange rate in Albania up to now has not played any significant role in worsening the trade balance. The deterioration is of structural and not monetary origin. During its high-inflation rate years, Albania has not had any big production or exports, that because putting and keeping inflation under control (which has not been achieved through the exchange rate) it brought about lower exports. Finally, it should be stressed that the fall of inflation rate in Albania, assisted also by the IMF advices, which has become quite fashionable lately to criticize, has come mainly from fiscal adjustments and not foreign exchange control.

Another problem of a higher inflation rate is related to the psychological drive it has on the public. This phenomenon has to do with the fact that a higher level might lead to an everlasting inflationary spiral. Despite all the BoA's efforts to take higher the reputation of its objectives in front of the public, a strategy of bringing inflation from a lower to a higher level might put at risk the today's reputation. The shift of inflation could be regarded from the market as an inability of the central bank to keep inflation low. Hence, it would be difficult for the central bank to peg market expectations at a new, higher level.

The BoA has been clarifying the public in these last months on distorted concepts and data on the inflation rate in Albania. Being the central monetary body, it is the responsibility of the BoA to inform the public through the media that the present economic system enjoys stability in inflation indicators, and those ideas about lek depreciation, seem rather paradoxical.

One of the fewest efficient fiscal policies applied in these 13 years of transition is certainly the monetary one adopted by the BoA and generally accepted by the public and international financial institutions.

However, with this argument we had no intention to put an end to all the arguments on the optimal inflation level in Albania, which is being carefully analyzed by the BoA in a recent research. What we wanted to underline is that although the theoretical and empirical literature gives ground to speculations on the optimal inflation level, arguments favoring a higher inflation rate are not so convincing, at least in the present circumstances.