IMF: Inflation remains high if budget deficit is not kept low

The only way to bring the inflation back down to 5% level quickly and without incurring high economic costs is a good correlation of the monetary and fiscal policies. However, this is an optimistic scenario, believes the International Monetary Fund (IMF)
“If the current fiscal policy is tightened, which would entail having the budget deficit remain at 1-1.5% of GDP in 2008, compared with the Government’s projection of 2.7%, then it will be possible for inflation to temper a moderate interest rate increase in the second half of 2008, without any adverse effects for the economy,” stated Juan Fernandez-Ansola, the regional representative of IMF for Romania and Bulgaria during a seminar organised by ING. He points out that as far as the IMF is concerned, this “is the best situation possible”.
For the time being, the IMF official believes the monetary policy (which is now tightening) is colliding with the fiscal policy, which continues to relax.
“If the NBR is left to struggle with inflation alone, then this will be a costly process. The fiscal policy has to play an important part,” Ansola said.
The IMF official explained that the fiscal policy is used to settle expenses that account for 40% of total expenses of the economy, this making a significant impact on aggregate demand.
“Unless correlated action is taken, we will be seeing high inflation for a long time.”
A pessimistic scenario, which would have NBR push for a significant rate increase to contain inflationary expectations, would generate a reduction in the capital investments, which will translate into a reduction of the economy’s growth potential.
The IMF view of the inflation over the coming period takes the negative situation into account.
Eugen Dijmarescu, NBR vice-governor says inflation in October (1.08%) was again higher than indicated by the forecast model used by the central bank, which anticipated a 0.2% lower level.