Formulation

Under the CBA 2000, the Bank is required to target price stability as its objective of monetary policy, compared to the previous broad goal of monetary stability. Maintaining price stability in a small open economy like PNG requires amongst other things, relative stability in the exchange rate.

Consistent with this objective, the analysis of price changes became central to the assessment of macroeconomic conditions and the conduct of monetary policy. In 2000, the Bank began to closely monitor and report on “Underlying inflation”, together with the headline inflation measure released quarterly by the National Statistical Office (NSO). The underlying rate of inflation measures the inflationary pressures in the economy that are predominantly due to market forces, i.e. changes in prices that reflect the longer-run supply and demand conditions in the economy. This distinction is crucial so that any assessment on the appropriate stance of monetary policy has to exclude the effects of temporary shocks caused by highly volatile, seasonal or policy factors and persistent shocks on future inflation.

The CBA requires the Bank to produce semi-annual statements, which spell out the Bank’s stance and conduct of monetary policy over the coming six months. The first statement was released on 17 July 2000, one month after the Act came into effect. This statement covered the monetary policy for the full year of 2000, while the policy in the first six months was a continuation of that adopted in 1999. In this statement, the Bank reaffirmed its commitment to maintain a tight monetary policy stance throughout 2000 in a continued effort to mitigate the downward pressure on the exchange rate, and increased inflationary pressures experienced during 1999.

The formulation of monetary policy has been broadly guided by analysis of the main factors that influence the achievement of price stability, and an understanding of their economic consequences. In designing monetary policy for 2000, the Bank considered actual and projected developments in the international economy, domestic economic conditions, the balance of payments, and fiscal operations of the Government and their potential impact on monetary aggregates, the exchange rate and inflation. These projections also incorporated the requirements of the financial program with the IMF and World Bank, one of which was to rebuild foreign exchange reserves. Accordingly, the projected inflation rate, monetary and credit aggregates which were considered essential to the achievement of price stability and to encourage external financial support, were set for 2000.

Throughout the year the Bank continued to assess market developments and the main macroeconomic indicators that impacted materially on future inflation performance, to determine whether monetary policy was on track or whether any changes were warranted. The key indicators included; movements in exchange rate, maintenance of positive real interest rate, money and credit aggregates, prudent implementation of the 2000 budget, draw down of budgeted external extra-ordinary financing and retirement of domestic debt by Government. A cautious approach was taken by the Bank to ensure that any changes to its policy stance were implemented gradually consistent with developments in these key areas and their impact on the rate of inflation.