Monetary policy, Euroization challenges in 2025, and the need for credibility

Albania finds itself at a delicate juncture where its monetary policy no longer wields the influence it once did. While the central bank has raised interest rates and maintained the stability of the lek, a significant portion of the economy remains closely tied to the euro, diminishing the effectiveness of interventions by the Bank of Albania.

This reality underscores a fundamental issue: in an environment where external factors often dominate economic decision-making, the primary challenge is how to make monetary policy effective without compromising financial stability.

Similar to many Central and Southeastern European countries, Albania faces a complex phenomenon—partial euroization. A substantial share of deposits and loans is denominated in euros, which significantly limits the Bank of Albania’s ability to directly influence inflation and domestic credit.

This situation contrasts sharply with countries like Norway and Sweden, which, due to the absence of euroization and full monetary independence, can exert clear and strong influence over economic activity whenever they adjust their base rates. In contrast, Albania experiences a diminished effect, particularly concerning credit and exchange rates.

Transmission channel limitations

The primary transmission channels of monetary policy in Albania are constrained by the prevalent use of euros in the economy. Interest rate interventions impact only lek-denominated loans, while euro-denominated loans and deposits are primarily influenced by decisions of the European Central Bank.

In practice, an increase in the base rate by the Bank of Albania is often neutralized by borrowers’ choices to switch to euro-denominated loans, especially during periods of monetary tightening. This weakens the central bank’s ability to curb consumption or stimulate savings as needed.

The exchange rate of the lek has been another crucial element in recent monetary policy. After a prolonged period of a strong euro against the lek, developments in the past 3-4 years led to a noticeable depreciation of the euro, creating new pressures for exporters and sectors directly linked to external markets.

Subsequent stability, achieved through careful interventions by the Bank of Albania and other market factors, has partially helped maintain confidence and limit pressure on imported inflation. However, this imposed stability, following a period of significant fluctuations, has reduced the flexibility of monetary policy to be fully transmitted through the exchange rate channel.

Consequently, the Bank of Albania finds itself with narrower space to influence domestic economic dynamics, while the market remains dependent on external movements of the euro.

Regional comparison and disparities

Compared to other Central and Southeastern European countries with lower levels of euroization, such as Poland and the Czech Republic, Albania faces a noticeable limitation. In these countries, a 1-percentage-point increase in the base rate is immediately reflected in credit and deposits, slowing lending and curbing consumer spending.

In Albania, conversely, effects are felt only in lek-denominated credit and deposits, while the much larger euro-linked segment remains almost untouched. This creates a disparity where the impact of domestic monetary policy remains partial and often supplanted by the pressure of external factors.

An interesting comparison can be made with Croatia, which, prior to joining the eurozone, had a high level of euroization but gradually implemented policies to increase the share of the domestic currency in financing. This process was accompanied by measures to strengthen the credibility of monetary policy and improve the management of exchange rate risk by businesses and individuals. Albania, though in a different context, can draw valuable lessons from this experience.

Social and economic dimensions

Euroization is not merely a technical issue. It has direct social and economic consequences.

Small businesses, lacking access to advanced currency risk hedging instruments, are often more exposed to fluctuations. Similarly, families that take out loans in euros but have income primarily in lek remain unprotected against exchange rate risks, making monetary policy also a social issue.

This risk is not limited to borrowers. A significant portion of Albanian households still rely on remittances, which primarily come in euros, and exchange rate fluctuations directly affect their purchasing power.

A similar situation is encountered by groups working or earning income from international projects funded in euros, who face a noticeable imbalance between income and costs in the domestic currency.

On the other hand, tourism, now one of the main engines of the Albanian economy, is strongly influenced by the euro/lek exchange rate. A weak euro makes Albania more expensive for European visitors, potentially reducing revenues for domestic businesses dependent on this sector.

These examples clearly show that the limitations of monetary policy do not only affect financial markets but also directly impact the daily lives of thousands of families and the stability of sectors most exposed to the euro.

If this reality continues, the risk is that the most vulnerable segments of the market, such as low-income consumers or small businesses, remain more exposed to external crises, and domestic monetary policy decisions fail to assist them adequately.

Measures taken and necessary reflection

Measures taken so far have provided limited stability.

The reduction of the base rate during 2025 has only partially affected lek-denominated credit, indicating the limitations of monetary policy transmission in a highly euroized economy. The Bank of Albania’s decision to lower the rate from 2.75% to 2.5% in July and maintain it unchanged in subsequent months reflects a cautious approach aimed at supporting price stability while preserving market confidence.

The stability of the lek exchange rate, maintained through consistent interventions, has minimized rapid fluctuations and limited pressure on imported inflation. However, this imposed stability has reduced the flexibility of monetary policy to be fully transmitted through the exchange rate channel.

In this context, although monitoring foreign currency loans and improving communication of monetary policy have helped raise market expectations, the overall effectiveness on inflation and credit remains reduced.

Exchange rate stability remains a key element, but it must be accompanied by sufficient flexibility for monetary policy to be more effectively transmitted throughout the economy.

A clear and credible policy, combined with concrete measures to encourage the use of the lek and manage currency risk in loans, can strengthen the impact of the Bank of Albania and adapt the economy to the realities of euroization.

In summary, Albania’s main challenge lies in the limited effectiveness of monetary policy due to euroization and the influence of external factors. Measures taken so far have ensured stability but have not provided a full impact on inflation and credit.

The way forward requires an integrated approach that combines maintaining exchange rate stability, developing lending in lek, and strengthening the credibility of monetary policy.

Credibility must remain at the core of the Bank of Albania’s actions, which needs to build a stronger, more flexible policy tailored to the realities of a euroized economy, to face external challenges with determination and ensure long-term stability for society and the economy.