Thursday, March 13, 2008

Interest rate hikes and prices

Last week, the central bank raised interest rates by 25 basis points to 6.25 percent. The CBA stated that continued growth in private consumption and an expansionary fiscal policy will exert upward pressure on prices. It further stated that to the extent that inflationary pressures eminate from external factors, it is impossible to offset them through monetary instruments. The tightening of the monetary policy is intended to moderate the impact of domestic growth in consumption and government spending.

The higher interest rates will boost or at least shore up the value of the Dram. But other than that I am not sure how effective this monetary policy will be.

It is true that government spending is slated to increase, but is it
deficit financed?
As the CBA stated, much of the pressure is from external sources (energy and food I presume). These will have a large impact on prices, and there is nothing that the CBA can do. Rather, the government, by implementing policies that reduce transaction costs and improve competition, and international donors have a much stronger role to play. First and foremost, the government should reform the customs agency and improve governance. Sacking its senior officals would be a good start. Second, there is little if any logistics expertise in the country. Clearly training and education should be a high priority, and funding is an issue. Third, diluting market concentration and monopolistic practices should be a priority for the government. Again training is also critical here; there are no visible IO economists in the country. Obviouly, these changes may not be large enough to offset the increases in import prices, but are nevertheless necessary for the efficient functioning of a market economy.
It is true that the economy has been growing at double digit rates for the past five years, and this may have led to further expectations of growth. But the post presidential election events will very likely result in slower growth. The country may face both higher prices (import driven) and increasing unemployment. I am not sure if there is anything that the CBA can do here.


Nika said...

"It is true that the economy has been growing at double digit rates for the past five years, and this may have led to further expectations of growth..."

Actually, according to the Economist, the growth in Armenia is expected to decline from its recent 13 percent to 8 percent. Azerbaijan, on the other hand, is expected to have close to 17 percent GDP growth - the second largest growing economy in the world in 2008. I thought it was an interesting fact to mention. And also add that I am very extremely happy to have found this blog.

David said...

Few weeks ago I would've said the Economist was wrong, as was everyone else over the past five years. With the events following the elections in February, I would be surprised if the economy grows at all.
As for Azerbaijan, and reflecting upon the recent spike in oil prices, I think its economy will grow faster than the prediction by the Economist.

R said...

It is pointless to compare Armenia with Azerbaijan because of that country's unique energy situation. Its like comparing Lebanon with the U.A.E.

Comparison's are more useful with Georgia, Ukraine, Albania, etc. i.e. former communist countries with limited natural resources.

David, did the turmoil surrounding Georgia's election last fall have an impact on that country's growth and exchange rate?

David said...

I only looked at Kenya's exchange rate where the currency had dropped by some 15 percent within a month of the late December elections. I have not looked at Georgia's national (central) bank web site yet.
If the government and the rest of the opposition get their act together and work out a compromise, actually things can realy turn around. This will take more than a prayer!