Trade Balances. Inflation, and Monetary Efficiency

What is it about?

The traditional and appropriate view of monetary efficiency - the extent to which management of the monetary economy, which comprises of inflation, interest rates, exchange rates, investments, savings, and output etc. - is that monetary efficiency is evident in minimization of volatility of output and inflation. This view is rooted in free market economics, that is, absence of constraints on interactions between demand and supply. In presence of constraints that obtain in countries within which exchange rates are not allowed to be determined by forces of demand and supply only (these countries operate what is referred to as hybrid exchange rate regimes), will inflation continue to be an appropriate measure of monetary efficiency? Empirical findings show inflation is less appropriate than real rates of return, which in turn is less appropriate than trade balances as measures of monetary efficiency. Inflation performs so badly, it underperforms trade balances as a measure of monetary efficiency by as much as 800 percent. Empirical findings indicate it is imperative countries that operate hybrid exchange rate regimes reexamine approaches for estimation of monetary efficiency.

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Why is it important?

If inflation is not an appropriate measure of monetary efficiency in countries that operate hybrid exchange rate regimes, estimates of monetary efficiency either are biased upwards or downwards, implying performance of central bankers cannot be appropriately measured. If monetary efficiency is not measured appropriately, this implies inability to infer sources of inefficiency and progression along paths that may be inefficient for an economy.

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