The challenges and opportunities faced by Central Bank of Poland in conducting monetary policy during a period of global inflationary pressure

I. Introduction

As Consumer Confidence Index is on its lowest ever recorded level (OECD, 2022), global inflation firmly on a rise (IMF, 2022) and weak economic growth is ahead of OECD countries (World Economic Forum, 2022), it has become increasingly challenging for central banks to operate in such difficult macroeconomic setting. Moreover, low nominal interest rates that were introduced to push economies out of recessions now became problematic as energy and food crisis caused by Russia’s war against Ukraine fuelled inflationary pressures (Walker, 2022). Consequently, central banks found themselves in a difficult position between expansionary pressure from policymakers to ease the pain for households and contractionary commitment to inflation targets (Rogoff, 2021). De-anchoring inflation expectations is another cause for concern for central bankers as it can have profound spillover effects on asset prices, debt market and broadly macroeconomic outlook (Kose et al., 2022; McMahon, 2022; Walker, 2022).

Narodowy Bank Polski (abbr. NBP), Central Bank of Poland, is reckoned to be particularly interesting subject for a thorough analysis of global inflationary pressure on monetary policy environment. As Poland is confronted with one of the highest inflation rates of European Union (Eurostat, 2022) and the country has recently scored its lowest ever consumer confidence level (Statistics Poland, 2022a), NBP approaches very demanding headwinds. Furthermore, Polish government expansionary pressures make it difficult for the central bank to keep its inflation target of 2.5% credible. The need to make a public reaffirmation of its sovereignty following series of political accusations, raises additional questions (PAP MediaRoom, 2021). Credibility and independence will play an essential role in the following discussion on opportunities and risks faced by Central Bank of Poland in conducting monetary policy in current geo-economic situation. The author acknowledges that non-conventional monetary measures won’t be discussed as imposed length of the paper constitutes considerable limitation on a scope of the analysis.

The rest of the essay proceeds as follows. Section II and III will evaluate opportunities and risks for the central bank in pursuing its potential monetary policies. Section IV will critically reflect on current position of NBP and conclude the paper.

II. Contractionary policy for a long-term stability

As short-term outlook might look grim, with current inflation rate of 17.4% and GDP growth expected to reach 4.1% in 2022 and then plunge to 1.5% in 2023 (Statistics Poland, 2022b; Instytut Prognoz i Analiz Gospodarczych, 2022), the long-term stabilisation is possible. As Poland is not part of Euro zone, the central bank in not under fixed regime. Contingent rule allows for more flexible responses to supply shocks but it also adversely impacts the central bank’s credibility (Buol and Vaughan, 2022). NBP will have to balance out its policies in the environment of rising inflation and falling GDP. Setting interest rate too high will trigger asset prices falling and debt costs surging, whereas not acting firmly enough may push interest rates up due to market concerns surrounding financing of the debt and credibility and independence of the central bank (Pradhan and Goodhart, 2021; Walker, 2022).

Short-term advantage of increasing interest rates, from current level of 6.75%, would be appreciation of zloty on foreign exchange market. Consequently, cutting prices of foreign goods imported to Polish market which directly reduces inflation level. Notwithstanding, it is important to take into account decisions of foreign central banks. As European Central Bank has experienced, a small increase of interest rate might be deemed too modest if Federal Reserve System makes steeper adjustments to inflation (Financial Times, 2022a). As European Union member states, in 2019, accounted for 59% and 29% of Poland’s imports and GDP, respectively, stronger zloty should support reduction of global inflationary pressure (Mroczek, 2020; The World Bank Group, 2022).

As far as public opinion is concerned, rising interest rate is never a good idea. Higher interest rates means higher debt repayments which only deepen the burden of high living costs for households. However, this is a very shallow view of consequences of Rada Polityki Pieni??nej’s (abbr. RPP, Monetary Policy Council) actions. As inflation is expected to peak at 19.6% in first quarter of 2023 and at the same Polish economy is predicted to record one-period downturn of -0.8% (Narodowy Bank Polski, 2022a), it is crucial to keep inflation expectations anchored (McMahon, 2022). There is a strong argument behind keeping the central bank reputation in high public esteem. As hikes of interest rate increase the current pain, they ease the future one. As long as investors trust central bankers to fight inflation, they will not expect the central bank to forgo its policies in a long run, hence their future inflation expectations will be firmly anchored at NBP’s target. Good indicators of current market forecasts are two-year and ten-year Polish bonds, currently both at around 9% yields. When two-year bond return is higher than its ten-year counterpart, investors exhibit doubts about the central bank’s commitment to their inflation target. As returns from both bonds are dangerously close, NBP should be more than concerned about its credibility. Losing it makes long-term debt repayments more costly and fighting inflation much harder, with potentially higher interest rates necessary to put out the fire of Polish economy. Once credibility is lost, it is extremely difficult and painful to earn it back (Walker, 2022; Kolany, 2022; McMahon, 2022).

Contractionary policies of NBP have their obvious drawbacks to economy?prospects. As recession is already looming over Poland, to strike a healthy balance of high enough interest rates might be a difficult task for RPP. If inflation are persistently over NBP’s target, Central Bank of Poland might be forced to engage in sudden monetary tightening to demonstrate their intentions of keeping inflation under control. Such a drastic change of magnitude of interest rate’s hikes might lead to sharp rise of bankruptcies and non-performing loans, which could profoundly damage Polish economy. With tax revenues falling, steep increase in debt servicing costs and public sector expenditures, compounded with slowly adjusting high inflation, this could lead to budgetary difficulties for Polish government (Kose et al., 2022; Pradhan and Goodhart, 2021).

After NBP chief’s salient involvement in national politics, a public trust in the central bank’s independence has been shaken (Cienski, 2022) which can be perceived by investors as a negative sign for NBP’s inflation commitments.

III. Expansionary policy as a short-term painkiller

Central Bank of Poland might also adopt expansionary approach in order to ease short-term debt repayments costs, consequently boosting economic growth and driving inflation upwards. As two-years and ten-years Polish bonds demonstrate, ING bank’s economists also reckon that NBP seems to be more concerned with short-term solutions rather than medium to long-term outcomes (Kalwasiński, 2022). Hence, a pause in process of increases of interest rates might already be discounted by the market but a 180-degrees expansionary change in monetary policy could trigger drastic reaction from the market. Goldman Sachs Economics Research still upholds its expectations of interest rate peaking at 8% (Business Insider Polska, 2022). However, with real interest rate recovering slightly in November 2022, the central bank might resolve to keep nominal interest rate stable in order to keep Polish economy above water. Moreover, Stanis?awska et al. (2020) found that the central bank’s communication has higher weight on private sector’s inflation expectations than actions.

Notwithstanding, dovish policy has its downsides. If the market stops believing in NBP’s inflation commitment, it will discount future volatility of real return and will mark up debt costs. With lost credibility, interest rates will have to experience steeper growth to decrease inflation, ultimately lowering asset valuations further (Walker, 2022). Another consequence would be depreciation of zloty, which would negatively impact government’s capabilities of paying off foreign-denominated debt that accounts for 56.6% of Polish nominal GDP (CEIC Data, 2021) and increase costs of imported goods and services (Kose et al., 2022; McMahon, 2022).

IV. Current state of affairs for Narodowy Bank Polski

At the beginning of Ukraine-Russia conflict, NBP decided to intervene on foreign exchange market to stop depreciation of zloty and fight already rising costs of living (Financial Times, 2022b). Commitment to low inflation of the central bank has been noted, however, with real interest rate remaining strictly negative for extended period of time, it will take more than that to return to 2.5% inflation target. In current situation, it is the rate of changes of nominal interest rates that will impact Polish economy (Pradhan and Goodhart, 2021).

Joanna Tyrowicz, current member of RPP, argued that further growth of interest rates will be necessary to drive inflation down to NBP’s target. Expansionary fiscal environment, high discrepancies from Taylor rule and constant negative real interest rate since its first hike were arguments presented by Tyrowicz for stricter contractionary measures. Furthermore, the central bank chief’s and RPP’s miscommunication of its objectives, only worsens inflation expectations of the market (Parkiet, 2022). However, not all Monetary Policy Council members share her concerns. On 7th December 2022, RPP didn’t surprise analysts and decided to keep interest rates at the same level for another month. Monetary Policy Council clearly communicated that they hadn’t closed interest rates hikes cycle yet and the following month they would re-evaluate their position as more recent data becomes available. Contrary to RPP’s statement, experts remain sceptical to NBP’s commitment to stricter hawkish measures and expect complete termination of aforementioned cycle (Narodowy Bank Polski, 2022b; Kalwasiński, 2022; Parkiet, 2022).

Situation outlines two possible scenarios for Polish economy going forward. As long as credibility of NBP hasn’t been damaged as much as data suggests and the central bank’s prediction, about fading of global inflationary pressure due to major central banks’ monetary tightening and about effects of global economic downturn, holds true, inflation might indeed slowly move back to NBP’s target (Parkiet, 2022; Narodowy Bank Polski, 2022b). In this optimistic case, Polish economy might just avoid recession and de-anchoring of inflation expectations. Nevertheless, there is also a possibility that adverse fiscal environment coupled with NBP’s inaction and lack of credibility might cause inflation to upsurge (Parkiet, 2022). Sole objective of Central Bank of Poland is to keep inflation at set target, neither to drive economic growth nor to decrease unemployment. One aspect of monetary policy where common agreement between practitioners and scholars exists is credibility of central banks (McMahon, 2022). Narodowy Bank Polski is facing a trade-off between its reputation and Polish economy’s growth, and ultimately it must choose one.

DISCLAIMER: All information presented in above article are as of 12 December 2022. The author declares no conflict of interest. This essay was submitted for a university assignment to Department of Economics of Lancaster University. All views expressed represent solely views and opinions of the author and by no means are to be affiliated to Lancaster University.

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