Money does matter in an economy and central banks ignoring this fact do it so at their own costs. Well, to be perfectly fair they do it at our costs. Romanian central bank (NBR) is one such central bank.
The NBR has been cutting the key policy rate for 10 months now from 5.25% to 3.50%. The NBR promotes these cuts as evidence of loose monetary policy. But is it? Lower interest rates are justified by the central bank by lower inflation. In the same time the central bank says that the main reasons for a fall in inflation are: persistence of domestic demand deficit and above average agriculture production.
Ignoring the agriculture production argument the deficit of the domestic demand infers to me that monetary policy has been too tight. Thus, lower interest rates today are a sign of tight monetary policy during the last few. And there is evidence that shows that.
Credit growth in domestic currency follows very closely the evolution of the M1. As the central bank took money (Romanian lei – RON) out of the market via FX interventions to fight capital flight the domestic market of RON denominated credit contracted.
There is more evidence of tight monetary policy over the period 2009-2013 if we look at money supply M1 (controlled by the NBR) and RON domestic credit as percentage of GDP. In both cases we see a fall as percentage of GDP. This is more evidence that the NBR had the wrong reaction to the economic crisis that hit the country in 2009 and had an important contribution to the very slow recovery of the economy since then.
Milton Friedman 1968 “As an empirical matter, low interest rates are a sign that monetary policy has
been tight-in the sense that the quantity of money has grown slowly; high interest rates are a sign that monetary policy has been easy-in the sense that the quantity of money has grown rapidly.”
Sources: NBR and own calculations