ferenc karvalits : challenges of monetary policy – a global perspective and the hungarian situation speech by mr ferenc karvalits, deputy governor of magyar nemzeti bank ( the central bank of hungary ), at the 46th economic conference, organised by the hungarian economic association, budapest, 28 june 2008. * * * this invitation is an honour, which i am more than happy to fulfil as in recent months public attention has been increasingly focused on various decisions taken by the magyar nemzeti bank, while, at the same time, monetary policy has attracted media investigation and has become a hotly debated issue among financial experts. according to mervyn king, governor of the bank of england, monetary policy is considered efficient when it is boring. today, monetary policy can by no means be called boring. on the contrary, it is quite interesting, fascinating and, above all, difficult. the happy days, as it were, are over. while the past decade was a period of prosperity and price stability, thanks to globalisation and financial integration, growth and inflation currently seem to pose serious risks, while the menace of stagflation seems to threaten numerous large economies. furthermore, the credit market crisis has put the global financial system at risk. besides international events, domestic problems have also focused the spotlight of public opinion on the central bank ’ s activity. although the perceived controversy regarding monetary policy has numerous aspects to it, the time available here does not make it possible to even touch upon these issues, let alone answer all the related questions. i have, therefore, selected three interrelated and frequently asked questions which i will try to elaborate on : • to what extent does the evolution of the global financial environment influence hungarian monetary policy? • is it possible or worthwhile to fight the impact of growing commodity prices with monetary instruments? • how does the exchange rate influence the economy within the framework of domestic monetary policy? before addressing these questions, please allow me to briefly explain the principles of monetary policy. on the principles of monetary policy the fundamental principles of monetary policy were formed and bolstered in the debates between theoretical economists and practising central bankers, which had lasted for a decade and which are now the subject of a broad consensus worldwide. as my colleague judit nemenyi mentioned in her article published a few days ago, it would be well worth the effort to encourage the hungarian public to acknowledge these principles. central banks, concurrently with the development

following day, the executive board summarises its discussions and assesses the consequences for monetary policy for the next four months. this assessment constitutes an important internal reference when the executive board later makes a decision regarding the interest rate. it will also provide the basis for our external communication through speeches and the media. the key rate is assessed by the executive board every sixth week. monetary policy decisions are announced in a press release followed by a press conference. as an example, allow me to present the background for the monetary policy decision in june, when the key rate was raised from 6. 5 per cent to 7 per cent. developments in international financial markets were uncertain at that time, as they are today. we assumed that activity among our trading partners would show only a gradual recovery. oil prices were high, also measured in nok. private consumption had shown a substantial rise as a result of strong income growth. households expected strong income growth and borrowed heavily. housing investment was high and financial investment was low. house prices were rising. public expenditure was growing as a percentage of gdp. it was also expected that the level of petroleum investment would be high. against this background, pressures on real economic resources were deemed to be strong. wage growth was markedly higher than projected earlier. the outcome of the various settlements pointed to wage growth of 5½ - 6 per cent this year. the wage settlement awarded high pay increases with effect from next year for some groups even though they will also be negotiating pay increases in 2003. developments in the krone exchange rate had the opposite effect. the krone had appreciated. expectations of higher interest rates as a result of developments in wage settlements probably contributed to this. against this backdrop, consumer price inflation, with an unchanged key rate of 6. 5 per cent and an unchanged krone exchange rate from the average exchange rate for the second quarter, was projected at 2¾ per cent from the summer of 2004. cf. cournot - nash equilibrium in game theory 2 cf. stackelberg equilibrium in game theory projections showed that price inflation could be lower than 2½ per cent in the short run. if we had tried to reach the inflation target in the short term, i. e. strict inflation targeting, we would have lowered the key rate. we know that would probably imply a weaker krone and higher inflation. a more pronounced increase in interest rates than the increase we actually implemented would then probably have been necessary in a year ’ s time. this would have led to unnecessary