Hungarian Economic Development Minister Marton Nagy has proposed the upwards revision of the Hungarian National Bank’s 2-4% inflation target in an opinion piece published in the pro-government daily Magyar Nemzet on June 12.

The former deputy governor of MNB said that inflation is a pressing issue, but not the foremost, though it can hinder social-economic competitiveness.

"It would be a mistake to wish for a return to the past and for Hungary we may not be able to reach the 2-4% level once inflation falls to a single-digit range", he added. "It is conceivable to achieve that, but this is not a necessity for an economy in a catch-up phase", he observed.

Poland's and Hungary's radical right-wing governments have been outliers in Central Europe in still making populist promises to their electorates, despite yawning deficits and the freezing of vital EU aid payments because of their violations of the rule of law.

Hungary has suffered high inflation from well before the energy and cost of living crises triggered by the Russian invasion of Ukraine.

Headline inflation remained within the central bank's tolerance band between 2013 and 2020, with two years of deflation in 2014 and 2015. CPI then averaged 5.1% in 2021, pushed up by a massive government stimulus following the pandemic. In February 2022 Hungary had the highest annualised inflation in the EU at 8.3%, showing the impact of the high-pressure economic policy and the pre-election spending splurge.

Inflation has soared further since the energy price increases triggered by the Russian invasion, as well as increased government spending and tax cuts to ameliorate its impact on citizens and businesses, which all led to cost-push inflation and surging wages in the tight labour market. The central bank’s subsidised lending programmes, pushing trillions in cheap financing to the economy, also had an impact. As a result, Hungarian inflation continued to be the highest in the EU, peaking at 25.6% year on year in March.

The MNB, which took a more hawkish turn in mid-2021, phased out much of the programmes at the time it launched its tightening cycle and warned of the inflationary risks of a loose fiscal policy.  During the MNB’s 15-month tightening cycle, the base rate moved up from 0.9% to 13%. One-day quick deposit tenders were announced at 18% during an emergency rate hike in mid-October after a global market rout  that led to the collapse of the currency.

Hungary has been targeted by the markets as the economy with the weakest fundamentals in the region. Prime Minister Viktor Orban’s pre-election spending splurge left it with a deficit of 6.2% of GDP last year and gross public debt of 76.1% of GDP – the worst in the region – as well as the highest inflation and interest rates in Europe. In Q1 the economy remained in recession for the third consecutive quarter, declining by 0.3% q/q.

Nagy, who quit the MNB in May 2020 to become an economic advisor to Prime Minister Viktor Orban before taking the post of the Economic Development Ministry in May 2022, argued that a higher inflation target could help lower real interest rates, reduce borrowing costs and thus stimulate investments and economic growth.

Boosting GDP growth has always enjoyed a priority for the Orban government. It shrugged off the MNB's call to pursue a prudent fiscal policy after an economic rebound in 2021 and continued to pour trillions into state investments.

In the opinion piece, Nagy argued that inflation tends to rise during times of wars or natural disasters and the recovery from the shocks, such as the pandemic and the impact of reglobalisation also play a part.

He cited structural reasons as well. The transition to a green economy will require huge investments in renewable energy, a factor that will drive up prices.  Global capital flows are increasingly determined by geopolitical interests, hence capital allocations are often based on political reasons that affect investments and interest rates, he adds.

Demographic decline, which in the case of Hungary is one of the most severe problems, could also contribute to the scarcity of capital and its most obvious impact is a labour shortage that adds to wage pressures. Financing needs from higher pensions and healthcare spending in an ageing society also exert inflation pressures, he added. The corporate sector’s innovative capabilities could be hindered by the reduction of the workforce.

In a short commentary, financial news site Portfolio.hu called Nagy’s proposals provocative. At first glance, it suggests that achieving price stability is not a priority for economic policy, which has serious risks. It could damage the credibility of the central bank and could also be negative for fighting inflation, as higher inflation expectations become quickly entrenched in pricing decisions. Experience shows that inflation above price stability (2-3%) cannot be kept fixed because expectations become unstable, they add.

The MNB’s inflation target is higher than its regional peers. Both the Polish and the Romanian central bank have a target range of 1.5%-3.5%  Since 2010 the inflation target of the Czech National Bank stands at 2%.

According to the MNB's latest forecast, annual average inflation is set to fall to the 3-5% range in 2024 from 15.5-19% in 2023. The MNB will release its updated macroeconomic output after the June 20 rate-setting meeting.