Monetary and fiscal policies to head off overheating

The last two years saw a strong acceleration of economic activity in Poland. With the aim to safeguard the sustainability of economic growth both monetary and fiscal policies were tightened in 2007. Yet, despite an uncertain international outlook, it is clear that monetary and fiscal policies need to be further adjusted to head off overheating in the domestic economy. Although the surge in headline inflation to well above the central bank’s target of 2.5% has been mostly driven by external shocks, as in other countries, a considerable build-up in wage pressures could darken the inflation outlook. Failing to contain inflationary pressures could harm the hard-won credibility of the monetary authorities and make it costlier to achieve their primary objective of price stability in the medium term. Delaying the policy response could increase future adjustment costs in terms of activity and employment and jeopardise the ultimate objective of adopting the euro. A tightening of monetary policy is therefore needed to steer the economy towards a sustainable low-inflation growth path, assisted by any further appreciation of the currency. But monetary policy should not bear the whole burden of stabilising the economy. A significant retrenchment in public spending could considerably improve the policy mix.