In Albania, Monetary Policy is part of a wider macroeconomic program aiming at the stabilization of the economy. The ultimate target of monetary policy is price stability, which however allows for the economy to grow at its potential rate. Since the Bank of Albania is not able to directly control its ultimate target, it imposes an intermediate target - Broad Money. Broad Money targets are based on the estimates of the demand for money consistent with the ultimate targets imposed in the medium-term stabilization program. (ESAF).
In Albania, the control of the money supply relies primarly upon the use of direct instruments of monetary policy i.e. credit ceilings. Ceilings on domestic credit of the banking system to the goverment and economy are imposed on a quaterly basis.
In addition to the direct instruments of monetary policy some indirect instruments are used as well, such as reserve requirements, discount window facility and the control of commercial banks deposit rates.
Apart from abiding by credit ceilings, commercial banks are obliged to hold required reserves at the Bank of Albania. Reserve requirements ratio is currently 10% of banks' deposits. At the present phase of development, the arguments for the imposition of reserve requirements on banks are, to partially back up their deposit liabilities to the general public, to mop up excess liquidity of the banking system, to function as a source of revenue for the central bank and to set the stage for the Bank of Albania to shift from direct to indirect monetary policy instruments. Consequently, reserve requirements will become an active instrument of monetary policy only after the removal of the credit ceilings and the full reliance upon indirect instruments of monetary management.
Discount window is another indirect instrument of monetary policy which enables the individual banks to obtain marginal financing from the central bank and to maintain deposits at the Bank of Albania. Due to the presence of high excess liquidity in the banking system, Bank of Albania has encouraged the development of the interbank market, giving the refinancing facility only minimal importance. Furthermore, banks' excess reserves are remunerated with interest rates clearly below the market rates, so that banks' trading in Interbank and Treasury Bill markets are encouraged.
In order to expedite the transition of monetary policy towards the use of indirect instruments, Bank of Albania has recently introduced a liquidity management framework. The principal objective of the liquidity management is to avoid excessive increase of base money supply in the economy in the presence of credit ceilings. Thus, even if an excess supply of monetary base has no immediate effect on economy, its existence would be a major impediment to the later removal of credit ceilings. The main instrument to control monetary base and banks excess reserves is the Bank of Albania'credit to the goverment. A yearly limit to the financing of goverment budget deficit by the Bank of Albania is set consistently with the imposed excess reserve targets.
Taking into account the actual economic environment and the lack of developed financial markets, the Bank of Albania has counted on administratively determined interest rates. The interest rates, that commercial banks charge on deposits are determined in terms of a band, of which extreme values are binding to the banks. In 1993, aiming at increasing the flexibility of this variable, Bank of Albania liberalized commercial banks lending rates. However it still continues to give its reference lending rates.
In July 1992, the Bank of Albania moved from fixed to flexible exchange rate regime, which excludes the necessity of interventions in the foreign exchange market. This regime was adopted in order to adjust the external inbalances of the economy. Besides, this move was prompted on the one hand by the lack of sufficient foreign reserves and on the other one by the collapse of domestic production as the domestic demand pressures increased. The flexible exchange rate regime has proved successful.
The monetary policy line followed by the Bank of Albania has led to a notable improvement in the stability of the economy. Inflation has dropped from 240% in 1992 to about 8% in April 1995, while Gross Domestic Product has increased by 11% and 7.4% respectively in 1993 and 1994. This favorable developments have also shown up in the steady decrease of unemployment rate and budget deficit.
The Albanian authorities do have ambitious objectives for the further stabilization of the economy. In 1995, inflation is targeted to slow down from 15.8% at the end of 1994 to 10% at the end of 1995. At the same time the economy is expected to grow by 6% and the employment situation to improve.