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Inflation Targeting in Armenia: Monetary Policy in Transition

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Abstract

As the monetary and financial systems in transition economies have evolved so have monetary policies. Many central banks have followed a course from exchange rate targeting, to targeting monetary aggregates to targeting inflation. We examine the development of monetary policy in Armenia, a small, open transition economy that adopted inflation targeting in January 2006. First, we review monetary policy in Armenia. Then we evaluate the capacity of the Central Bank of Armenia to implement inflation targeting. Finally, we estimate and simulate reaction functions to evaluate the effectiveness of monetary policy. We find that the Central Bank may have been overly restrictive.

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Notes

  1. See IMF, September 2005. ‘Does Inflation Targeting Work in Emerging Markets?’ Also note that technically it is inflation forecast targeting that is the best policy descriptor, and the targets may be explicit or implicit. Below we will simply use the term inflation targeting.

  2. If we take January 1990 as the beginning of transition, the Czech Republic was the quickest taking about 8 years, adopting inflation targeting in the first quarter of 1998, then Poland in the first quarter of 2001 and Hungary in the third quarter of 2001. See Jonas and Mishkin (2005) and Orlowski (2006).

  3. See also Poole (2005) and Gerdesmeier and Roffia (2004).

  4. The other objectives in Article 5 do not include any other macroeconomic objective, but make reference to assuring smooth functioning of the banking and payments systems. The law may be read online at http://www.cba.am/legal/central.pdf.

  5. CBA, ‘Development Vision’. http://www.cba.am/publications/vision.pdf, 11 November 2003, last viewed 16 April 2006.

  6. See Central Bank of the Republic of Armenia (2006a) and Central Bank of the Republic of Armenia (2006b) p.28.

  7. Ibid, p. 30. One can see that while CBA states its goal of 3% inflation for 2006, it nevertheless must file forecasts for monetary aggregates, including reserve money. See pp. 31–32.

  8. Note that this is quite different than the case of fully developed economies like the G3, the US, Japan and Germany, which pursue what Clarida et al. (1998) call ‘soft-hearted inflation targeting’.

  9. See also Batini and Laxton (2005), Carare et al. (2002) and Dabla-Norris et al. (2007).

  10. See Table 11a, p. 28 of Dabla-Norris et al. (2007).

  11. Stone (2003), p. 8 notes that median interest rates in 1998–1999 were 12.4% for countries engaged in inflation targeting lite versus 9.9% for full-fledged inflation targeters.

  12. Central Bank of the Republic of Armenia (2006c), p. 10.

  13. See Dabla-Norris et al. (2007) section IV.D and Table 10 for additional details.

  14. See Table 5 of Dabla-Norris et al. (2007), p. 14.

  15. 1996 Republic of Armenia Law on the Central Bank.

  16. It is worth noting that, while the CBA is adopting an inflation targeting strategy, it specifically notes that it is also not abandoning ‘all of the principles of the monetary aggregate targeting strategy’. Central Bank of the Republic of Armenia (2006c), p. 11. Such explicit pronouncements may confound public perceptions of monetary policy.

  17. Cukierman et al. (2002) attribute this in part to being a latecomer to central bank reforms and also for countries which had two central bank reform laws, the second tends to make the central bank even more independent. This was indeed the case for the Central Bank of Armenia. See pp. 241–244, and in particular Tables 1, p. 242 and 2, p. 244. Also see Table 6, p.16 of Dabla-Norris et al. (2007).

  18. Central Bank of the Republic of Armenia (2006b).

  19. Note that Taylor (2001) is sceptical about adding the exchange rate into the interest rate rule. Edwards (2006) agrees, noting concern about adding volatility to monetary policy. However, when the exchange rate is included in empirical specifications it is typically statistically significant. Thus, the exchange rate may be capturing meaningful information about real sector disturbances, inter alia.

  20. See Goodfriend (1991), section IV, for a detailed explanation of interest rate persistence results from the pursuit of monetary stabilisation.

  21. We also estimate specifications with the nominal exchange rate. There is virtually no difference between the two exchange rate equations in their forecasts. Likewise, there is little substantive difference between the de-trended and actual nominal and real exchange rates. Since it might be expected for real and nominal rates to appreciate naturally in transition, as productivity improves, we could imagine that monetary authorities would look more at deviations from trend than at the level itself as indications that monetary conditions are moving away from equilibrium.

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Acknowledgements

The authors would like to thank the anonymous referees for helpful comments on an earlier draft. All errors remain the responsibility of the authors.

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Authors and Affiliations

  1. Department of Economics, St. Cloud State University, 386 Stewart Hall, 720 4th Ave.S., St. Cloud, Minnesota, 56301, USA

    King Banaian

  2. Armenian International Policy Research Group, 6303 Massachusetts Avenue, Bethesda, 20816, MD, USA

    King Banaian & Grigor Sargsyan

  3. Department of Economics, University of Memphis, Memphis, 38152, TN, USA

    David M Kemme

  4. Central Bank of Armenia, 6 Vazgen Sargsyan, St. Yerevan, 375010, Armenia

    Grigor Sargsyan

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  1. King Banaian
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  2. David M Kemme
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  3. Grigor Sargsyan
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Banaian, K., Kemme, D. & Sargsyan, G. Inflation Targeting in Armenia: Monetary Policy in Transition. Comp Econ Stud 50, 421–437 (2008). https://doi.org/10.1057/ces.2008.22

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