Monetary Policy and Inflation in Georgia (1996-1998)

Monetary policy and inflation in Georgia in the years 1996-1998 are the subject of this paper. As it is written in the middle of 1997, the discussed period is in a natural way divided into two parts: past and future. Correspondingly, first sections of the paper deal with facts which have already occurred and with their interpretation, while the remaining sections contain some projections that the authors tried to make for the future. The paper is organized as follows. Section 2 describes the framework in which the monetary policy of Georgia is conducted. The first part of this section names the monetary authority, shortly sketches the legal and political framework in which it operates and lists the instruments which it can use. The second part concentrates on the IMF’s ESAF program which is implemented in Georgia since 1996 and will be continued until 1998, and which tightly constraints the acceptable monetary policy range. The discussion of this program revolves around its two core (and sometimes inconsistent) macroeconomic elements: the quantitative performance criteria and the exchange rate policy. Section 3 discusses two characteristic features of the Georgian economy that were inherited from the hyperinflation period 1993-1994: low money multiplier and low monetization. Low money multiplier is directly related to the situation in the banking sector, which is thus also sketched. Low monetization is an indirect indicator of a whole set of factors. While discussing it we resort to recent literature on this problem and to international comparisons contained in it. Section 4 is of a more descriptive nature: it presents the past behavior of money supply and of the exchange rate in a chronological fashion, but attempts to interpret the observed phenomena are also made. Section 5 opens the forward looking part of the paper: it characterizes prospects for the future for M2 and real output. Section 6 sketches the econometric modeling strategy which the authors applied for Georgia. The constructed model has been used to obtain forecasts of inflation and nominal GDP, on the basis of assumed scenarios of money supply and the real output. The forecasts for 1997 H2 - 1998 (the remaining part of the discussed period) are presented in section 7. Finally, some conclusions are drawn in section 8. Technical details of the estimations can be found in the Appendix.