The sharp tightening of monetary policy has often caused financial stress or even crises, especially in developed economies, but also in developing countries. Because of higher credit and currency risks, global investors have typically pulled out quickly when interest rates have risen without being able to further clarify their medium-term objective. Of course, the arguments about Albania are valid with reservations since it cannot be compared with these countries, but it is still worth mentioning what happens as an experience in these countries.<\/p>\n
So, what does the presentation of the situation for developed and developing countries mean for Albania?<\/p>\n
The reason is related to the performance of the Albanian economy, which until now has shown itself to be resilient in its modest functioning, although below the unused potential over the years. This elasticity is observed both in the tightening of monetary policies, but also in the tightening caused by inflationary shocks and the low exchange rate of the euro against the lek.<\/p>\n
Now, the monetary market and the economy present two obvious dynamics: bank interest rates have increased at the sharpest rate in the last two decades, and inflation has increased at high rates unprecedented in the last two decades.<\/p>\n
Economic growth was strong last year (2022) and is expected to be well maintained this year, while the sector that reinforces growth is construction and exports of energy and natural resources.<\/p>\n
What justifies the economic performance above the forecasts?<\/p>\n
A critical factor is the entry of foreign and domestic capital that has occurred systematically in the last decade with a high and increasing value reaching at the end of 2022 an investment stock close to 70 percent of the GDP value.<\/p>\n
While capital has entered in large measure, even in amounts difficult to absorb from the still structuring economy, it seems that investments in the residential and commercial real estate sector, as well as energy have encouraged the orientation of foreigners (formal and informal) [1]<\/a> based to a quick recovery of their value serving as a valuable working capital in times of crisis.<\/p>\n But these performing sectors of the economy cannot help the entire economy with a reduction in credit and currency risk. However, the fact that the Central Bank is seen to be moving towards greater exchange rate flexibility by moving to using the exchange rate as a nominal anchor in flexible inflation targeting, higher policy transparency is needed to allow investors (individuals and businesses) to better ascertain risks and be less inclined to flee during periods of financial stress.<\/p>\n While strengthening the credibility of monetary policy is a surmountable challenge, monetary policy is more important for minimizing people’s fear of today’s and tomorrow’s high inflation.<\/p>\n Turning to the outlook for inflation, the financial market seems encouraged by the resilience it has seen and the continued decline in external inflation. While there is a significant divergence between Albania’s trading partner countries in their inflation rates, our market expects inflation to fall quickly to aim for financial stabilization, without a major impact on economic growth. And this expectation for inflation to decrease is the Bank of Albania’s political instrument that will allow it to start reducing rates a little later this year.<\/p>\n Despite this optimism, high inflation remains close to the zone of surprises.<\/p>\n The Albanian economy cannot maintain the same elasticity if, in addition to decreasing inflation, there will also be a devaluation of the lek in favor of increasing purchasing power inside and outside the country.<\/p>\n In fact, inflation has consistently surprised in fluctuations within diverse groups of goods and services of daily consumption. While goods inflation has fallen significantly, services inflation has been strong. Furthermore, policy tightening has not significantly cooled the labor market and wage growth remains the powerful instrument currently as the government’s main fiscal policy.<\/p>\n But it remains an undeniable fact that we still do not know exactly what the reason for the rise in inflation is, but several factors are likely to play and present high risks of inflation in the future.<\/p>\n First,<\/em> while monetary policy has tightened significantly, the economy has not slowed as much, leaving unemployment near historic lows. Of course, monetary policy operates with long and variable lags and the full effects of recent policy tightening have yet to be felt.<\/p>\n But the transmission of monetary policy so far appears less robust than might be expected. This may reflect tailwinds to growth from strong pent-up post-pandemic demand and strong balance sheets from previous fiscal and monetary policy support, both reducing interest sensitivity.<\/p>\n Second,<\/em> we have seen a strong rotation of demand from goods to services. This can generate persistent inflationary pressures because demand for services tends to be less sensitive to interest rates. Services also tend to be intensive, and massive wage increases are unlikely to happen anytime soon.<\/p>\n Third,<\/em> the post-pandemic has reduced output and potential employment, which may add to upward pressures on both labor costs and inflation. While there is considerable uncertainty regarding the outlook for inflation and the exchange rate, as well as related interest rates, according to the argument based on non-Albanian historical precedents, it is quite difficult to reduce inflation without a significant economic slowdown. Thus, the fact that the labor market and economic activity in the construction and energy sectors remain quite strong suggests that we may see significant upward pressure on inflation.<\/p>\n These upward pressures would intensify if the unemployment rate were lower in the agricultural sector and if informality were to slow down in the next few years.<\/p>\n There are also reasons to worry that the current still high inflation, if it continues to be stable, could change the dynamics of inflation. Rather than absorb increases in factor costs into their profit margins, businesses feel more comfortable passing them on to consumers. While workers will have to seek reimbursement for the real loss of wage value, even more so at a time when labor market supply cuts put pressure on demand.<\/p>\n In other words, the longer inflation stays high, the more difficult it can be to reduce it and the greater the contraction of production that would be required to overcome the rising costs of the situations we mentioned.<\/p>\n There is a strong rationale for central banks to maintain a tight policy stance and react aggressively to the presence of high inflation rates.<\/p>\n The central bank has other ways to reduce the tension between price targets and financial stability.<\/p>\n These include ex-ante tools, such as: macroprudential and preventive tools to limit capital flows and financial risks. But on the other hand, there are also tools that can be used in current cases of financial stress of businesses and individuals[2]<\/a>, such as long-term lending with temporary discounts, with repurchase agreements (Repo)[3]<\/a>, through the relief instrument and quantitative easing, which must be supported by central bank swap lines.<\/p>\n In these cases, it is worth offering liquidity support, reducing financial stress.<\/p>\n However, in Albania we are in the conditions of limited use of the few instruments listed above, due to the Bank of Albania’s caution not to create confusion in the market and monetary policy. Such an attitude, which aims to prevent exposure to credit risk or its maturity, has established a high conservatism for such interventions.<\/p>\n The use of these tools should be guided by a careful analysis of the frictions and the nature of the shocks, which in fact are transmitted to the foreign exchange market in Albania. Allowing the exchange rate to adjust flexibly is desirable if the foreign exchange market is truly transparent and part of an economy that can absorb high daily exchange rates. But, in the case when the shocks affect the prices of goods and now when the risk of financial stress cannot be ignored, then an intervention with the means as above is needed, with the aim of balancing the monetary demand and supply.<\/p>\n Some of the side effects of fighting inflation with monetary policy, including financial stress, should be reduced by allowing fiscal policy to play a greater role. The government should prioritize the needs of the most vulnerable in society and economy by reducing broad-based fiscal support and especially for construction. This approach has two reasons, firstly<\/em>, construction has taken more than it should from the budget taxes, creating inequality in distribution, secondly<\/em>, the investment in construction at this time is not guaranteed as a recovery of the investment after it is predicted that we will live in a high inflation environment.<\/p>\n Why?<\/p>\n Monetary tightening, which is recommended to cool down the overheated economy, is to be analyzed differently than the ECB, international organizations (IMF, WB) and the various countries themselves. When they make this recommendation, they have their economies in mind, where the principle of fair redistribution of the budget in sectors and social strata is applied, where informality is low and evasion is not one of the sources of financing activities, where the anti-corruption culture and democracy of in the country is at better levels, as well as where the principle of inclusiveness is applied and political cronyism and the use of political patronage do not exist to this suffocating extent as in Albania.<\/p>\n In the Albanian case, monetary tightening did not prevent construction and other sectors from applying the same rules that are affected by monetary tightening. In Albania, the opposite happened, while monetary tightening was implemented, the Albanian economy performed better than any forecast.<\/p>\n What are the reasons why the recipes used by other countries from which Albania borrows some of their policies could not be implemented?<\/p>\n Answer: Informal market, structure and weak competition, speculation, and informal money.<\/p>\n First, the informal market does not follow the rules followed by a formal economy, where an action of monetary or fiscal policy also affects its response. The informal market is followed by the principle of its informal lending, by informal declarations that are not part of accurate calculations, as well as by a self-exclusion from all those related to those that are given as an approach to healing the market in times of economic crises.<\/p>\n Second, in an economy without adequate competition, business prices and profits rise, while workers’ wages fall. This means that mostly big businesses and their shareholders gain wealth, while consumers and workers’ pay the cost. Here in Albania, there are not enough suppliers that offer competition to buyers.<\/p>\n Given this, it is no coincidence, thirdly and fourthly, that there is a stagnation of market and social reforms, a control of prices and wages, a situation where consumer confidence has little credibility in the market and of course, as a small economy and still unopened with world markets, the inflation rate for some products, unemployment and economic performance based on market speculation and informal money can be temporarily kept under control.<\/p>\n While fiscal consolidation, as an integral and accompanying part of monetary tightening policy, has the same approach, but from the point of view of reducing public debt and reducing inflationary pressures. The value of the public debt stock came because of the devaluation of the euro in the foreign exchange market oversaturated with euros of unknown origin in at least 1\/3 of the entire Albanian foreign exchange market. All this affects the reduction of the debt payments that the government has taken as Eurobond and other debts in euros and later the sufferings of consumers and exporting businesses will be forgotten. But, if the accounts were in the Albanian lek, then the fiscal policy would have to give other reasons, which do not coincide with the political declarations for debt reduction.<\/p>\n So, both approaches are clearly effective in reducing inflation<\/a>.<\/em> However, they work through different channels: monetary tightening reduces demand by raising interest rates and causing the currency to appreciate, while fiscal tightening curbs demand without having to raise interest rates\u2014in fact, interest rates fall in effect theirs according to monetary policy and the currency tends to depreciate. Moreover, monetary tightening causes government debt to rise given higher debt servicing costs and the negative effects of economic slowdown on the primary balance sheet, while government debt falls in the case of fiscal consolidation.<\/p>\n Considering the current situation, it is clearly seen that the pedal of the fiscal policy has been pressed more in favor of the interest of the budget and less of the public and affected businesses.<\/p>\n [1]<\/a> 34.7% (476 million Euros) of Foreign Investments in 2022 (1.37 billion Euros) are from offshore companies<\/em> The sharp tightening of monetary policy has often caused financial stress or even crises, especially in developed economies, but also in developing countries. Because of higher credit and currency risks, […]<\/p>\n","protected":false},"author":2,"featured_media":15674,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"inline_featured_image":false,"footnotes":""},"categories":[9756],"tags":[9763,11905,11904,8502,11906,8419,11134,8563,11850,9921,11907,9466,11908,11130,11129,11232],"class_list":["post-15676","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-blog","tag-albania-en-2","tag-capital-flows","tag-economic-reforms","tag-euro","tag-financial-risk","tag-fiscal-policy","tag-inflacion-en","tag-inflation","tag-informal-money","tag-lek-en-2","tag-macroprudential","tag-monetary-policy","tag-monetary-tightening","tag-politika-fiskale-en","tag-politika-monetare-en","tag-repo-en"],"featured_image_src":{"landsacpe":["https:\/\/altax.al\/wp-content\/uploads\/2023\/05\/leku-1140x445.jpg",1140,445,true],"list":["https:\/\/altax.al\/wp-content\/uploads\/2023\/05\/leku-463x348.jpg",463,348,true],"medium":["https:\/\/altax.al\/wp-content\/uploads\/2023\/05\/leku-300x169.jpg",300,169,true],"full":["https:\/\/altax.al\/wp-content\/uploads\/2023\/05\/leku.jpg",1280,719,false]},"yoast_head":"\n
\nThe export sector and consumption (individual and investments) are already being disfavored.<\/p>\n
\n[2]<\/a> A condition that is the result of financial and\/or economic events that create emotional tension particularly related to money, or a sense of lack thereof, and is accompanied by a physiological response to this stress.<\/em>
\n[3]<\/a> is a form of short-term borrowing for trading government securities. In the case of a repo, government securities are sold to investors\/buyers, usually daily, buying them the next day at a slightly higher price.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"