Hungary Development Minister Nagy urges cenbank to set inflation target higher

In an opinion piece published in daily Magyar Nemzet, Minister of Economic Development Márton Nagy called for a reconsideration of the central bank's inflation target (3%+/- 1 percentage point). He believes that inflation, while not the most important issue, is the most pressing one these days, as it can significantly hamper socio-economic competitiveness.

he thinks inflation may not return to its previous 2-4% range.

On the basis of historical experience and economic logic, he argues that inflation may shift upwardly from historical levels in the medium term, especially as a result of shocks such as wars or natural disasters. Supply shortages, globalisation and uncertainty may also contribute to higher inflation.

Nagy argues that the structural factors he presented in the article could make inflation sticky in the single-digit range over time. "If this is a structural, unavoidable change, the question arises as to how long and at what cost it is worth fighting it, what social and economic cost we would pay for an unattainable goal," he says.

the minister believes that fiscal and regulatory policy will play a more important role in shaping inflation and will also play a stronger role in setting the inflation target.

Nagy also sees risks in this area, and considers the issue of inflation expectations and the credibility of the central bank to be sensitive. But as he writes: "a higher inflation target than in the past could even provide a more credible long-term vision for economic agents, who would incorporate this vision into their expectations, while at the same time putting the credibility of the central bank on a new footing."

As regards price drivers, he points out that energy and capital are the factors that can drive prices higher persistently. The global green transition requires major investments and governments are supporting this process. Capital flows may also be diverted in new ways by the transformation of the global environment and this may affect the availability of capital. The role of geopolitical links in the supply of capital is also increasing, he says. Capital policy will be used as a political tool and this could have an impact on investment and interest rates.

He also argues that demographic decline - also known as a grey or autumn transition, along the lines of the green transition - can also contribute to capital scarcity, but can also have a number of price-boosting effects, even if it cools inflation by reducing consumption. The most obvious mechanism is a labour shortage, which puts upward pressure on wages. Population decline is accompanied by an increase in public pension and health care expenditure, the financing needs of which can also trigger inflationary pressures.

Márton Nagy's suggestion to raise the inflation target is a provocative idea. It is the first signal from the government that achieving price stability is not a priority for economic policy. Such a move has a number of risks, which obviously need to be taken into account before such a step is taken. One of them is the potential damage to the credibility of the central bank, which is very likely should the the price stability objective is let go of. On the other hand, experience has shown that inflation above price stability (2-3%) cannot be kept fixed because expectations become unstable.

Importantly, the economic policy benefits of raising the inflation target are not obvious. The economic policy intention to let inflation loose would be rapidly reflected in inflation expectations. As a consequence, "surprise demand shock" aimed at boosting demand could cause deviation from the new (higher) target, which would lead straight to inflation spiralling out of control.

Another important element is that Hungary currently has the highest inflation target in the region, with Poland and Romania at 2.5% +/-1.0 ppt and the Czech Republic at 2%, also with a target range of +/-1 ppt.