For example, higher commodity and food prices function roughly in the same way as a tax increase for households and dampen domestic demand. Price rises on energy and commodities also mean that companies' costs increase. This also tends to dampen production and growth. In such a situation it is important to try to find a policy that is sufficiently tight to prevent inflationary impulses gaining a lasting grip. This is necessary to ensure that they do not spread to inflation expectations, wages and other prices. At the same time, the policy must be sufficiently loose to avoid unnecessary negative effects on production and employment. It is a difficult balancing act. To manage this in a way that provides a good growth in the economy that is sustainable in the long term requires that the credibility of the inflation target remains intact. This is the premise for formulating monetary policy. If the expectations of inflation are pushed up and remain above the inflation target, there is a risk that they will become a self-fulfilling prophecy. And dealing with high and fluctuating inflation rates is often a very difficult and expensive process – for individual households and the economy as a whole. The oil price shocks in the 1970s are examples of how external inflationary impulses were allowed to gain a firm foothold and spread throughout the economy at the same time as economic activity was weak. The cost of dealing with this adjustment was high, not least because our competitiveness was undermined.
In the EU countries that are not using the euro, the effects from monetary conditions in the euro area led to improving macroeconomic environment, loosening financing conditions, and high bank liquidity. That stimulated lending and, in turn, the increase in residential property prices. However, these developments also increased cyclical risks. The Bulgarian National Bank conducted research into Bulgaria’s financial cycle. Our findings showed that we are currently in an upward phase of cyclical risk accumulation. Hence, we activated and then raised the rate of the countercyclical capital buffer. We have so far taken two decisions. In 2018, we set the countercyclical capital buffer rate applicable to credit risk exposures in Bulgaria at 0.5%, with effect from October 1 2019. In early 2019 we raised the rate to 1.0%, with effect from April 1 2020. The rate is applied to the overall credit stock of banks and not to the volume of newly issued loans. We announced that we could increase the rate to a higher level earlier if credit growth significantly accelerates. Our decisions were taken despite the fact that the standard metric of how the credit-to-GDP ratio deviates from its long-term trend remained deep in negative territory. Furthermore, we strengthened the macroprudential powers of the Bulgarian National Bank. The key element here was the introduction into Bulgarian law of a framework of borrower-based measures – requirements such as loan-to-value (LTV) and loan-to-income (LTI) – in addition to the existing capital-based measures.