Journal number 1 ∘ Malkhaz Chikobava ∘
About The Monetary Policy Of The National Bank Of Georgia

10.36172/EKONOMISTI.2023.XIX.01.MALKHAZ.CHIKOBAVA

Annotation. The article analyzes the inflation targeting policy of the National Bank of Georgia, its impact on prices, the exchange rate of the national currency, and financial stabilization. It has been shown that based on inflation targeting policies, it is difficult to convince monetary authorities that they can deal with inflation and exchange rate fluctuations by manipulating interest rates.

The document also mentions that raising interest rates to reduce inflation and strengthen the national currency is a template recommendation of the International Monetary Fund, which is based on mathematical models of market equilibrium, does not correspond to economic reality and is absolutely counterproductive for import-dependent countries.

The paper emphasizes that the main directions of the current monetary and credit and currency policy do not take into account either protecting or ensuring the stability of the national currency. Unfortunately, the monetary authority is convinced that the increase in interest rates increases the attractiveness of bank deposits, which limits demand and leads to a decrease in prices, as well as drains free money and reduces its supply in the foreign exchange market, thereby contributing to the strengthening of the national currency. But this argumentation does not take into account that the increase in interest rates leads to an increase in the costs of borrowers, which they transfer to the cost of production, resulting in an increase in prices and a decrease in the purchasing power of the national currency. A decrease in demand can also lead to a drop in production and an increase in costs through the effects of returns to scale; As a result, prices may not even decrease, but may even increase.

Finally, if we want to end inflation and thereby stabilize the exchange rate and the financial system, then we must understand that it is the policy of inflation targeting that contributes to inflation.

Key words: inflation, target, stabilization of currency exchange rate, cross-border movement of capital, International Monetary Fund, stagflation, refinancing rate. 

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Inflation targeting means that the central bank subordinates its policy to the sole purpose of reducing the rate of inflation. The latter, according to numerous explanations of the Central Bank, means a moderate increase in the consumer price index. Thus, by announcing the transition to an inflation targeting policy, the central bank has in mind that monetary policy depends on achieving the targets of the consumer price index.

We note that the reduction of inflation has always been the main priority in the activity of the Central Bank, which set target parameters for the planning year and for the perspective. However, in the operational policy of the Central Bank, along with the inflation target orientations, the orientations of the growth of the currency exchange rate and monetary aggregates - the monetary base and the monetary mass - were also monitored. Along with the development of refinancing instruments, another controllable parameter appeared - the refinancing rate, which the central bank replaced by the key rate. What is the difference between the current inflation targeting policy and the existing monetary policy until 2009, during which it was also aimed to reduce inflation to a certain level?

In the operational document of the monetary policy of the National Bank of Georgia, we read that "the monetary policy of the National Bank is based on the inflation targeting regime. The National Bank of Georgia switched to the inflation targeting regime in 2009, thus replacing the previously effective monetary targeting. During the mentioned regime, the target rate of inflation, which must be maintained in the medium term, is determined in advance. The target rate of inflation is determined by the National Bank of Georgia and subsequently approved by the Parliament. The inflation target for 2019-2023 is 3 percent" [1].

The inflation targeting regime is a relatively new practice and has been quite successful in the fight against inflation since the 1990s. This regime was first introduced by the Central Bank of New Zealand in 1990.

During the inflation targeting regime, the target rate of inflation for the medium-term period is announced in advance - the level of inflation desired for the economy. One of the main determining factors of inflation is the expectation of inflation, therefore the goal of the National Bank is to establish the correct inflation expectation. Therefore, the National Bank attaches great importance to the transparency and predictability of its activities. One of the advantages of the inflation targeting regime is its transparency and ease of communication with the public, since one predetermined target indicator allows to precisely define the main goal of the National Bank and create expectations about the direction of monetary policy.

Before the introduction of inflation targeting, the monetary policy of the National Bank was based on monetary targeting, which meant achieving the desired growth rate of the money supply. Under monetary targeting, the National Bank used the money supply as an intermediate link to regulate inflation. Under this regime, in contrast to inflation targeting, an important factor is a stable relationship between the money supply and inflation. However, in practice, the demand for money is variable (especially in conditions of rapid development of new means of payment and banking systems), which changes the relationship between the growth of monetary aggregates and the growth of money, and there is a need to constantly revise the target - the rate of growth of the money supply. Accordingly, in the case of an active monetary policy, using the money supply as an operational model is ineffective" [2].

Judging by the main direction of the unified state monetary-credit and currency policy and the speeches of the monetary authorities, the peculiarity of the inflation targeting policy is the refusal to establish the target orientation of the national currency exchange rate and the use of the refinancing rate as a control parameter. The monetary authority states that inflation targeting means moving the national currency rate to a free floating mode. At this time, neither in the main direction of monetary and credit and currency policy, nor in the speeches and articles of the monetary authorities and the ideologues of the given policy, not a single convincing evidence of this thesis was given. It was accepted as an axiomatic truth, even though the policy of inflation targeting still raised serious doubts about its feasibility among people more or less well versed in economics.

It is known that the monetary system is very complex, its situation is constantly changing depending on the external and internal factors that determine the demand and supply in the money market, the speed of money circulation, business conditions and investment activity. From the point of view of management theory, the assertion that inflation targeting implies the abolition of control over the factors that determine the price dynamics of a large number of consumer goods - ie. The abolition of control over the exchange rate is absurd. It's like trying to heat a room with the windows open while it's cold and windy outside. Obviously, in such a case, the temperature in the room will depend not on the power of the heating device and its adjustment, but on the temperature outside the room. Therefore, we must first close the windows and then start adjusting the heater to heat the room.

By choosing to target inflation, the monetary authority is left with a simple mechanism with a single manipulator. At this time, if there are no restrictions on the cross-border movement of capital, and the exchange rate of the national currency is in a free floating mode, then only one instrument of currency and financial market regulation remains - the interest rate.

In order to control inflation in the conditions of an open economy and in the case of its dependence on imports, first of all, it is necessary to control the exchange rate of the national currency. But the monetary authorities, on the contrary, refused such control, as well as many other instruments of currency and financial market regulation, including the most effective one, which is connected with the use of currency restrictions. At the same time, it is clear to any experienced currency speculator that it is impossible to maintain the exchange rate of the national currency with the interest rate alone, according to the capital movement account, in the conditions of free cross-border movement of financial capital, if the country in question is not the issuer of the world reserve currency.

Therefore, it is unnecessary to talk about the regulation of the currency exchange rate during the time of self-limitations, which are generally accepted in the world practice of the instruments of currency and financial market regulation. The state of the currency and financial market as a whole will depend on the mood of the main financial players, on the plans of financial speculators, and not on the intention of the monetary authority, which deliberately allows chaos. In fact, under inflation targeting, the monetary authorities do not understand the system of measures to achieve the target rate of inflation, but the reduction of monetary policy instruments only to the refinancing rate at which short-term credits are provided to commercial banks to support liquidity. The question is: why should the National Bank limit itself to only one tool if there are many potentially available tools for managing the monetary system?

By a monetary authority that has chosen an inflation targeting policy, if it is refused to control the cross-border movement of money according to the capital account, then in order to manage macroeconomic parameters under market pricing conditions, the monetary authority has the following tools of monetary policy along with the control of the currency exchange rate: the discount rate and other conditions of liquidity supply, Mandatory reserve norms, capital adequacy, the formation of reserves based on loans and securities, as well as the ability to manage the size of operations in the open market with government debt bonds and foreign exchange interventions, which together form the monetary base. The scientific literature recognizes the trilemma that in the absence of a gold standard, it is impossible to have an open capital market, a fixed exchange rate of the national currency, and an autonomous monetary policy at the same time. Apparently, based on this logic, the monetary authorities choose an autonomous monetary policy, preferring interest rate manipulation and refusing to manage exchange rates.

The mentioned trilemma was formulated by M. by Obstfeld based on empirical studies of monetary policies of national banks in the period between the First and Second World Wars [Obstfeld et al., 2004, p. 75]. But a lot has changed since then. A global financial market emerged with the world reserve currency (the dollar), the issue of which is carried out by the US Federal Reserve System, mainly based on the debt obligations of the US government.

Since during the last 10 years the volume of these liabilities has been increasing in geometrical progression and exceeded the limits of sustainability of the American tax-budgetary system, the above-mentioned trilemma is being added to the growing emission of world capital in the form of unsecured liabilities of the USA, the European Union, Japan and Switzerland, in parallel with which the US dollar, euro, pound are growing. , yen and franc emission as well. After the global financial crisis of 2008-2009, the mass of these currencies on the world financial markets increased almost 5 times (the total growth of the monetary base of the dollar, euro, pound, yen and Swiss franc in 2007-2018 reached 7 trillion dollars, and their average annual emission - on average, 800 billion dollars).

The modern capital market is characterized by the inflation of the financial soap bubble at the expense of the unsecured issuance of the world's reserve currencies. Therefore, countries with an open financial market face the inevitable pressure of the growing emission of the above-mentioned currencies due to the arrival of powerful flows of speculative capital. This indicates the emergence of a network monopoly in the world financial market, which is connected to the mega-speculators issuing world currencies. The latter have enormous opportunities for manipulation of reserve currencies, including the free movement of capital in the open national segments of the world financial system. Unlike the world commodity market, which is more or less subject to competition laws and regulation by the norms established by the World Trade Organization, the world financial market is not seriously regulated, and the norms of the International Monetary Fund protect such deregulation in the interests of financial speculators (investment superbanks) who benefit from the central banks - With unlimited lending by issuers of world reserve currencies.

Based on the above, if the central bank does not have the ability to issue the world reserve currency and maintains the free cross-border movement of capital, then it will not be able to control either the exchange rate of the national currency or the interest rate in the market. Credit and financial organizations with access to the issuance of world reserve currencies can at any moment make a speculative attack on the vulnerable national financial market, devalue local currencies or offer borrowers of this country any amount of credit at an acceptable interest rate. They have done this many times in relation to our country.

Thus, in order to manage the state of the national currency and monetary system, it is necessary to control the cross-border movement of money according to capital operations. Otherwise, the macroeconomic situation, even the development of the national economy, will be subject to manipulations from abroad. At the same time, it becomes impossible to manage currency and financial markets in terms of reducing entropy (chaoticness of changes). Refusal of control of the foreign exchange and financial market by the state to both foreign and local financial speculators, which include quasi-state and oligarchic offshore business groups.

Based on the above, inflation targeting from a political point of view is nothing more than the transfer of control over the national monetary and financial system to external forces, while from an economic point of view it serves only the interests of financial speculators. If the government loses control over its own currency, then it gives currency speculators the opportunity to manipulate them. If the central bank accredits them at this time and transfers them to the currency exchange for management, then speculators are given the opportunity to manage the national currency rate with any amplitude of fluctuations. At this time, the foreign exchange and financial market enters a state of turbulence, there is a disorganization of foreign economic activity and a delay in the process of re-production of enterprises dependent on it. It is this fact that our economy is facing as a result of the transition to inflation targeting policy.

It should be noted that the stability of the national currency implies not only the support of a stable nominal exchange rate of the GEL compared to other currencies, but it also includes two more components: first, the stability of the purchasing power of citizens' incomes and savings, which are denominated in the national currency; Second, at the expense of managing exchange rates, creating the most favorable macroeconomic conditions, sustainable development of the national economy, financial system, investments and, ultimately, raising the well-being of citizens.

The main directions of the current monetary and credit and currency policy do not consider either protection or ensuring the stability of the national currency. Blind adherence to the principles laid down in it has already led us to failure both in protecting the purchasing power of citizens' incomes and savings, and in providing favorable conditions for macroeconomic growth.

It is even more difficult to convince monetary authorities that they can deal with inflation and fluctuations in national currency rates by manipulating interest rates. During the years of market reforms, many studies were published, the results of which testify to the absence of statistically significant relationships between the dynamics of interest rates and money supply, on the one hand, and inflation rates, on the other hand. At the same time, there is a strong relationship between the first two indicators and the dynamics of production and investments. Always and everywhere a reduction in the money supply and an increase in the interest rate are inherent in a fall in production and investment. This is also clearly visible on the example of our economy [Glazev S., 2015, 10].

Raising interest rates to reduce inflation and strengthen the national currency is a standard recommendation of the International Monetary Fund. It is based on mathematical models of market equilibrium, which do not correspond to economic reality, but illustrate very simple and apparently convincing reasoning. Unfortunately, the monetary authority is convinced that the increase in interest rates increases the attractiveness of bank deposits, which limits demand and leads to a decrease in prices, as well as drains free money and reduces its supply in the foreign exchange market, thereby contributing to the strengthening of the national currency. But this argumentation does not take into account that the increase in interest rates leads to an increase in the costs of borrowers, which they transfer to the cost of production, resulting in an increase in prices and a decrease in the purchasing power of the national currency. A decrease in demand can also lead to a drop in production and an increase in costs through the effects of returns to scale; As a result, prices may not even decrease, but may even increase. And vice versa: a decrease in interest rates and an increase in the money supply can be transformed into an expansion of investment and production and, therefore, a decrease in costs and prices. The monetary authority cannot take into account the obvious fact - the non-linearity and imbalance of economic processes, and in our case - the destructiveness of demonetization of the economy. In the low monetization of our economy, the expansion of the money supply would still be accompanied not by an increase in inflation, but by a decrease, as a result of the absorption of money by the uncredited real sector. If the National Bank does not change the mechanism of refinancing of commercial banks and they continue to use the received credit resources to finance currency speculations, then the increase in credit will lead to a new wave of currency speculations and another decrease in the national currency rate with further acceleration of the inflationary wave. There is no doubt that if the demonetization of the economy continues in our country, the decline in investment and production will deepen.

In order to get rid of the stagflationary trap, we should move to a multi-channel system of refinancing of commercial banks, which will be based on the demand for credits from industrial enterprises and control over the targeted use of the offered credit resources. At this time, refinancing rates through different channels should correspond to the level of profitability of the relevant sector of the economy and the risks characteristic of them. In order to support liquidity, refinancing can be offered to commercial banks, provided that they do not use these credits for speculation against the national currency (Chikobava M., 5).

The main thing in the described scheme is to ensure returnability and targeted use of the offered credits to expand the production of goods and services, which will connect the increased demand with the expansion of the money supply to the corresponding increase in the supply of goods. To do this, the central bank has the necessary control tools and capabilities to block attacks by foreign speculators - starting with currency restrictions according to the capital account and ending with the introduction of taxes on currency-financial speculation. It is necessary to learn to use them, as all successful developing economies of the world do.

In our opinion, the reason for dragging our economy into the stagflation trap is the policy of the monetary authority. Can he fix it? Yes, if they refuse the standard recommendations of international organizations, first of all, the International Monetary Fund. The latter act not to protect the economy of our country, but the interests of international capital. What they need from our country is not the expansion of production, but favorable conditions for extracting profits, which can best be obtained by a speculative attack by destabilizing the national financial market.

Inflation is an argument for the National Bank to maintain a high refinancing rate. It is currently 11% in Georgia. The National Bank of Georgia explains that a large part of the nominal rate is inflation. For example, according to the results of 2022, according to the National Statistics Service, the average annual rate of inflation was 10%. It turns out that the real refinancing rate is 1%. Is it big or small? If we compare the indicators of economically developed countries, then it is big.

A high key rate is a sign of a dependent, semi-colonial economy. We should keep in mind that the refinancing rate of the National Bank of Georgia is a benchmark used by our commercial banks to determine interest rates on their loans. On average, interest rates double at this time. This is fatal for the real sector of the Georgian economy [Katasonov V., 7]. 

Figure 1. Monetary policy rates in Georgia

(2008-2022) 

 

Source: https://tradingeconomics.com/georgia/interest-rate

 

Figure 1 shows the change of monetary policy rates in Georgia. The National Bank of Georgia is trying to limit the high rates of inflation by increasing the mentioned indicator. 

Figure 2. Inflation in Georgia

(January-November 2022) 

 

Source: https://tradingeconomics.com/georgia/inflation-cpi 

However, fig. Diagram 2 shows that by raising the base interest rate, the National Bank of Georgia can only slightly curb inflation, but it increases the cost of loans, which worsens the state of the real sector of the economy. 

Figure 3. Annual rate of inflation in Georgia for the last 25 years

 

Source: https://tradingeconomics.com/georgia/inflation-cpi 

The target inflation rate chosen by the National Bank of Georgia is 3%. However, Figure 3 shows that the inflation targeting policy failed to achieve its goal. 

Figure 4. Volume of refinancing loans, GEL 

 

Source: https://nbg.gov.ge/statistics/statistics-data 

In addition to the monetary policy rate, the National Bank of Georgia is also actively manipulating refinancing loans (See fig. 4). By changing the latter, he tries to influence the exchange rate of the national currency. When the Georgian lari depreciates sharply against the US dollar, the National Bank of Georgia stabilizes the nominal exchange rate of the lari by sharply reducing refinancing loans. However, the result of such a policy is the again and again declining amount of lari in circulation, which puts the already low-monetization’s economy in an even more difficult situation. 

Figure 5. Changes in the exchange rate of the Georgian lari to the US dollar

(2017-2022)

 

Source: https://tradingeconomics.com/georgia/inflation-cpi 

Figure 5 shows the change in the nominal exchange rate of the national currency lari against the US dollar. Its strengthening coincides with periods of sharp reduction in refinancing loans. In other words, the reason for the strengthening of the Georgian lari is a sharp reduction in its amount in circulation (see Figure 6, which shows the indicators of the monetization of the Georgian economy by M2 aggregates). The deficit of the Georgian lari is increasingly depleting the real sector of Georgia. 

Figure 6. Monetization ratios in Georgia

(2009-2022)

 

Source: https://nbg.gov.ge/statistics/statistics-data 

As can be seen from Figure 6, the monetization rate in Georgia is about 22 percent, which is far behind that of developed countries (see Table 1). The low level of monetization indicates that the Georgian economy is extremely drained of blood, which is the result of a flawed inflation targeting policy. 

Table 1. Monetization indicators according to the world's leading countries by 2022 

Countries	GDP (billion $)	M2 (billion $)	Share of M2 in GDP (%)
USA	22996	21415	93.12
China	17734	37923	213.84
Eurozone	14493	16356	112.85
Japan	4937	8857	179.40
Germany	4223	4054	96.00
have fun kingdom	3187	3822	119.92
India	3173	669	21.08
France	2937	3194	108.75
Italy	2100	2038	97.05
Canada	1991	1746	87.69
Sat. Korea	1799	2893	160.81
Russia	1776	1096	61.71
Brasil	1609	916	56.93
Australia	1543	1688	109.40
Spain	1425	1594	111.86
Mexico	1293	608	47.02
Indonesia	1186	528	44.52
Netherlands	1018	1222	120.04
Saudi Arabia	834	567	67.99
Turkey	815	425	52.15
Switzerland	813	1157	142.31
Argentina	491	60	12.22
Sat. Africa	420	222	52.86
Singapore	397	548	138.04

 Source: https://tradingeconomics.com/country-list/money-supply-m2?continent=g20 

In the play called "inflation targeting", the National Bank behaves as if it is fighting inflation with all its might. And under the guise of this struggle, it reduces the money supply, which is the "oxygen" of the economy.

In recent years, the level of monetization of the Georgian economy (the ratio of the money price to GDP measured with the help of the M2 indicator) is about 21%. For comparison, in the USA it is equal to about 94%, in Great Britain and Canada - 140%. And in China it reaches 213%, and in Japan - 179%. For some reason, not only hyperinflation, even moderate inflation is often not observed in the listed countries, even deflation occurs in some countries. Therefore, the National Bank's struggle with inflation reminds us of the bitter joke that the best cure for a headache is the guillotine. Moreover, the main culprit in inflation in Georgia is the inflation targeting policy chosen by the National Bank.

First, money becomes extremely expensive in the economy. In the structure of production costs of many firms in Georgia, which are forced to use bad credit, the main component is not the cost of wages or raw materials, but the cost of servicing the credit. Interest costs of enterprises feed the increase in costs and prices (wholesale and retail) of goods and services.

Second, the most effective means of combating inflation is the increase in the mass of goods. This is an axiom that occupied a key place in the old textbooks of economics.

And inflation is a violation of the proportion between the commodity and money supply. The monetary authority of Georgia could quickly end inflation if it engaged in lending to its own economy and thereby contributing to the growth of the supply of goods and services, if it issued credits at the same interest rates that it receives by placing currencies on deposits of foreign banks or buying treasury obligations of other states. There, if we look at the indicators of many years, the average return does not exceed 1% per year. Is it not possible to find projects in Georgia that provide the National Bank with income at an annual rate of 2-3% (this could be the optimal base rate)? As long as the vicious policy of the National Bank destroys the economy of Georgia with the help of high key rates and reducing the money supply, while simultaneously investing its own resources in foreign assets, inflation will be maintained (Chikobava M., 8).

Thirdly, the National Bank refused to maintain the exchange rate of the lari, which makes foreign goods more and more expensive. Despite numerous calls for import substitution, a significant portion of consumer goods and services are of imported origin. This is a very important factor that feeds the inflationary processes in Georgia.

Fourth, the banking system drains the economy of Georgia. The National Bank, as a financial mega-regulator, is committed to provide supervision of banks, but we cannot call it satisfactory. Financial organizations are busy taking money out of the country, and they are not interested in the development of the real economy because it is unprofitable. The National Bank, as a financial mega-regulator with the right of legislative initiative, could raise the issue of introducing bans or restrictions on the withdrawal of capital from the country (banks currently do this for themselves and for their clients - both individuals and corporate clients). But the National Bank not only does not raise the issue of the need to introduce control in the field of cross-border movement of capital, but on the contrary, time and again pronounces the oath of loyalty to the "Washington Consensus" and the International Monetary Fund, which requires full freedom of capital movement. Proof of this is the visit of the head of the International Monetary Fund, Christine Lagarde, to our country on May 19-21, 2019, to whom the Georgian monetary authority handed over the report in the form of a pioneering grant. Of course, the latter has neither the ability nor the desire to resist the "obvious template monetary policy" of the International Monetary Fund.

The International Monetary Fund influences the policy of the National Bank not only with periodic instructions, but also with the introduction of appropriate methods. These are: economic-mathematical models, formal presentations on the interrelationships of macroeconomic parameters. The specified models and methods, in many cases, cannot reflect the state of the real economy, give false estimates of its growth and development, and their use deprives our country of the opportunity to conduct a sovereign monetary and credit policy.

Therefore, if we want to put an end to inflation and thus ensure the stabilization of the currency exchange rate and the financial system, then we must understand one thing: it is the National Bank that promotes inflation through its vicious inflation targeting policy. 

References: 

1. Chikobava M. (2011). “About the causes of constant inflation.” Journal “Economics and Business,” November-December, #6, 2011, pp. 41-48.
2. Chikobava M. (2011). About the causes of constant inflation. Journal “Economics and Business,” November-December, #6, pp. 41-48.
3. https://www.nbg.gov.ge/uploads/mpc/ monetary_policy_operations_manual/mp_manual.pdf
4. https://www.nbg.gov.ge/index.php?m=538
5. Obstfeld M., Shambaugh J. C., Taylor A. M. (2004). Monetary sovereignty, exchange rates, and capital controls: The trilemma in the interwar period. IMF Staff Papers, Vol. 51, Special Issue.
6. Glazyev S. (2015). About inflation targeting (In Russian), Economic Issues. No. 9.
7. Katasonov V. (2021). Inflation targeting and the role of the Central Bank (In Russian), https://tsargrad.tv/articles/ targetirovanie-infljacii-ili-kak- kozla-postavili- kapustu-sterech_186068

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