During the transition, the supply capacity of the economy accordingly increased by more than would otherwise have been achieved; and any given increase in real aggregate demand would have put less pressure than otherwise on supply, and so would have had a weaker effect on firms’ costs and prices. That does not mean, however, that the feed through of demand pressures into inflation will be permanently weaker. Instead, the apparently flat relationship, illustrated in Chart 3, between unemployment and wage inflation is, at least in part, most probably a symptom of the sustainable level of unemployment having gradually fallen. That is effectively what the MPC has assumed in making judgments about the outlook for inflation. We can be reasonably confident about the direction of change, but not about its size. That can be illustrated by the current conjuncture. Over the past few years, there have been at least two other influences at work. First, for some years we enjoyed an improvement in our ‘terms of trade’. That meant, simply put, that the aggregate price of the goods and services we produce and export rose relative to the aggregate prices of our imports. This increased the purchasing power of households’ incomes (Chart 9), and so may have dampened wage pressures as the labour market tightened. To the extent that this explanation should be given any weight, it would tend to be a temporary factor, pointing to an upside risk to earnings growth looking ahead. A second apparent feature of our environment works the other way round.

The choice made was  2  BIS Review 100/2006  imposed by the circumstances: lack of developed financial instruments and institutional financial structure; absence of the interest rate transmission mechanism, and high interdependence between the aggregate demand and money supply. In October 1995, NBRM made a shift towards monetary strategy of targeting the nominal exchange rate against the German Mark, and later against the Euro, with the Denar exchange rate stability being the intermediate monetary policy objective. Such a strategy, applied in a small and open economy such as ours, has proved to be very successful for maintaining the price stability until present day. All reforms in the monetary policy instruments since the independence have been directed towards introducing indirect, market-oriented instruments for enabling efficient monetary policy conduct. Therefore, in 1993 deposit and credit auctions were introduced, and at the end of 1994 CB bills auctions were introduced. The initial development and strengthening of the financial system of the Republic of Macedonia, especially of the government securities market, enabled us to include new instruments, following the example of the modern central banks. In April 2005, we promoted the overthe-counter market for government securities. In the same year, we launched the general repo agreement and we started with repo operations when concluding lombard credits. In March this year, together with the Ministry of Finance we introduced Treasury bills for monetary policy purposes. The transition of the monetary strategy and of the monetary instruments would not have been successful without adequate banking reforms.