Tighter Fiscal Policy Can Help Mongolia Control Inflation
IMF News, November 26, 2024
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Bibliographic details
- Authors: Angana Banerji, Thomas Helbling November
- Published: November 26, 2024
Background and context
- Article authors: Angana Banerji and Thomas Helbling.
- Publication date: November 26, 2024.
- Discussion at the Bank of Mongolia’s recent international conference marking its centennial highlighted alignment of monetary and fiscal policies to tackle high inflation.
- Historical milestones cited:
- The Bank established a two-tier banking system in 1991.
- The fixed exchange rate was scrapped in 1993.
- Elements of an inflation targeting framework were introduced in 2013.
Inflation drivers and fiscal vulnerabilities
- Mining exports constitute about 90 percent of exports.
- Nearly a third of government revenue comes from the mining industry.
- Government spending often follows the business cycle in an economy deeply tied to global commodity markets, producing procyclical fiscal policies that fuel boom-and-bust cycles and surges in inflation.
- Reliance on external borrowing reduced the domestic pool of debt securities available for monetary policy operations; planned domestic securities issuances were deferred, causing a sharp decline in available government securities for the Bank’s operations.
Monetary policy constraints and institutional issues
- The Bank of Mongolia’s journey toward full-fledged inflation targeting remains incomplete.
- Two obstacles identified:
- A lack of operational independence for the Bank of Mongolia.
- Significant fiscal influence on monetary policy outcomes because of the large share of government in the economy.
- Institutional specifics limiting autonomy:
- Parliament has constitutional authority over monetary, financial, and credit policy.
- Lawmakers approve the central bank’s inflation target and other monetary policy guidelines annually.
- The Bank is required to provide specific kinds of government-mandated lending to the private sector.
- Operational workaround and risks:
- Unable to use government securities for monetary operations like most other central banks, the Bank has relied on issuing its own bills to absorb excess liquidity.
- The high interest costs of issuing its own bills are weakening the Bank’s balance sheet and could hinder monetary policy operations down the road.
Policy recommendations and prescriptions
- Grant the Bank of Mongolia greater independence from the government, including eliminating requirements for the Bank to provide specific kinds of government-mandated lending to the private sector.
- Align fiscal policy with monetary policy objectives, especially when inflation is high:
- When inflation is high, fiscal policy should also be tighter to assist tighter monetary policy.
- Synchronization can prevent the central bank from having to raise interest rates to very high levels, reducing disproportionate burdens on borrowers and limiting risks to financial stability.
- Implement countercyclical fiscal discipline:
- Avoid procyclical spending by sticking to fiscal rules.
- Maintain spending discipline during commodity booms to prevent overheating, keep inflation in check, and build fiscal buffers for downturns without imperiling debt sustainability.
- Restart issuance of government domestic securities to:
- Help the central bank better manage liquidity.
- Develop the domestic debt market.
- Improve monetary transmission by establishing benchmark bond yields.
Key findings and implications
- Better monetary-fiscal coordination—working together but independently—can help win the fight against inflation and foster economic stability and growth for years to come.
- In an economy heavily influenced by commodity market swings, the government shares responsibility for helping the central bank achieve its inflation objectives.
- A robust domestic securities market supports effective monetary operations and reduces reliance on central-bank-issued bills that strain the Bank’s balance sheet.
Angana Banerji is a deputy division chief and Mongolia mission chief in the IMF’s Asia and Pacific Department. Thomas Helbling is a Deputy Director in the IMF’s Asia Pacific Department and oversees the IMF’s work on Mongolia.