Dariusz Filar
Professor of Gdańsk University, member
of the Monetary Policy Council

The general shape of the Monetary Policy Council and its framework of activity are defined by Article 227 of the Polish Constitution. According to it, the Council is composed of the President of the National Bank of Poland (central bank) and experts on finance appointed in equal numbers by the lower and upper chambers of the Polish parliament – Sejm and Senate – and the President of Poland. In practice, in the Council’s present and previous term of office, the Sejm, Senate and the President appointed three members each. Members of the Council are appointed for six years. This Council started activity in 2004 and its term will expire in 2010.
Article 227 of the Constitution also puts the obligation on the Monetary Policy Council to adopt guidelines for the monetary policy for the next calendar year to be submitted to the Sejm at the same time when the government submits its budget bill.
The Council has already adopted and published its guidelines for the monetary policy for 2008. Under the guidelines, the main objective of the Council is to maintain price stability. As is the case with other central banks, price stability is understood as keeping inflation low enough to prevent it from exerting an adverse impact on economic decisions, particularly those related to savings and investment.
In its guidelines for 2008, the Council says its policy is based, as in previous years, on the direct inflation targeting strategy. Since 2004 the inflation target has been set at 2.5% with a symmetrical tolerance range for deviations of +-1 percentage point. Additionally, the Council is going to focus on keeping inflation as close to the target of 2.5% as possible rather than merely within the range. This means that the limits of deviation are only meant as safety margins, which can be used only in extraordinary and unpredictable situations. The Council also states its target is permanent, which means it refers to inflation measured as a year-on-year change in prices of consumer goods and services (CPI) in each month compared to the corresponding period of the preceding year.
Monetary policy, by its nature, is always future-oriented. In Polish conditions, the impact of interest rate changes is the strongest five to seven quarters after the changes have been made. This horizon has to be present in all decisions taken by the Council. This means that the full impact of decisions taken in 2007 cannot be assessed until the end of 2008 or 2009.
As the end of 2007 is nearing, it seems that decisions taken in 2005 and early 2006 were right to a large extent. As a result of these decisions, at the beginning of 2007 inflation hovered in the lower band of the inflation target range (1.6% in January, 1.9% in February) and in March it reached the target point of 2.5%. In most of the subsequent months of the 2nd and 3rd quarter inflation stayed very close to the inflation target. Its average rate in this period was 2.2%. In the 4th quarter of the year inflation is expected to increase slightly but should not cross the upper limit of the tolerance range.
In Poland’s case, there is one more rationale for setting the inflation target at 2.5%. Upon its entry to the European Union Poland committed itself to join the euro area, which means the need to meet the Maastricht monetary criteria, including the one related to inflation. To avoid going into details concerning the calculation of the reference value for this convergence criterion, one can say that since 2000 it has never left the 1.9%-3.1% range and has stayed within a very narrow band of 2.3%-2.7% most of the time.
Keeping inflation permanently close to 2.5%, makes it highly probable for Poland to achieve convergence with the reference value of the Maastricht criterion. From this point of view, 2007 was a successful year: Poland has met the criterion in each month since the beginning of the year and since April has been one of the three EU countries with the most stable prices, that is countries which set the reference value.
The fact that 2007 was good is no guarantee of equally good performance in keeping inflation in check in the future. The Monetary Policy Council has to constantly monitor economic developments and take adequate measures in time.

To monitor or to intervene?
(excerpts from the minutes of the Monetary Policy Council
meeting on August 29, 2007)
Council members talked about disturbances on the international financial markets in August and their impact on the outlook for the Polish and global economy. Some members pointed out that the disturbances resulted in downward revisions of economic growth projections in the United States and Europe. Although at the moment it is difficult to assess the scale of impact on the American economy, one can expect further downward revisions in growth projections in the external environment of the Polish economy.
It was argued that if economic growth in the United States and Europe were lower than predicted, then Poland’s exports would decline, leading to a slower economic growth and lower inflationary pressure. In view of these factors, it was recommended that the Council should remain cautious, keep interest rates on hold and adopt a “wait-and-see” approach, just as some other central banks did. It was argued that the decision to keep interest rates on hold would not have any major impact on the monetary policy effect on inflation.
Other Council members argued that financial disturbances have a strong impact on the global economy when coupled with a considerable and long-lasting slump in stock prices. Such a situation occurred in 2000 when stock market indices fell sharply, one reason being decreased confidence in the reliability of companies’ financial reports. Meanwhile, in the opinion of these Council members, the disturbances observed in August were more similar to the turmoil of 1998, which had been rooted in financial markets themselves. The 1998 disturbances had had no major impact on the situation of the commercial sector nor had they dampened economic growth in the United States to any significant extent. Additionally, the August turmoil on the global financial market did not affect the Polish financial market. The members pointed out that some central banks had decided to raise interest rates in the face of disturbances on financial markets. In their opinion, deferring the decision to tighten the Polish monetary policy to respond to disturbances on international financial markets might suggest that the National Bank of Poland would be tending in the future to relax its monetary policy in the event of problems resulting from financial institutions’ incurring excessive risk, which could increase moral hazard. It was also argued that, as the economy was now primarily driven by domestic demand, the impact of economic growth in the external environment of the Polish economy on GDP growth was smaller than previously.

Report from a meeting
of the Scientific Council at the Management Board of the National Bank
of Poland published
on September 21, 2007
The Scientific Council at the Management Board of the National Bank of Poland held a meeting on September 12, 2007. The meeting took the form of a seminar and the topic was “Dilemmas of Monetary Policy in the Light of Developments on International Financial Markets.”
Members of the Scientific Council analysed the situation on international financial markets and exchanged views on current problems of monetary policy, with a special focus on measures taken by the world’s largest central banks, especially the Federal Reserve (FED) and the European Central Bank (ECB), in response to disturbances on the U.S. mortgage market.
It was stressed that an important task of central banks was to maintain financial stability. In the face of financial disturbances, FED and ECB modified their strategies and took decisions aimed to calm down the market and restore equilibrium.
The Scientific Council pointed out that, according to some observers, the current disturbances on the international financial markets might be seen as a threat of a financial crisis of similar magnitude as those which had hit the global economy in 1987 as a result of a stock market crash and in the years 1997-1998 as a result of financial troubles in Asia and Russia. Many analysts believe that the current crisis on the U.S. mortgage market is really serious and may have an adverse impact on the real economy. International financial institutions have already started to revise down their growth projections for the United States and some European countries. For this reason, in the opinion of Scientific Council members, some central banks have refrained from taking monetary policy measures previously expected and are carefully monitoring developments on financial markets and their potential impact on economic growth.
In Poland, which is a relatively small country with an open economy, developments in the global economy, particularly the euro zone, which is Poland’s main trading partner, should be monitored particularly closely because the global situation impacts on the outlook for inflation and growth in our country.
Scientific Council assessed that in the existing situation the right strategy for central banks – a strategy applied by the European Central Bank and the Bank of England – was to proceed with extreme caution, closely monitor developments on international financial markets and carefully assess their consequences for the real economy.

Increased uncertainty
(excerpts from the minutes of the Monetary Policy Council
meeting on September 26, 2007)
Members of the Council devoted much attention to the situation on international financial markets and discussed the impact of increased uncertainty on the growth outlook for the Polish and global economy. Some participants in the discussion argued that the Polish financial sector was not threatened by disturbances similar to those which had occurred on the U.S. and Western European markets in August and September. They pointed out that in Poland, in contrast to the United States, mortgage loans are only granted by institutions which are under banking supervision and that financial instruments offered on the Polish market are not as complex as those available on the markets hit by the turmoil.
Other participants in the discussion argued that the financial disturbances had spread beyond the U.S. sub-prime mortgage market, as reflected in troubles on the German and British financial markets. They also argued that if the troubles on the American property market exacerbated, then this – coupled with the appreciation of the euro – might dampen euro area growth. They also assessed that increased uncertainty might persist for several months because adjustments to the structure of assets and liabilities of international financial institution would be a gradual process. It was also pointed out that in the face of the turmoil some central banks had decided to relax monetary policy or refrain from its further tightening by adopting a “wait-and-see” approach to monitor developments on financial markets and in the real economy.
When discussing the outlook for economic growth, members of the Council pointed out that, due to the turmoil on global financial markets, growth projections for the United States had been revised down, while European outlook indices declined. It was argued that if economic growth in the external environment of the Polish economy were lower than projected, then the rate of growth in Polish exports would decrease, resulting in slower economic growth and lower inflationary pressure. Additionally, members of the Council pointed out that GDP growth was close to potential GDP, while growth structure was still very favourable from the point of view of the inflation outlook, thanks to increased investment activity in the commercial sector.
Other members of the Council argued that the slowdown in economic activity in Europe did not need to be translated into a lower rate of growth in Polish exports. They pointed to past experience when demand from Western European countries, particularly Germany, for relatively cheap Polish products had increased, despite the sluggishness of their economies. In the opinion of these members, the current data indicated the Polish economy was still on a fast growth track, while the demand gap was positive, which contributed to higher inflationary pressure.
When talking about the stability of the financial sector, some participants in the discussion argued that the Polish economy relied more on the banking than capital market for financing, while Polish banks were dominated by foreign capital. In their opinion, possible troubles of financial institutions holding stakes in Polish banks might affect the condition of the Polish financial sector. In this context, members of the Council pointed to the problem connected with separating banking supervision from the central bank: in the case of disturbances on the financial market, this could make it more difficult for the central bank and banking supervision authority to coordinate their activities.