Monetary Policy is one of the macroeconomic policies used by the Government through the Central Bank to primarily influence domestic prices to achieve and maintain price stability and to support economic growth and employment. Monetary policy is the responsibility of the monetary authority or central bank of a country, like the Bank of Papua New Guinea. When conducting monetary policy, the Bank of PNG’s main aim is affect monetary and financial conditions. Specifically, this means to influence the supply of money or price of money; that is, the interest rate. The impact on these conditions are aimed at achieving a broader objective which is to influence the demand for money thereby impacting on employment and prices.
Monetary policy involves both direct and indirect controls and tries to strike a balance between the supply of and demand for money such that there is neither too much nor too little supply of money in the banking system and in circulation to ensure it is not inflationary while still supporting economic growth. A change to a particular monetary policy instrument indicates the stance in domestic monetary policy. For example, when the Bank of PNG increases its Kina Facility Rate (KFR) it should signal to the market, a tight monetary policy stance. That is, it can be interpreted that the KFR increase is aimed a quelling expected increases in future inflation and vice versa when the KFR is reduced.
The Monetary and Economic Policy Group is responsible for the design and formulation of monetary policy, while the Financial Markets Group implements the policy.
The Monetary and Economic Policy Group is led by an Assistant Governor. There are currently two departments in the Group. The Economics Department comprises three units looking at the different sectors of the economy: Monetary Policy, Balance of Payments, and International Transactions Monitoring. The Research Department has two units: Economic Analysis and Projects.
Objectives of Monetary Policy
The objective of monetary policy in Papua New Guinea, as stipulated in the Central Banking Act 2000 (Section 7) is to achieve and maintain price stability as its primary objective and subject to that it can also promote growth and employment. This involves pursuing low inflation supported by stable interest and exchange rates. Maintaining price stability is expected to:
- Improve confidence in the kina exchange rate and management of the economy;
- Lay the foundation for stable fiscal operations of the Government;
- Provide certainty for businesses to plan for long-term investment opportunities; and
- Support a stable macroeconomic environment conducive to economic growth.
Experiences from both developing and industrialised countries show that low inflation helps to promote economic efficiency and growth in the long run, while the adverse impact of high inflation on the economy has been empirically recognized to be harmful to consumers and economic growth.
Formulation of Monetary Policy
The Bank of PNG releases two Monetary Policy Statements each year, as required under the Central Bank Act 2000, the first on 31st March and the second on 30th September. The amendments to the Act from 2024 establish an independent Monetary Policy Committee, separate from the Bank of PNG Board, which is solely responsible for the formulation of the statement and the intervening announcement of the Bank’s monetary policy decisions every six weeks.
Expected developments in the global economy and their implications for the domestic economy, through the balance of payments, fiscal operations of the Government, monetary aggregates, real sector, exchange rate and ultimately the impact of these variables on inflation are considered in the formulation of monetary policy for the announcement of the six monthly stance of monetary policy via the Monetary Policy Statement and the six weekly decision of the policy signaling rate, the Kina Facility Rate (KFR).
Implementation of Monetary Policy
Monetary policy is managed within a reserve money framework. This means that the Bank of PNG uses a range of tools and ways to control the supply of money with the aim of maintaining stable prices. Reserve money comprises currency in circulation and deposits of commercial banks with the Bank of PNG.
Following the announcement of the KFR policy signal, weekly auctions through open market operations are conducted with the aim to guide market rates towards the KFR. The implementation of monetary policy is vested with the Monetary Operations Committee that meets on a weekly basis to assess liquidity conditions and, interest rate and exchange rate and fiscal developments before deciding on how much liquidity to defuse or inject into the banking system.
Through the open market operations, the Monetary Operations Committee issues Central Bank Bills through the 7-day Fixed Rate Full Allotment auction and other competitive auctions to influence liquidity. The Bank of PNG also uses its direct prudential policy instrument, the Cash Reserve Requirement, to absorb liquidity.
In late 2024, for liquidity management purposes, the Bank introduced the monthly Cash Reserve Requirement averaging tool which aims to help commercial banks access up to 50 percent of their monthly prudential requirements. This was done to ensure that banks had some flexibility in managing their liquidity needs. To further improve liquidity management of commercial banks, the Bank introduced the Reverse Repo instrument to complement the Repo instrument to allow deposits with and lending by the Bank of PNG, respectively. Open market operations remain the main instrument used in implementing monetary policy.
At times, the Bank of PNG has also operated a Central Bank Bill Tap facility to absorb excess liquidity while allowing small retail investors to participate in the securities market and help develop a savings culture in the country.