Monetary policy decision-making regarding the key rate in European countries and their impact on inflation

Abstract

Introduction. For many years central banks around the world kept low rates. In 2021-2022 European countries experienced rising inflation in response to which the European Central Bank, as well as the central banks of countries with their own currencies, raised rates to the highest level in decades. At the same time, the effect of changes in accounting (key) rates turned out to be much weaker than expected. Problem Statement. The research is based on the popular hypothesis that the central bank will raise the key (accounting) rate as a tool to curb inflation. Purpose. To determine the correlation between inflation and the accounting (key) rate of the monetary policy body and approaches to the formation of the composition of bodies that make decisions on the accounting rate. Methods. Economic and statistical methods are used to assess the correlation and volatility of inflation rates and key rates of central banks, comparison, descriptive method, analysis, generalization and induction. Results. A comparative analysis of inflation dynamics in 2022–2023 in European countries and the key rate of central banks was carried out. Countries that are direct participants in the military conflict - Ukraine, Russia, and Belarus - should be considered separately, which is why they are excluded from the analysis. Particular attention is paid to the rationale and procedure for decision-making by monetary policy bodies on revising the key rate. Conclusions. In the euro area, under the conditions of a single policy regarding the key rate, a significant range of inflation rates among countries is allowed in the observation period of 2022-2023 in a wide range. The effect of reducing inflation comes in about 6 months after the key rate increase, however, the impact of non-monetary factors (fluctuations in world prices for oil, gas and grain) may be considered decisive in such a reduction. Accordingly, the discount rate increase has a greater effect not in terms of curbing inflation, but in the context of slowing economic growth. In the countries of the euro zone, inflation has increased and is returning to a moderate level, but the range of fluctuations of its inflation rates is very high. This contradicts the postulates of European market integration. Also, changes in inflation rates are very similar to the dynamics of global energy and food prices. In general, non-monetary factors of inflation remained the main ones, and the effectiveness of the key rate as a tool for reducing inflation in theory seems overestimated. In addition, a comparison of inflation rates and the level of the key rate in a sample of countries produces different ratios: in most countries, inflation exceeds the key rate many times over. Decisions about its level attract attention of market participants, and they are mostly expected (increase, preservation, decrease), but sometimes unexpected situations occur regarding the scale and direction of changes. The decision-making procedure and information disclosure are characterized by a high level of transparency and attention to the consequences and impact on the national economy. In the leading countries of the world, the decision on the level of the discount rate is always made by a collegial body, the composition of which is formed according to different approaches, despite the status of the central bank as independent from political influence.

Ukraine’s Monetary Policy Under Martial Law

“…According to S. Arzhevitin, the rise in inflation in European countries in 2021-2022 led to a sharp increase in interest rates by central banks to the highest level in recent decades. At the same time, the effect of changes in the key rates was much weaker than expected (Arzhevitin, 2023). T. Iefymenko notes that empirical targeting by reducing inflation to a threshold that causes monetary deflation and a transition to depression increases real GDP growth, while an increase in inflation above the threshold reduces real GDP growth (Iefymenko et al, 2021).…”