Central banks face new credibility test over rate cuts

Monetary Authorities Confront Credibility Challenges Amid Rate Cut Decisions

Central banks face new credibility test - Economists are cautioning that central banks could allow inflation to remain above their targets if they reduce interest rates prematurely. Policymakers are navigating a particularly demanding period following several years of elevated price levels and recurring economic disruptions. These concerns emerged during the inaugural Monetary Policy Dialogue held in Tashkent, where delegates from the International Monetary Fund, various central banking institutions, and academic circles discussed how monetary authorities should address uncertainty, inflationary pressures, and evolving financial circumstances.

Lessons from the Post-Pandemic Era

Athanasios Orphanides, who serves as a professor at the Massachusetts Institute of Technology and previously led the Central Bank of Cyprus, emphasized that the period following the global health crisis revealed significant costs associated with misinterpreting inflation trends. He noted that numerous central banks worldwide failed to adjust their policies appropriately, resulting in price increases that substantially exceeded their stated objectives for price stability.

"If we look at the post-pandemic experience, many central banks around the world did not calibrate policy correctly and ended up with inflation that was significantly higher than the definitions of price stability that they were aiming for," Orphanides told Euronews.

According to Orphanides, the concern persists that numerous central banking institutions are considering policy relaxation before the appropriate moment. However, the challenge extends beyond merely determining when to reduce interest rates. Central banks must preserve their credibility while confronting shocks to pricing, supply networks, and consumer demand that have become increasingly difficult to forecast.

Learning from Recent Crises

Koba Gvenetadze, representing the IMF in Uzbekistan, highlighted that policymakers must evaluate both successful and unsuccessful approaches implemented during recent crisis periods. She explained that the repetition of economic shocks over the past five years makes the exchange of experiences and accumulated lessons particularly valuable for monetary authorities worldwide.

"There have been repeated shocks for the last five years and that is why lessons learned from those shocks and the sharing of experiences are absolutely very important," she told Euronews.

Gvenetadze further observed that the pandemic demonstrated why central banks cannot consistently assume that supply disruptions will be temporary. She noted that supply shocks affecting inflation might not immediately impact price levels, but could begin influencing inflation at a later stage, requiring careful monitoring and response.

Inflation Targeting as a Guiding Framework

Orphanides maintains that inflation targeting continues to represent one of the most successful frameworks for directing monetary policy when economic conditions grow more complex to interpret. He pointed out that this approach, which has been embraced by Uzbekistan in recent years, focuses on stabilizing inflation and preserving price stability as the foundation for other necessary economic adjustments during periods of shock.

Uzbekistan has been progressing toward comprehensive inflation targeting as part of wider market-oriented reforms. Data presented by the nation's Central Bank revealed that inflation decreased from approximately 20 percent in 2018 to 5.5 percent by May 2026. Additionally, inflation expectations among both households and businesses dropped from an average of 20 percent to roughly 10 percent.

These metrics hold particular significance for the inflation-targeting transition, which relies not solely on reduced headline inflation figures but also on whether businesses and consumers genuinely believe that price increases will remain manageable. The Central Bank additionally identified declining dollarisation as evidence of strengthening confidence in macroeconomic stability.

Financial Market Reforms and Future Outlook

Foreign-currency deposits now represent approximately 20 percent of total banking deposits, a substantial reduction from the nearly 50 percent level previously recorded. Similarly, dollarised lending has decreased from 54 percent to 37 percent. For investors and commercial enterprises, this reduction in dollarisation may indicate heightened confidence in the domestic currency and could enhance the effectiveness of monetary policy through local financial channels.

Samigjon Inogamov, who directs the Monetary Policy Department at Uzbekistan's Central Bank, explained that policymakers are implementing a series of interconnected reforms. These include deepening domestic financial markets, liberalizing financial accounts, and developing a more resilient capital market. Inogamov confirmed that the central bank intends to sustain tight monetary conditions to accomplish its inflation objectives and reinforce the credibility of its monetary policy framework.