How can the pursuit of monetary policy be strengthened?
The recent pickup in demand owes much to the substantial relaxation of monetary policy since the end of 2001. With inflation reduced to less than 2 per cent, the National Bank’s monetary policy strategy now appropriately focuses on maintaining inflation at low levels. In order to maximise the Bank’s capacity to meet this objective and influence expectations, it should proceed with plans to release its quarterly Inflation Report more quickly and include in it projections for inflation. Moreover, it would be desirable for the Monetary Policy Council to regularly indicate how policy is likely to react to projected increases or decreases in inflation as it did following its February and March meetings. Although real interest rates remain high, the strong depreciation of the currency means that monetary conditions have eased below the levels observed in 1998, just prior to the re-acceleration of inflation. In this context, and especially given the very relaxed stance of fiscal policy and already strong growth, policy rates should not be relaxed any further. Rather, monetary authorities need to watch inflation and wage developments carefully and be prepared to raise rates, if necessary, so as to prevent any resurgence in inflation or financial market jitters. Once fiscal policy is significantly tightened, inflationary pressures should ease – opening the way for a further easing of monetary policy. As concerns the adoption of the euro, fiscal consolidation will also be essential to ensure that nominal convergence criteria are met. In assessing the optimal path towards meeting the criteria for euro area membership, the Polish authorities will want to evaluate the advantages that a rapid adoption of the euro would entail in terms of increased credibility and reduced uncertainty for international transactions, versus the potential disadvantages of an early move in terms of the loss of an independent monetary policy and the loss of exchange-rate flexibility.
How to ensure the sustainability of public finances?
Steps need to be taken immediately to slow the growth of public expenditure, both in order to adjust the overall mix of macroeconomic policy and to ensure the medium-term sustainability of public finances. Recently, the public debt has been increasing by 4 per cent of GDP per annum. Moreover, with the general government deficit expected to reach 5.7 per cent of GDP in 2004, the pace of debt accumulation is likely to accelerate further. Here, the measures outlined in the authorities’ Public Expenditure Reform, which would imply an eventual permanent 1.3 per cent of GDP improvement in the structural balance, will help. Unfortunately, because most of the savings will not come on line until 2005 and 2006, there is a real risk that the planned reform will not prevent the 60 per cent debt level barrier from being broken, legally constraining the government to pass balanced State and local government budgets the following budgetary year (two years following the breach). To avoid such a draconian tightening and the painful macroeconomic consequences it would entail, it is essential that significant fiscal consolidation begin now, before these statutory thresholds are broken. The authorities should, therefore, put in place additional permanent savings now. A more aggressive consolidation strategy would have the further advantage of obviating the need for additional cuts to spending when privatisation revenues eventually dry up. Finally, the authorities should resist the temptation to replace the current Polish definition of debt with the lower ESA 95 definition until fiscal consolidation is complete. While such a move would delay hitting the 60 per cent mark by a year, it would send a disturbing message to financial markets and could hurt Poland’s long-term credibility.
Even if the proposed fiscal consolidation programme is passed into law, the authorities will need to take steps to improve medium-term budgetary planning and control mechanisms in order to ensure that these plans are executed and that overall savings are realised. Introduction of a binding medium-term expenditure rule and the requirement that additions to spending be accompanied by offsetting reductions would help to reduce the likelihood that policymakers take short-sighted decisions that permanently affect the sustainability of public finances. Moreover, budgetary systems need to take into better account all of government spending, in particular that of the various extrabudgetary funds. In this regard, the recent decision to make the Ministry of Economy, Labour and Social Policy responsible for the Labour Fund is a step in the right direction. It should be reinforced by requiring much more comprehensive information about this and other extra budgetary funds in the State Budget. Moreover, monitoring and parliamentary oversight of extrabudgetary programmes should be raised to the same level as for programmes financed directly from the State Budget. Finally, the authorities need to face the issue of the accounting treatment of compulsory private pension funds. Recent practice includes contributions to these funds in government revenues but excludes from expenditures the transfer of these funds to individuals’ pension accounts. The argument that excluding such revenues would make Poland’s deficit position look bad relative to countries that have not passed a similar pension reform is valid. However, recording only the revenues in the general government balance causes it to understate the extent of the financing shortfall in current government operations. Even though the associated liability is included in debt figures, this approach may contribute to complacency concerning public finances, which could incite policy makers to spend more than would otherwise have been the case. Indeed, insofar as the projected deficit excluding these revenues for 2004 exceeds 7 per cent of GDP, current practice may be preventing the pension reform from improving the government’s long-term budgetary position as it was originally meant to do.
Fiscal and monetary conditions
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