Mohamed Abdel Aal writes: A reading about the inflation targeting policy!!
Mohamed Abdel Aal writes: A reading about the inflation targeting policy!!
The Central Bank of Egypt has played a crucial role in implementing the inflation targeting policy since March 2024.
On March 6, 2024, the Central Bank of Egypt announced its historic reform decisions, which revealed without a doubt that the lofty interim goal is to target inflation. So what does the inflation targeting policy mean? And why did the Central Bank of Egypt adopt this policy?
Combating inflation is one of the most important challenges facing monetary policies in many countries around the world, whether developed or developing countries, as inflation negatively affects the economy, consumers and markets.
Effective monetary policies are the key to combating inflation and maintaining price stability. Therefore, monetary authorities and central banks around the world, including the Central Bank of Egypt, have been activating and adopting monetary policy mechanisms, seeking to control and curb inflation.
Inflation is defined as an increase in the quantity or supply of money at a rate greater than the rate of increase in the supply of goods and services, which means an increase in prices and a decrease in the value of money, and this automatically results in a decrease in the real income of individuals, especially if the increase in prices occurs while cash incomes remain stable, or are not met with a proportionate increase in cash income, or the increase in cash income is at a rate less than the increase in prices.
Most economists agree that inflation is a direct cause of slowing growth rates, depreciating the value of money, weakening confidence in the national currency, and reducing the attractiveness of direct and indirect foreign investment. High levels of inflation also lead to an increase in the prices of locally produced goods for export purposes, reducing their price competitiveness with their counterparts in global markets, and thus negatively affecting both the trade balance and the balance of payments.
Therefore, the inflation targeting policy is one of the most important and prominent policies implemented by central banks in their relentless efforts to confront and control inflation, measure and track its readings and compare it to the target number.
The concept of inflation targeting policy is based on the central bank announcing and disclosing a specific numerical target for the inflation rate that it wants to approach or achieve within a specific period of time in the future, or that can be achieved in two periods, one short and the other medium, and achieving its sustainability and stability in the long term after that.
One of the most important requirements for the success of this policy is the full commitment of the Central Bank to work and strive to achieve the targeted inflation figure during the specified period, except if external circumstances, events or shocks arise, such as wars or pandemics, which may extend the time horizon necessary to achieve the targets.
It is noted here that according to this definition, three elements must be available in the inflation targeting mechanism policy: the first is agreement on a basic numerical target for the inflation rate, the second is the central bank’s commitment to work to achieve it within a specific time frame, and the third is adopting a strategy to achieve the target, especially with regard to monetary policy tools, for example, raising interest and fixing it at a high rate as a framework for a very restrictive strategy to confront a high and stubborn rate of inflation.
Changes in actual inflation rates from the targeted rates require the intervention of the Monetary Policy Committee of the Central Bank on a regular or exceptional basis, and the escalation of the use of appropriate monetary policy tools in accordance with the applied strategy.
These three elements are among the most important basic conditions that must be met to ensure the effectiveness of the inflation targeting policy.
The first experiments with inflation targeting policy began in New Zealand in 1990, and were followed by most industrialized countries. The success of implementing this policy in these countries encouraged many developing countries to adopt this policy in order to reduce inflation rates.
Central banks rely on a set of basic concepts and tools, through which they can control to a large extent the expected paths of inflation figures, reaching the target figure over a specified time frame. Among these tools, and indeed the most famous and widely used, is working to reduce the money supply, by increasing interest to stimulate savings, reducing the volume of credit, as well as reducing the cash in circulation, through open market policies, raising the required reserve ratio, and reducing government spending.
Egypt adopted an inflation targeting policy in conjunction with the implementation of the economic reform program “2016-2019”. The Central Bank of Egypt also played a decisive role in implementing the inflation targeting policy since March 2024, when it adopted a very restrictive monetary policy regarding interest rates. It raised them during the first quarter of 2024 by 800 basis points in order to confront high inflation and work to contain it, gradually reaching its planned targets. It continued to maintain the high interest rate until now (27.25% - 28.25%), but it extended the time horizon for achieving the targets to reach 7% plus or minus 2% on average during the fourth quarter of 2026 and 5% plus or minus 2% on average during the fourth quarter of 2028, targeting to keep it at low levels not exceeding 5% after that.
The Central Bank of Egypt continues to intervene through open market mechanisms to regulate the money supply and withdraw excess liquidity from banking system units through the main process, and amend the weekly deposit acceptance system from accepting deposits according to the allocation system, to accepting according to absolute deposits, all to ensure price stability and precise control of the liquidity rate and the amount of payment methods available in the market, and thus achieve control over the money supply and the inflation rate.
Now it is time for us to ask ourselves, will inflation decline in Egypt during the current year 2025? And are we on the threshold of shifting to an accommodative policy targeting growth and employment?
No one denies that the inflation rate itself seems to be on its way to decline further due to the monetary policies pursued by the Central Bank, but there are concerns about the escalation of regional and global conflicts, especially in the Middle East, and the creation of a new phase of uncertainty, in response to the ideas and actions of US President Donald Trump, which may impose significant risks on commodity markets in the new year, generating uncertain, but possible, inflationary pressures.
But economic growth will not wait in the long run to be a victim of all the successive and potential external shocks.
This is why we expect the Central Bank of Egypt's monetary policy to remain tight for a long time, although there are possibilities that may reach the point of certainty among some interested parties that the Monetary Policy Committee may see the initiative to cut official interest rates at its next meeting on February 20.
In my opinion, this is possible, and even welcome. It does not mean at all that the Central Bank of Egypt will get rid of its tight monetary policy, but it will work on a gradual reduction that will not affect the exacerbation of inflation, but on the contrary will support the requirements of growth and stimulate the private sector, to increase credit demand, and reduce the cost of goods for the final consumer in Egypt and abroad, which means an increase in the supply of local production and a decrease in prices, i.e. a decline in inflation.
At the same time, the Central Bank is cautiously and very carefully watching the gradual trend of the inflation curve, and ensuring that it declines towards its specified targets.
We are really between a rock and a hard place, the harshness of resisting inflation and the aspiration for growth gains.
Mohamed Abdel Aal
Banking expert
