Greater Independence for Bank of Mongolia and Prudent Fiscal Policies Key to Stabilizing the Economy

Since its establishment in 1924, the Bank of Mongolia has been integral to the country’s transition from a centrally planned economy to a market-driven one.

At the Bank of Mongolia’s centennial conference, held recently to mark its historic 100-year journey, the central theme of discussions revolved around improving monetary-fiscal coordination to address the persistent issue of high inflation in the country. The conference, attended by key policymakers and experts, emphasized how better alignment between the central bank’s policies and government fiscal decisions could accelerate Mongolia’s ability to meet its inflation targets and stabilize the economy.

The Need for Synchronization of Policies

The ideal relationship between monetary and fiscal policies is often likened to a rider and horse: both working in concert but within their defined roles and responsibilities. In Mongolia’s case, despite efforts to modernize the economy, there remains room to make the monetary-fiscal policy interaction smoother and more effective in addressing inflationary pressures.

Since its establishment in 1924, the Bank of Mongolia has been integral to the country’s transition from a centrally planned economy to a market-driven one. The Bank has gradually implemented important reforms, such as introducing a two-tier banking system in 1991 and adopting market-oriented monetary policies by moving away from a fixed exchange rate in 1993. In recent years, the central bank adopted an inflation targeting framework in 2013, though it has yet to fully implement this strategy, hampered by challenges such as lack of autonomy and the heavy influence of fiscal policies on inflation outcomes.

Challenges to Effective Inflation Targeting

Mongolia's central bank faces significant obstacles in its pursuit of an inflation-targeting framework. The lack of operational independence is a key issue. Unlike more advanced economies with inflation-targeting frameworks, where central banks enjoy autonomy, the Bank of Mongolia operates under the influence of the parliament, which sets inflation targets and other monetary policy parameters annually.

Another challenge is the procyclical nature of fiscal policy, which is influenced by fluctuations in global commodity markets. As a country heavily reliant on mining exports—particularly coal, copper, and other minerals—Mongolia’s government revenue is tightly linked to global commodity prices. When commodity prices rise, government spending tends to increase, fueling inflationary pressures. Conversely, during periods of low commodity prices, government spending contracts, contributing to economic downturns.

Recommendations for Strengthening Fiscal Discipline

Experts at the conference stressed that improving fiscal policy could play a critical role in reducing inflation and supporting the central bank's goals. A key recommendation is to reduce procyclical fiscal policies, encouraging the government to adhere to fiscal rules that promote disciplined spending, particularly during commodity booms. This approach helps avoid overheating the economy and keeps inflation under control.

Building fiscal buffers in good times is equally important. These buffers can provide essential support during economic downturns, helping the government manage external shocks without exacerbating inflation or jeopardizing fiscal stability.

Enhanced Fiscal Support for Monetary Policy

As Mongolia continues to rely heavily on the commodity sector, the government has a shared responsibility to support the central bank’s inflation objectives. Better alignment of monetary and fiscal policies would enhance the effectiveness of both, ensuring that fiscal spending does not undermine efforts to control inflation.

One proposed solution is for the government to tighten fiscal policy during times of high inflation, complementing the Bank of Mongolia's monetary tightening. This alignment would help prevent the need for drastic interest rate hikes, which can burden borrowers and create financial instability. By synchronizing monetary and fiscal measures, the government can avoid a situation where the central bank is forced to raise interest rates to unsustainable levels, causing economic strain.

The Importance of Domestic Debt Securities for Effective Monetary Operations

In terms of monetary policy tools, the Bank of Mongolia faces challenges due to the limited availability of domestic securities for its operations. Unlike most other central banks, which rely on government-issued bonds to manage liquidity and conduct monetary policy, Mongolia's government has traditionally relied on external borrowing, benefiting from lower global financing costs.

However, domestic securities issuances have been deferred in recent years, resulting in a shrinking pool of debt instruments that the central bank can use to manage liquidity. This has led to the Bank issuing its own bills to absorb excess liquidity—an approach that comes with high-interest costs, placing additional strain on the Bank’s balance sheet.

To address this, experts suggest restarting domestic bond issuance to strengthen the domestic debt market, which would also help the central bank manage liquidity more effectively. A robust domestic market for debt securities would also establish benchmark bond yields, enhancing monetary policy transmission and providing the Bank with better tools for managing inflation.

Looking Ahead: A Harmonized Approach to Monetary and Fiscal Policies

Ultimately, the Bank of Mongolia’s centennial conference highlighted the importance of better policy coordination in addressing the country’s inflation challenges. As Mongolia strives to meet its inflation targets and stabilize its economy, there is a strong case for granting the central bank greater independence and aligning fiscal policies to support its monetary objectives.

By drawing inspiration from the ancient Mongolian tradition of horse racing, where precise coordination between rider and horse leads to victory, Mongolia’s policymakers have the opportunity to create a smoother, more effective policy environment—one that benefits the nation’s economic stability and long-term growth.