Mongolbank’s dream

N.Zoljargal, the President of Mongolbank (The Central Bank), introduced the draft monetary policy to be pursued next year along with its main directions to the parliament last week.He said that Mongolbank in cooperation with the government would keep inflation low:under eight percent when the impact of supply side-inflation is measured using the Consumer Price Index by the end of 2013. It was informed that after that they would even hold inflation rate between 5-7 percent. Is this new monetary policy from Mongolbank only a dream? And, what effect will this dream produce on the real economic growth of Mongolia?

Inflation

The Gross Domestic Product (GDP) of Mongoliarose by 17.3 percent in 2011 and this year it is likely to come to 15 percent due to global economic slowdown.However, inflation rate went up by 15 percent in 2011 and it looks like that the same levelit will happen hit again this year. This means that the spending of a middle-income Mongolian has been increased by the same percentage as well. In other words, his real purchasing power increased only 2.3 percent last year while no growth at all will occur this year. That is why he will hardly notice the economic growth because changes in his real income are too little.

When consumer goods supply does not increase as much as the supply of money, like with any other product, the value of money gets reduced. This is what we call “inflation”, where money loses its value and prices rise. Economists such as Hume, Ricardo, Mill, Fisher and Friedman support the quantity theory of money, which advocates that inflation is only a monetary phenomenon and argues for the relationship between money supply and price level.

The new administration of our central bank, which implements monetary policy of the government, is going to target only inflation rather than money supply and to pursue a policy aimed at price stability only.This will not be enough to overcome the coming economic crisis.

Any central bank in the world has two major duties. The first is to keep inflation and unemployment rates as low as possible and support economic growth. The second duty is to provide liquidity when overcoming a national or international economic crisis. In order to fulfill these duties, a central bank makes necessary changes to its monetary policy, the cost (interest rate) of money and the amount of money (supply).

Policy for price stability

Almost a hundred years ago, Harvard professor Irving Fisher believed, just like Mongolbank’s president N.Zoljargal doestoday, that normal economic growth could be sustained by directing monetary policy to inflation only and keeping price of goods stable. Fisher, who formulated the price equation and laid the basis for Producer Price and Consumer Price indexes, could not foresee the 1929-1933 financial collapse and lost all of his fortune in the stock market crash.

Thinking that economy will do fine as long as prices don’t increasebears a risk to focus too much onshort-term changes in money market and to neglect changes in capital market that produces long-term impacts.
When inflation keeps rising, decreasing its policy rate by pursuing not tight but loose monetary policy will increase the supply of money. The central bank in cooperation with the government, which is unable to go back from its “inefficient social care” policy, willexpand the money supply, even though it had a slight tendency to be reduced, and increase demand-pull inflation.

Monetarist rule

Monetarists including Milton Friedman and some other economists argue for implementing a monetary policy that determinesthe national economic real situation reality by changes in both money supply and price (interest rate).This advice of theirs is also called “Monetarist rule” and it states that M2 money supply growth should come close to long-termaverage growth of economy. For example, it means that, if the real economic growth (GDP growth rate adjusted for inflation) is two percent, money supply can be expanded by about two percent the same year.

This rule requires the government to strictly follow its budget discipline and to increase money supply in coherence withchange of supply of goods. The U.S. Congress incorporated this relation into its Employment Act in 1946. This law stated that the main purpose of budgetary and monetary policies was to provide employment to everyone and to keep prices stable. This way, the purpose of the cooperation between the central bank and the government was legally defined, which contributed significantly to further sustainable economic growth in the US.

Fiscal policy

If Mongolbank is going to pursue a soft monetary policy aiming for inflation, expansion in the money supply should be expected and they need to create and implement a monetary policy that goes in harmony with budgetary policy and is pointed at increasing supply of goods, number of jobs and labor productivity.
This harmony between monetary and budgetary policies should have three objectives. The objectives would include providing jobs to as many people as possible, keeping prices stable and holding interest rates low in long term.

Mongolbank does not have any instrument that can reduce apartment loan interest rates, which has a major influence in maintaining price stability in long term. Therefore, relevant organizations that regulate the capital market need to be involved.

With a similar fashion, if our fiscal policy reaches out to both money and capital markets and is implemented with clear objectives, the private sector will have an incentive to create jobs, provide stable employment in order to improve its competitiveness and find an opportunity to plan in long term and expand their businesses.

The government and Mongolbank both should be responsible for ensuring the normal functioning of the private sector, reducing their cost of financing its operation and creating free competition.

When the private sector is strengthened, middle income people, who have a job, regular income and are capable of starting an accumulation (more income than spending) will emerge and expand. Then, conditions will be created for peopleto get a 10-year mortgage with low interests and, ultimately, the real economic growth can be sustainable.

Mongolia is at the crucial moment today, when its monetary policy has to be coherent with the capital market and a comprehensive policy of budget and finance has to be created and implemented.

Translated by B.AMAR

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