• Alessandro Consonni (Italy)

Monetary policy challenges in Central and Eastern Europe during the Russia-Ukraine war



The outbreak of the Russia-Ukraine war reveals how the future of money hinges upon, at least, three challenges. First, the price control has rocketed up again, with central banks grappling with the dilemma of having to reduce inflation and safeguard the value of citizens’ savings without at the same time sharpening the economic slowdown already underway. Furthermore, there is a technological challenge to make transactions faster and more convenient to take over the payment instrument market. Finally, the geopolitical test is based on currency choice.


Given their power in terms of population and sheer economic size, emerging market economies have now become one of the most dynamic and economically important groups in the world scenario. As these economies become larger and more integrated into international trade and finance, they face an increasingly complex set of policy challenges, in designing monetary policy frameworks that work well in terms of promoting monetary and financial stability, with multi-level implications even beyond their national borders. Hence, despite their newborn economies, many emerging market States still have relatively underdeveloped financial markets and institutions with a significant portion of the population struggling against poverty.


Furthermore, it is important to bear in mind that the developing countries' legal framework is quite disorganized so much so that it can be described as a tricky puzzle. Those are the reasons why central banks in emerging markets have to learn to cope with a unique set of challenges. Generally speaking, monetary policy, with its aim of guarantying price stability, is the first line of defense against a variety of internal and external shocks to which these economies are now exposed. Central banks, keeping inflation low and stable, must promote growth and employment. Challenges are either institutional or technical, but both of these act as severe constraints on monetary policy implementation.


The key institutional constraint is, without a shadow of a doubt, the lack of central bank independence. In the same way, monetary policy is often hampered by a weak transmission mechanism related to the underdevelopment of the financial system. As can be expected, a weak banking system can make it difficult for a central bank to aggressively use policy interest rates to achieve domestic objectives given that large changes in interest rates can have potentially devastating consequences on the balance sheets. At the same time, the lack of market integration within these countries reveals asymmetrical regional responses to the monetary policy adopted. In addition, one structural change, that is making it more difficult to isolate monetary policy from external influences, is the increasing openness of the capital account in emerging market economies.


Finally, a different type of problem of capital flows arises in heavily aid-dependent low-income economies, particularly present in Central and Eastern Europe. Even though aid flows are significant, they can be volatile depending on political and other factors. This paper sheds some light on the most significant monetary policy challenges in emerging market economies and attempts to answer questions such as: how should States respond to these volatile flows to the government? How should monetary policy respond to large shocks such as the worldwide surge in food and fuel prices?