How can the struggle against dependence on commodity exports and monetary policy be linked?

Nowadays Kazakhstan can be characterized as a country with a resource orientation and a high level of dollarization of the economy, as well as with a strong dependence on oil prices. From year to year, Kazakhstan imports 1.5-2 times more goods and services from the CIS countries than it exports. If you look at the dynamics of the foreign trade turnover of the Republic of Kazakhstan over the past 5 years, you will notice that imports to the CIS countries are growing at a higher rate than exports to the same countries (see Figure 1). Thus, in 2022, imports exceed exports by 38%. At the same time, Kazakhstan imports mainly goods with high added value (such as machinery, equipment, vehicles, shoes, textiles, etc.), while the country’s main export products are oil and petroleum products (57% of all exports in 2022). A decrease (or increase) in oil prices leads to a depreciation (or increase) in price of the national currency through a deterioration in the trade balance, as a result of which exchange rate fluctuations occur in the country. When the real exchange rate of the tenge strengthens, the volume of non-resource exports decreases - a negative effect called “Dutch disease” (or “resource curse”) in economic literature.

Figure 1. Dynamics of foreign trade turnover of the Republic of Kazakhstan with the CIS countries, million US dollars

Source: BNS RK

One of the most common solutions to the “Dutch disease” is the diversification of the sectoral structure of the economy, designed to increase the efficiency of non-resource sectors. The importance of a diversified economy for Kazakhstan is especially important at the present stage against the backdrop of geopolitical tensions. Economists also highlight the development of human capital and increased investment in education, which is necessary to prepare specialists for work and ensure the growth of non-resource industries, as another solution to the “Dutch disease”.

However, there is a study (Bergholt, Røisland et.al, 2023) that examines the role of monetary policy in shaping a resource-based economy. The authors develop an unconventional approach to discussing how monetary policy should respond to persistent shocks that change the sustainable structure of a commodity-exporting economy. The article presents an analysis of a situation where a country faces a significant drop in earnings from exports or other sources of foreign income. The authors also show how changes in resource income affect the equilibrium structure of the economy.

The starting point for the study is a situation where a permanent resource price shock implies the usual permanent (but endogenous) structural transformation of the economy towards a smaller non-tradable sector (industries to meet the country's domestic needs: healthcare, services, construction, etc.) and more large tradable sector (industries that produce goods for export).

Most traditional studies are based on the assumption that shocks to the economy are temporary. At the same time, the authors study the role of monetary policy, based on the fact that negative events occurred in the economy that produced permanent structural changes that affected the steady state of the economy. They also note that the structure of monetary policy influences the path and speed of transition to a new long-term equilibrium position. In this case, monetary policy affects not only the short-run misallocations due to nominal rigidity of the economy (prices and wages), but also the relative prices that stimulate the reallocation of capital.

It is not at all obvious that monetary policy should play a role when the economy faces structural changes. In most economies around the world, monetary policy is neutral over the long term. It means the central bank monitors economic data and responds to significant imbalances, but generally seeks to maintain a balance between maintaining macroeconomic stability and excessive intervention. However, the authors' research shows that even if monetary policy is neutral, it affects how quickly the economy approaches its new long-run equilibrium. Persistent shocks produce structural changes quite independently of the central bank's response, suggesting that monetary policy should address short-term stabilization issues rather than long-term structural issues. Because of this, the development of monetary policy has important welfare implications.

It is important to note that, in the long term, monetary policy cannot influence total employment or its distribution across sectors. However, this does not mean that monetary policy should not respond to this, and there are two reasons. The first reason, which has been widely studied by economists, is that at nominal rigidity, a resource price shock destabilizes the economy, and monetary policy can soften these fluctuations. The second reason is highlighted by the authors themselves and they conclude that, although monetary policy does not affect the steady state of the economy, it affects the path and speed of adaptation to the new steady state.

The authors show that to achieve optimal structural changes, the central bank must ensure sufficient exchange rate depreciation. The logic is simple: given the nominal rigidity of the domestic economy (prices and wages), the exchange rate should compensate for the rigidity of domestic prices. Without such pass-through, relative prices shift and the economy ends up in a state of “Dutch disease” with unemployment rates that are too high and a transition period that is too slow.

The authors analyzed the welfare consequences associated with different monetary policy regimes and showed that a regime in which the nominal exchange rate remains fixed prevents the desired depreciation of the real exchange rate in the short run. In turn, this leads to a significant increase in unemployment and limited capital redistribution over a long period of time. Inflation targeting does not eliminate these problems as long as the exchange rate affects prices. This is because the central bank must raise interest rates to combat rising import prices under the inflation targeting regime. At the same time, the authors find that targeting non-tradable inflation, which, unlike consumer inflation, is not directly affected by the exchange rate, implies an overly expansionary monetary policy response. In particular, this monetary policy stance implies excessive depreciation of the exchange rate.

The study examines a regime such as nominal wage growth targeting, which the authors note as a “Goldilocks regime”, when the economy is in a state of optimal balance between inflation and unemployment, which contributes to stable and sustainable growth. The reason is that wage growth targeting comes close to solving two traditional “Dutch disease” problems with one tool. First, unemployment is avoided along the transition path. Second, to keep nominal wage growth constant, the central bank must initiate a lower real interest rate and a depreciation of the real exchange rate. These price signals are required for the necessary structural changes to gain effective speed. It follows that monetary policy can be an effective tool for treating “Dutch disease” if the target is the growth rate of nominal wages.

First of all, it is worth immediately noting that the authors’ conclusion that monetary policy can be used as one of the tools for escaping dependence on raw materials through a change in target cannot be implemented in Kazakhstan. This solution would require significant structural changes, which are impossible and impractical for Kazakhstan at the present stage. However, based on the study, an important conclusion can be drawn: a diversified economy for Kazakhstan is not only an opportunity to escape the influence of the negative effect of the “Dutch disease”, but also a chance to increase the sphere of influence of some domestic policies, in particular, monetary policy. Diversification of industries, which involves developing domestic production and reducing imports, will significantly reduce the effect of pass-through of the exchange rate to inflation. Under the inflation targeting regime, when the exchange rate does not significantly affect domestic prices, according to the results of the authors’ research, a situation is possible where a well-implemented monetary policy curbs the growth of unemployment and affects the redistribution of capital. Thus, the study once again emphasizes the need to implement measures to diversify the economy of Kazakhstan. Due to monetary policy, not only will the rate of price growth decrease, but the well-being of the population will also increase.