The History of Monetary Policy (1993-2023)
In 1993, the Armenian national currency, the Armenian dram, was introduced into circulation, and the Central Bank of Armenia began implementing its monetary policy. The first “Law on the Central Bank of Armenia,” adopted in that year, identified the establishment of the national currency and the maintenance of external stability as the primary concerns for the CBA to address, but it did not mandate a primary objective for the Central Bank. The national currency was introduced on November 22, 1993, after most of the other post-Soviet republics had started circulating their national currencies. In this period, when other post-Soviet countries had commenced using their currencies and no longer accepted the Ruble, the inflow of the Ruble to Armenia contributed to a rapid growth in prices commensurate with hyperinflation. In 1993 alone, year-on-year CPI inflation stood at 11000%.
In 1994, the Central Bank of Armenia adopted monetary aggregate targeting as its monetary policy strategy, and that year marked the first monetary policy strategy of the CBA.
The adoption of a monetary aggregate targeting regime was cemented in 1996 with the adoption of the “Law on the Central Bank of Armenia (1996)” which made price stability the primary objective of the CBA whereas money supply and broad money were identified as intermediate and operational objectives. With further institutional development, the law explicitly established the Central Bank’s independence, the supremacy of the primary objective, the implementation of monetary policy through indirect instruments, operational accountability, and strict limitations on CBA loans to the government alongside other principles. At the same time, the CBA adopted (and to this day continues to implement) a free-floating exchange rate policy which would imply that CBA FX interventions would only be practiced through indirect instruments.
In 1999, driven by the need to improve the effectiveness of the monetary policy, new principles and mechanisms for using monetary instruments were implemented and presented in the Indirect Instruments of CBA Monetary Policy announcement. In line with this document, the set of CBA policy instruments included internationally accepted and stellar monetary policy instruments which required the CBA to announce its policy rates. Additionally, this would support financial markets to ensure the stability of price indicators and send signals about the expected direction of policy.
From 1994 to 2005, the implementation of the monetary aggregate targeting strategy allowed the CBA to achieve macroeconomic stability by reducing and stabilizing inflation. Inflation became manageable in the second half of 1994, although year-on-year inflation at year-end stood at 1761%. 1995 was a turning point: economic activity accelerated to a positive 5.7% after the prior years’ extreme declines, and inflation stood at 32.2%. Between 1995 and 1998, inflation gradually stabilized after some volatility, and the Armenian economy finally entered a low inflation environment with annual inflation averaging 4.3%.
In 2003, the CBA presented to the public its vision for development which included the adoption of inflation targeting during its foundation. Over two years of research and studying other countries’ experiences, the CBA selected inflation targeting-lite as its preferred strategy. Inflation targeting-lite was considered a well-suited interim strategy for developing countries that faced several issues including frequent external and domestic shocks and a low capacity for dealing with them, underdevelopment of financial markets, high levels of dollarization, and volatility in trade terms. In this context, the operational objective was defined as being both the money supply as well as the policy rate, while FX interventions were frequently used.
On January 1, 2006, when the foundations of inflation targeting were established, the CBA shifted to a full-fledged inflation targeting regime, along the lines of the Law on the Central Bank of Armenia. The short-term (7-day repo) interest rate was selected as the operational objective, while the final objective was defined as the 4% annual inflation target with a +/- 1.5 percent tolerance band. Relative to previous monetary policy strategies, the full-fledged inflation targeting regime's advantages included adopting a more holistic, forward-looking policymaking framework that emphasized monitoring inflation expectations and making decisions within a Forecasting and Policy Analysis System (FPAS Mark I). In 2011 and 2012, the CBA invested meaningful resources in enhancing the FPAS framework and improving communications and transparency. At the same time, in Q2 2012, the CBA expanded the policy horizon from one year to three years and began to provide policy-consistent macroeconomic forecasts (including for inflation), replacing the prior approach to conditional forecasts that assumed a constant policy rate.
On April 9, 2018, the CBA’s primary objective was expanded to include both price stability and financial stability.
Since adopting inflation targeting and the FPAS Mark I framework between 2006 and 2023, the CBA has grappled with successive layers of crises and shocks. These include the 2008-2009 Global Financial Crisis, the 2014-2015 regional economic-financial crisis, the 2020 Covid-19 crisis, the 2020 Nagorno-Karabakh War, the 2021 Russia-Ukraine conflict, and the 2023 war in Nagorno-Karabakh, resulting in the forced displacement of its indigenous population. Additionally, the bank has faced several challenges stemming from various regional and global developments. In this context, whether viewed from the perspective of managing monetary or financial market risks, uncertainty has significantly increased. This surge in uncertainty has led to greater volatility in inflation, interest rates, and exchange rates.
Given all this, over the 18 years since adopting FPAS, the prudent policy actions of the CBA within the inflation targeting and the strengthening of the framework have allowed annual inflation to average around 4.2%, which is in line with the stated 4% target of inflation that is consistent with price stability.