The central bank has been standing up for the inflation target determinedly and vigorously since the abolition of the trading band. Leaders of the institution take every chance for a verbal intervention, stating day by day that the NBH will take the measures needed to keep the inflation target. According to this, the Monetary Council has been lifting continually the benchmark interest rate lately.
Background of the conflict
Inflation target was set jointly by central bank and the government – but many considerations have changed by today. Inflation had a far higher path than planned in the last few years. Moreover, external effects also raise the difficulties of inflation targeting: prices of raw material and food may stick at high levels persistently. Furthermore, prices ascended in the Asian region at a rate much higher than before.
These mean that reaching the inflation target requires more serious sacrifice, which is to be paid not by the central bank, as it is the cabinet’s reputation that reflects the state of the economy. However, the NBH acts as it is its only duty to reach the inflation target, and no external influence will make it deviate from the purpose. Credibility is crucial for a well functioning central bank: if it changed its objectives on account of external impacts, the exchange rate of the Forint along with the economy as a whole would become vulnerable. This does not concern the target date, which is more of a signal of the bank’s understanding and consideration of autonomous occurrences.
Objectives of the NBH and the cabinet only accord partly. Sometimes conflict is inherent between monetary and fiscal policy. Although cooperation was (at least) seemingly harmonious between the central bank and the cabinet after the appointment of András Simon, the central bank has found itself in crossfire of attacks between the government and the opposition
Cabinet has a political stake in criticizing the NBH
The reason of government-side criticism is clearer: although high inflation is unfavorable for governance, it is easier to tackle with on the short run than the effects of the interest rate increase. Moreover, underestimating inflation has long been used as a political stunt while planning the budget. And the government is interested in fostering the uniquely sluggish economic growth – an aim contradictory to the high benchmark interest rate. It is a political problem as well, because the opposition has been emphasizing for a long-while that the solution to the current bad economic state would be to boost economic growth and create new jobs; so monetary policy worsens the situation of exactly those areas that are politically most important for the government. Consequently, the cabinet has become less keen on reaching inflation target.
Presumably the government’s criticism on the NBH will become harsher in the times to come. The most likely is that the bank resists, and continues to stand up for the inflation target. In this case, the credibility of the monetary policy grows, but possibly on the expense of economic growth, and meantime the conflict between the cabinet and the central bank may intensify. It is much less probable that the bank surrounds to the pressure and modifies the inflation target. This would induce serious monetary risk, as a central bank lacking credibility might itself push up inflation through the inflationary expectations of market actors, and it could hardly defend the currency from an outside attack.
NBH under opposition’s attacks
The real surprise was definitely caused by the leading opposition party’s criticism over the monetary policy. Former finance minister Mihály Varga stated he was expecting an explanation from the Governor of the central bank. The move was part of the strategy to prove in front of public opinion the party’s ability to govern. Fidesz-criticism focused on the growth of the interest expenses. This is a message to demonstrate that as they are preparing to govern, they are at least as concerned about the budget deficit as the currently governing parties are.
Accordingly, Fidesz is suggesting an economic policy that differs from the one they led while ruling. With Zsigmond Járai in the governorship of the central bank, they were treating low inflation and a strong Forint as a priority.
Conflict between NBH and Fidesz also has a personal aspect. Viktor Orbán as Prime Minister confronted András Simor, the then-Chairman of the Budapest Stock Exchange on several occasions, and the Fidesz-cabinet took many measures that handicapped the Hungarian capital market.
Soon the Governor of the national bank will be heard in both the Committee on Budget and Finance, and the Economic Committee of the Parliament. Although the hearing was initiated by the National Bank of Hungary earlier, Fidesz tried to put it as if they were citing the Governor before the Committee, as this is a classical act of political pressuring in Hungarian politics.
What happens to the Forint?
Another effect of the interest rate raise is the significant strengthening of the exchange rate of the Forint. This may cause some negative consequences on the middle term. First, it makes exporting less profitable, which has been the only engine of the economy lately. On the other hand, it facilitates the conditions of taking loan denominated in foreign currency, which already accounts for a growing part of household debt (NBH itself warned against this phenomenon several times). These considerations increase political risks as:
- Companies interested in exporting keep pressuring the government and the opposition to criticize the interest rate policy of the national bank
- This exacerbates the tension between political forces and the central bank, keeping foreign investors guessing.
- Household indebtedness increases political risk through exchange rate risk. A persistently strong currency will result in an even higher debt ratio, therefore an incidental depreciation or a speculative attack would put a great many households at a disadvantage, seriously damaging public trust in the government.