Business cycle and monetary policy in Romania · Romania Lithuania Slovakia Austria Luxembourg Czech Republic Hungary Estonia Poland Sweden Changes in public debt in the EU from 2007

Business cycle and monetary policy in Romania

Lucian Croitoru

National Bank of Romania

The second ERMAS Confrence, 29-31 August 2015

Cluj Napoca

Content

I. Macroeconomic overview

II. Economic freedom and real convergence

III. GDP dynamics and its features

IV. The fiscal deficit and the cycle

V. The current account

VI. Inflation developments

VII. Monetary policy

VIII. Is a new monetary policy rate dilemma emerging?

I. Macroeconomic overview

Before the crisis Rapid GDP growth in 2001-2008 (6.5% average

annual growth) fuelled by large capital inflows: A real-estate and consumption boom emerged as

wage and credit were increasing rapidly An expansionary fiscal policy further contributed to

the overheating of the economy starting in 2005

Large imbalances were building up, rendering the economy vulnerable to negative shocks Unsustainable structural fiscal imbalances doomed

Romania to fiscal consolidation when the crisis hit Sizeable external disequilibrium (the current account

deficit peaked at 13.4% of GDP in 2007) External debt increased from euro bn. 30.9 in 2005 to

euro bn. 72.4 in 2008

The current account deficit plunged to sustainable levels (4.4% of GDP in 2012, 0.4% of GDP in 2014)

Sharp fiscal consolidation brought the deficit from 9% of GDP in 2009 to 1.5% of GDP in 2014

The public debt-to-GDP ratio increased rapidly during the crisis, but it is still one of the lowest in the EU and is estimated to stabilize below 40% of GDP over the medium term

Total external debt increased to euro bn. 100 in 2012 and decreased to euro bn. 63 in 2014.

Adjustments in the wake of the crisis

Expected economic outcomes in 2015 if fiscal plans receive approval: GDP growth estimated at 4.4% in 2015 and 4.1% in 2016

(beyond potential in both cases) O-Y-A inflation estimated at - 0.2% in December 2015 and

0.7% in December 2016. Annual average inflation of -0.2% in 2015 and -0.8% in 2016

The CA deficit, expected to deepen to -1.5 percent of GDP Budget deficit moves at 4 percent in 2016 and 5 percent in

2017 if both the Fiscal Code and the wage bill are approved

Weakened macroeconomic fundamentals would not support strong growth and would lead to further delayes in joining the Banking Union and the euro area

Outlook for 2015 and beyond

II. Economic freedom and real convergence

EU economies became more liberal in 2014 as compared to 1996 (see detailed charts at the

end of the presentation)

Economic freedom in 1996 Economic freedom in 2014

IT

GR

LI HU

PO RO

FR

0

20

40

60

80

100

120

140

160

180

40 60 80

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Overall index of freedom

Source: author’s computations; AMECO; Heritage Foundation

ES GR

IT

LI RO

0

20

40

60

80

100

120

140

160

180

40 50 60 70 80

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Overall index of freedom


EU countries migrate to upper clusters as regards property freedom. Slow progress for

Romania Unclear property rights in Romania in 1996

Romania has made little progress until 2014; Italy and Greece show regression

GR

FR IT

RO 0

20

40

60

80

100

120

140

160

180

20 40 60 80 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Property rights

1996


GR

FR

IT

RO

0

20

40

60

80

100

120

140

160

180

20 40 60 80 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Property rights

2014


Some developed countries have lost part of

their freedom from corruption

Romania was among countries with the lowest freedom from corruption in 1996

Greece and Italy have the lowest freedom from corruption in 2014 among EA countries

DE

GR CZ

IT

PO

RO 0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Freedom from corruption

1996


DE

GR

IT

PO

RO

0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)


2014


0.8

1

1.2

1.4

1.6

1.8

2

2.2

2.4

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Gross domestic product at current prices per hour worked (PPS, EU15=100): Change in positions (index)

Belgium Bulgaria Czech Republic Denmark Germany Estonia Ireland Greece Spain France Italy Cyprus Latvia Lithuania Luxembourg Hungary Malta Netherlands

Romania has increased 2.21 times its GDP/hour worked as a percentage of the EU 15

Source: author’s computations; AMECO

0

20

40

60

80

100

120

140

160

180

Be

lgiu

m

Bu

lgar

ia

Cze

ch R

ep

ub

lic

De

nm

ark

G

erm

any

Es

ton

ia*

Ir

ela

nd

G

ree

ce

Spai

n

Fran

ce

Ital

y

Cyp

rus

La

tvia

*

Lith

uan

ia

Luxe

mb

ou

rg

Hu

nga

ry

Mal

ta*

N

eth

erl

and

s

Au

stri

a

Po

lan

d

Po

rtu

gal

Ro

man

ia

Slo

ven

ia

Slo

vaki

a

Fin

lan

d

Swe

de

n

Un

ite

d K

ingd

om

EA

*

Gross domestic product at current prices per hour worked (PPS, EU15=100)

1996

2014

Note: * indicates that the indicator`s value refers to the year 2000, not to the year 1996

Source: author’s computations; AMECO

Romania`s scoreboard indicators in 2013

• Public debt: 37.9 % of GDP

• Curent account (CA) deficit (average over the past 3 years): 1.9 % of GDP

• Net international investment position: -61.5 % of GDP

• Real effective exchange rate (percentage change over the past 3 years): 0.3

• Market share of exports of goods and services (percentage change over the last 5 years): 16.4

• Unit labor cost (percentage change over the past 3 years): 0.7

• Houses price index (annual percentage change): -4.6

• Private sector debt: 66.4 % of GDP

• Credit flow to the private sector: -1.5 % of GDP

• Unemployment rate: 7 %

• Financial sector total liability (annual change): 3.1 %

13 Lucian Croitoru

Romania’s indices of economic freedom for 2015 compare well to those of Germany, except for property rights, freedom from

corruption, and financial freedom

Indicator Romania (66.6; ranks 57) Germany (73.8; ranks 16)

• Property Rights (RoL) 40.0 ~ 90.0 ~

• Freedom From Corruption (RoL) 43.0 + 78.0 - • Business Freedom (RE) 69.8 - 88.2 - • Labor Freedom (RE) 68.6 + 51.2 + • Monetary Freedom (RE) 77.3 + 81.5 + • Government Spending (LG) 62.3 + 40.1 + • Fiscal Freedom (LG) 86.9 - 60.8 - • Trade Freedom (OM) 88.0 + 88.0 + • Investment Freedom (OM) 80.0 ~ 90.0 ~ • Financial Freedom (OM) 50.0 ~ 70.0 ~ Source: Heritage Foundation RoL=rule of law; RE=regulatory efficiency; LG=low government; OM=open markets; - indicates a decrease as compared to the previous year; + indicates an increase as compared to the previous year; ~ = stable

14 Lucian Croitoru

III. GDP dynamics and its features

-20

-15

-10

-5

0

5

10 1

99

0

19

91

1

99

2

19

93

1

99

4

19

95

1

99

6

19

97

1

99

8

19

99

2

00

0

20

01

2

00

2

20

03

2

00

4

20

05

2

00

6

20

07

2

00

8

20

09

2

01

0

20

11

2

01

2

20

13

2

01

4

20

15

f

ROMANIA: Annual GDP growth rates (%)

Recession I Global recession of 1991

Recession II Financial and economic crises: Asia 1997; Russia 1998; Argentina 1999-2001

Recession III The financial and economic crisis of 2007

Source: data from the National Institute of Statistics

Financial repression 1990-1996

Moderate and high capital inflows 2000-2008

Romania’s GDP growth: some features

High dependency on capital inflows

Three distinctive periods of positive growth:

The financial repression period: 1990-1996

The boom period: 2000-2008 (high capital inflows fuelled high growth)

The “free” growth period (no implicit subsidies, no high capital inflows): 2011-until now. GDP growth averaged 2 percent a year

Period

Average growth rate

Cumulated growth over the period Comments

1990-1992 -10.7 -27.8*

low private capital inflows

1993-1996 4.08 17.2


1997-1999 -2.4 -7.2


2000-2004 5.4 29.8**

MODERATE PRIVATE CAPITAL INFLOWS

2005-2008 6.9 30.6

HIGH PRIVATE CAPITAL INFLOWS

2009-2010 -4.0 -7.9

high public external borrowings

2011-2014*** 2.0 8.3


* 3 years; ** 5 years; ***growth for 2014 estimated at 2.9 percent

In Romania, GDP growth depends on capital inflows (%) (Source: NIS and author`s calculations)

18 Lucian Croitoru

IV. The fiscal deficit and the cycle

-4

-3

-2

-1

0

1

2

3

4

-10

-8

-6

-4

-2

0

2

4

6

8

10 1

99

5

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Procyclical fiscal policy before and after the 2008 crisis

Source: AMECO and author's computation

Fiscal impulse (rhs, % of GDP)

Excess demand, % of PGDP

Structural balance, % of PGDP

GG balance, % of GDP

Implicit cyclical balance if at MTO, % of GDP

Implicit GG balance, if MTO, % of GDP

100

150

200

250

300

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Cumulated percentage growth of wages, labor productivity (2000=100), and public pensions (2001=100)

Pensions in the public sector

Wages in the budgetary sector* *Includes the public

administratin, education , health, and recreative activities

Wages in the private sector

Labor productivity (Real GDP per hour worked)

2001-2004: average real pension growth = 7,4 % 2001-2004: average real wage growth in the public sector = 6,9 % 2005-2009: average real pension growth = 21,7 % 2005-2009: average real wage growth in the public sector = 12,4 %

Source: author's computation based on data from National Institute for Statistics, and AMECO

177.1 132.1

130.2 109.7

107.5 106.5

97.7 95.0 94.2

89.4 88.6

85.0 84.5

80.9 76.9

74.7 68.8 68.0

59.3 53.6

50.1 45.2

43.9 42.6

40.9 40.0 39.8

27.6 23.6

10.6

0 20 40 60 80 100 120 140 160 180

Greece Italy

Portugal Ireland Cyprus

Belgium Spain

France Euro area

United Kingdom European Union

Croatia Austria

Slovenia Hungary

Germany Netherlands

Malta Finland

Slovakia Poland

Denmark Sweden

Czech Republic Lithuania

Latvia Romania Bulgaria

Luxembourg Estonia

Public debt as a percent of GDP in the EU in 2014. Romania has a enviable position

85.7 74.0

62.2 61.7

58.2 53.4

47.9 45.7

32.4 31.6

30.7 30.6

29.3 27.1

26.1 25.3 25.0

23.7 19.7 19.6

17.9 16.5

14.8 11.1 11.0 11.0

7.0 5.9 5.7 5.7

0 10 20 30 40 50 60 70 80 90

Ireland Greece

Spain Portugal Slovenia

Cyprus Croatia

United Kingdom Italy

Latvia European Union

France Euro area Romania

Netherlands Finland

Lithuania Slovakia Austria

Belgium Denmark

Luxembourg Czech Republic

Hungary Germany Bulgaria Estonia Poland

Sweden Malta

Changes in public debt in the EU from 2007 to 2014 (percentage points). Significant upward adjustment in the case of Romania, but

low by comparison to other countries

16.2 7.7

7.3 6.8

6.3 5.6

5.3 4.0

3.8 3.7

3.6 3.4

3.3 3.0

2.8 2.3

1.9 1.9

1.8 1.2

0.6 0.1 0.1

-0.1 -0.2

-1.9 -2.0

-3.6

-5 0 5 10 15

Greece Romania

Ireland Spain

Portugal Slovakia

Poland Lithuania

Netherlands Denmark

Czech Republic Euro area

France United Kingdom

Latvia Italy

Belgium Austria

Germany Slovenia Bulgaria

Malta Hungary

Luxembourg Cyprus Finland Estonia

Sweden

Changes in cyclically adjusted GG balances (percentage points): Roamania performed the second largest

adjustment („-” means a increase in the fiscal deficit)

-16

-11

-6

-1

4

Euro

are

a B

elg

ium

B

ulg

aria

C

zech

Re

pu

blic

D

en

mar

k G

erm

any

Esto

nia

Ir

ela

nd

G

ree

ce

Spai

n

Fran

ce

Ital

y C

ypru

s La

tvia

Li

thu

ania

Lu

xem

bo

urg

H

un

gary

M

alta

N

eth

erl

and

s A

ust

ria

Po

lan

d

Po

rtu

gal

Ro

man

ia

Slo

ven

ia

Slo

vaki

a Fi

nla

nd

Sw

ed

en

U

nit

ed

Kin

gdo

m

Cyclically adjusted GG balances: Romania compared badly to other EU countries before 2008 and compares well prezently. Adjustments made in 2010 were key to reaching the present

good positin

2014

2009

2007

1.5 1.7 1.1

2.5 2.2

1.0

6.2

2.4 2.2 1.7 1.8

1.3

2.4

4.3 3.8

1.9 1.5

0.6

1.4 1.0

1.7

0.4

2.3 3.4

3.0 2.6

1.9 1.4

-5.0

-3.0

-1.0

1.0

3.0

5.0

7.0

Euro

are

a B

elg

ium

B

ulg

aria

C

zech

Re

pu

blic

D

en

mar

k G

erm

any

Esto

nia

Ir

ela

nd

G

ree

ce

Spai

n

Fran

ce

Ital

y C

ypru

s La

tvia

Li

thu

ania

Lu

xem

bo

urg

H

un

gary

M

alta

N

eth

erl

and

s A

ust

ria

Po

lan

d

Po

rtu

gal

Ro

man

ia

Slo

ven

ia

Slo

vaki

a Fi

nla

nd

Sw

ed

en

U

nit

ed

Kin

gdo

m

Cyclical fiscal balance in EU countries (% of GDP). Almost each country was imprudently enjoying good times

2014

2009

2007

V. The current account

6.1 5

3.5 2.7 2.5

0.3 -0.2 -0.2

-3.2 -4.2

-4.9 -4.9 -4.9

-5.4 -6.7

-7.8 -9

-9.5 -10.7 -10.8

-11.2 -11.2

-13.1 -14.5

-15.5 -16

-19.3 -26.1

-30 -20 -10 0 10

Finland Luxembourg

United Kingdom Austria

Sweden Belgium

Germany France

Italy Netherlands

Czech Republic Denmark

Poland Slovakia

Cyprus Croatia Ireland

Malta Portugal

Spain Hungary Slovenia Romania Lithuania

Greece Estonia

Latvia Bulgaria

Significant changes in current account balances (percentage points). „-” indicates a reduction in

the CA deficit

1.9

-25.2

-4.3

1.4

7.4

-15.9

-5.3

-14.6

-10.0

-1.0

-7.2

-1.3

-11.8

-22.4

-14.4

10.1

-7.3 -6.2

6.7

3.5

-6.2

-10.1

-13.5

-4.2 -5.3

4.3

9.3

-2.4

-26

-21

-16

-11

-6

-1

4

9

Be

lgiu

m

Bu

lgar

ia

Cze

ch R

epu

blic

D

enm

ark

Ge

rman

y Es

ton

ia

Irel

and

G

ree

ce

Spai

n

Fran

ce

Cro

atia

It

aly

Cyp

rus

Latv

ia

Lith

uan

ia

Luxe

mb

ou

rg

Hu

nga

ry

Mal

ta

Net

her

lan

ds

Au

stri

a Po

lan

d

Port

uga

l R

om

ania

Sl

ove

nia

Sl

ova

kia

Fin

lan

d

Swed

en

U

nit

ed K

ingd

om

Current account balances in EU countries (% of GDP)

2007 2014

4.5 6.6 4.3 5.4 2.4 2.1 2.2 2.8 5.3 6.3

2.0

2.9

13.1 12.4

4.4 3.6 3.3 2.2

-4.0 -5.4

-10

-5

0

5

10

15

20

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

In Romania, the current account was mostly financed by debt creation during the boom phase of the cycle

(EUR bn.)

NON DEBT-CREATING FLOWS DEBT-CREATING FLOWS

NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT

Source: author’s computations based on NBR data

-20

-10

0

10

20

30

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Financing of the current account by instruments in Romania (EUR bn.)

Direct investment CAPITAL ACCOUNT

Currency and deposits Trade credits and advances

NET ERRORS AND OMISSIONS Portfolio investment

Financial derivatives Loans

Other accounts receivable/payable Reserve assets (- increase/+ decrease)

CURRENT ACCOUNT DEFICIT


-13.4

-0.4

-8.9

-1.5

-10.5

4.4

1.1

-15

-10

-5

0

5

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Romania: the current account deficit was mostly ascribable to the private sector external deficit during the boom

(% of GDP)

The current account deficit The GG deficit The private sector deficit

Source: author's estimation based on data from EUROSTAT, NBR and UNCTAD

3.4

-2.9

2.8

6.7

4.3

-4

-2

0

2

4

6

8

Romania: public savings and investment (% of GDP)

savings Investment


Decreasing investment during recession

Higher investment without much progress in infrastructure

13.0

25.8

21.2

31.7

17.7

0

5

10

15

20

25

30

35

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Romania: the private sector reduced savings and increased investment during the boom and reduced them both in the

aftermath (% of GDP)

Savings investment


VI. Inflation developments

A few features of the HICP consumer basket in Romania

• 32 percent of consumer bascket are given by food and volatile prices

• Had the NBR chosen the core inflation to be targeted, it would have been difficult for the public to understand the concept

• By choosing the headline inflation to be targeted, the NBR exposed itself to the reputational risk of missing the target because of high volatility of too many prices

32.4

27.9 27.7

25.8 24.9

22.8 22.3

0

5

10

15

20

25

30

35

Romania Latvia Lithuania Bulgaria Hungary Poland Czech Republic

Source: Eurostat

percent

The share of food items in the HICP consumer basket, 2015

41

.7

40

.7

38

.9

37

.5

37

.6

37

.4

37

.5

37

.2

37

.7

37

.6

37

.5

56

.3

54

.0

52

.2

49

.7

47

.6

46

.7

47

.7

48

.6

50

.0

50

.3

50

.1

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

CPI CORE3

Source: NIS

percent

Romania: the share of food items in the consumer basket

0

1

2

3

4

5

6

7

8

9

10

dec.05 dec.06 dec.07 dec.08 dec.09 dec.10 dec.11 dec.12 dec.13 dec.14 dec.15 dec.16

Romania: O-Y-A CPI inflation (%) percent

Source: NIS, NBR

2009 Q1:

- tobacco excise increase

- leu depreciation

2010 H2:

- VAT tax raised

- increase in

administered, food

and oil prices

2011 H1:

- increase in domestic and international agri-food

commodity prices

- increase of oil price

2012 H2:

- poor harvest

- increase of

administered

prices

2013 Q1:

- increase in electricity

prices

- poor food supply

- excise increase

2013 H2 - 2014 H1:

- good harvest

- bread VAT decrease

Multi-annual flat target: 2.5%

2008 H2:

- increase of

administered

prices 2007 H2 - 2008 H1:

- poor food supply

- increase of

administered prices

and of oil price

Note: Variation band of the target is ±1 percentage point.

2014 H2 :

- decrease of oil price

- abundance of food

VII. Monetary policy

Five distinct periods of inflation deviation from

the target prior to the downturn 1. The period up to the closing of the output gap (2003 Q1-

2004 Q2); 2. The following period up to the adoption of inflation

targeting (2004 Q3-2005 Q3); 3. The period between the shift to inflation targeting and

the surge in capital inflows (2005 Q4-2006 Q3); 4. The period of massive capital inflows, up to the outbreak

of the global crisis (2006 Q4-2007 Q3); 5. The period between the global crisis setting in until the

domestic economy entered recession (2007 Q4-2008 Q3), when the contribution of CORE3 inflation to the deviation of CPI inflation from the target was positive and relatively high for the first time.

Measures aimed at taming capital inflows before

downturn in 2008 Q4. Did they work? NO! (I)

Capital account liberalization (March 2003; last stage

Sep.2006)

Introduction of restrictions on mortgage lending (February

2004)

Stricter eligibility criteria for consumer loans (February 2004)

Larger exposures to one debtor from 20% to 25% (July 2004))

MRR on fx liabilities, from 25% to 30% (August 2004)

MRR lei from 18% to 16% (August 2005)

MRR on fx liabilities from 30% to 35% (January 2006)

MRR on fx liabilities from 35% to 40% (March 2006)

MRR lei, from 16% to 20% (July 2006)

Measures aimed at taming capital inflows before

downturn in 2008 Q4. Did they work? NO! (II)

Stricter criteria for household lending (LTV and Debt Service To Income)

Forex exposures limited to three times own funds (September 2005)

Unhedged borrowers (natural persons) cannot be classified into the top grade (A)

of financial performance (October 2005)

Regulation and supervision of non-bank financial institutions (February 2006)

Higher capital requirements since January 2007

Stricter eligibility criteria for the components of own funds (January 2007)

Loosening of credit standards for lending to households (March 2007)

Stricter provisioning requirements for loans to unhedged borrowers (natural

persons) (March 2008)

Exclusion of intermediate profit from own funds calculation (August 2008)

Adjustment of max DTI within internal procedures approved by the NBR

(August 2008)

-60

-40

-20

0

20

40

60

80

100

20

00

Q1

20

00

Q3

20

01

Q1

20

01

Q3

20

02

Q1

20

02

Q3

20

03

Q1

20

03

Q3

20

04

Q1

20

04

Q3

20

05

Q1

20

05

Q3

20

06

Q1

20

06

Q3

20

07

Q1

20

07

Q3

20

08

Q1

20

08

Q3

20

09

Q1

20

09

Q3

20

10

Q1

20

10

Q3

20

11

Q1

20

11

Q3

20

12

Q1

20

12

Q3

High annual credit growth rates in Romania indicating huge private capital inflows in 2004-2008 (%)

Total credit (nominal growth rate)

Total credit (growth rate adjusted for FX variation and inflation)

FX loans (growth rate adjusted for FX variation and inflation)

Source: author’s computations; NBR data

-10

0

10

20

30

40

50

Jan

-03

Au

g-0

3

Mar

-04

Oct

-04

May

-05

De

c-0

5

Jul-

06

Feb

-07

Sep

-07

Ap

r-0

8

No

v-0

8

Jun

-09

Jan

-10

Au

g-1

0

Mar

-11

Oct

-11

May

-12

De

c-1

2

Jul-

13

Feb

-14

Sep

-14

Ap

r-1

5

Faced with high capital inflows, the NBR increased minimum reserve requirements (MRR) in Romania (%). When the crisis hit Romania, the NBR reduced the MRR

CPI annual inflation Core 3 inflation

Monetary policy interest rate MRR lei

MRR foreign currency

2

3

4

5

6

7

8

9

10

-4

-2

0

2

4

6

8

10

20

05

T1

20

05

T2

20

05

T3

20

05

T4

20

06

T1

20

06

T2

20

06

T3

20

06

T4

20

07

T1

20

07

T2

20

07

T3

20

07

T4

20

08

T1

20

08

T2

20

08

T3

20

08

T4

20

09

T1

20

09

T2

20

09

T3

20

09

T4

20

10

T1

20

10

T2

20

10

T3

20

10

T4

20

11

T1

20

11

T2

20

11

T3

20

11

T4

20

12

T1

20

12

T2

20

12

T3

20

12

T4

20

13

T1

20

13

T2

20

13

T3

20

13

T4

20

14

T1

20

14

T2

20

14

T3

20

14

T4

20

15

T1

20

15

T2

A policy interest rate dilemma emerged late in 2006: should the NBR increase the interest rate to curb

inflation or lower it to tame capital inflows?

CPI annual inflation (%)

Annual GDP gap (%)

Nominal leu/euro exchange rate (quarterly average, rhs)

Annual inflation target (rhs)

Source: author’s computations; NBR data

-7

-5

-3

-1

2

4

6

8

10

2003 T

1

2003 T

2

2003 T

3

20

03

T4

2004 T

1

2004 T

2

2004 T

3

2004 T

4

2005 T

1

2005 T

2

2005 T

3

2005 T

4

2006 T

1

2006 T

2

2006 T

3

2006 T

4

2007 T

1

20

07

T2

2007 T

3

2007 T

4

2008 T

1

2008 T

2

2008 T

3

2008 T

4

2009 T

1

2009 T

2

2009 T

3

2009 T

4

2010 T

1

2010 T

2

2010 T

3

2010 T

4

2011 T

1

2011 T

2

2011 T

3

2011 T

4

20

12

T1

2012 T

2

2012 T

3

2012 T

4

2013 T

1

2013 T

2

2013 T

3

Contributions to the deviation of CPI annual inflation from the targer (pp): the monetary policy was not

procyclical

Inflation persistence GDP gap Imported inflation VAT Inflation expectations Other factors Administered prices VFE Fuel prices Tobacco, cigarettes and alcohol Deviation from the target (%)

The real effective policy interest rate (RRDPM)

The gap of the real effective policy interest rate (GRRDPM) Source: Croitoru (2014)

-8

-6

-4

-2

0

2

4

6

8

10

20

03

T1

20

03

T3

20

04

T1

20

04

T3

20

05

T1

20

05

T3

20

06

T1

20

06

T3

20

07

T1

20

07

T3

20

08

T1

20

08

T3

20

09

T1

20

09

T3

20

10

T1

20

10

T3

20

11 T

1

20

11 T

3

20

12

T1

20

12

T3

20

13

T1

20

13

T3

20

14

T1

20

14

T3

The history of contributions to the deviation of CPI annual inflation from the targer (pp)(old

coefficients of the supply curve, new NIS GDP data)

Core-3 inflation persistence GDP gap VAT Imported inflation Inflation expectations Other factors Administered prices VFE Fuel prices Tobacco, cigarettes and alcohol Deviation from target of annual CPI inflation (%)

The policy real interest rate

The policy real interest rate gap

An explanation for the criticism that the central bank did not increase the policy rate more aggressively prior to the

downturn

Critics were ignoring:

• “Distortion”-type shocks in the supply equation, such as variations in taxation rates, changes in markups pursued by firms or “cost-push shocks” (Clarida, Galí and Gertler, 2001; Smets and Wouters, 2003; Benigno and Woodford, 2003 and 2005; Woodford and Cúrdia, 2009)

• Endogenous responses (fluctuations) of the output gap to shocks (Erceg, Henderson and Levin, 2000)

• Endogenous responses of the gap between the natural level and the efficient level of output to supply-side shocks and to preference shocks (Blanchard and Galí, 2007 and 2008)

• Financial frictions, the banking sector (Bernanke, Gertler, Gilchrist, 1998; Woodford and Curdia, 2009) and real wage rigitities (Christiano et al., 2011)

The contribution to inflation of demand-pull inflation became positive in 2007 Q4-2008 Q3

Period Deviation

of annual

CPI

inflation

(pp)

Contribut

ion of

non-

CORE3

inflation

(pp)

Contribut

ion of

CORE3

inflation

(pp)

Real

monetary

policy

rate (%)

Real

monetary

policy

rate gap

(%)

Real

effective

monetary

policy

rate gap

(%)

(1) (2) (3) (4) (5) (6) (7)

2005 Q4-2007

Q3

0.25 1.58 -1.33 1.78 -0.57 -1.24

2007 Q4-2008

Q3

3.95 2.39 1.56 3.20 0.69 0.42

Table 1: The contributions of non-CORE3 inflation and CORE3 inflation to the deviation of annual CPI inflation

from the target and the real monetary policy rate

Source: Macroeconomic Modelling and Forecasting Department, NBR’s quarterly forecasting model, and the author’s

calculations.

0

5

10

15

20

25

Jan

-03

Au

g-0

3

Mar

-04

Oct

-04

May

-05

De

c-0

5

Jul-

06

Feb

-07

Sep

-07

Ap

r-0

8

No

v-0

8

Jun

-09

Jan

-10

Au

g-1

0

Mar

-11

Oct

-11

May

-12

De

c-1

2

Jul-

13

Feb

-14

Sep

-14

Ap

r-1

5

“Unconventional” monetary policy in the immediate aftermath of the crisis

Average interest rate on money market Monetary policy interest rate

(i) a speculative attack fended off also via foreign exchange market intervention, not by higher interest rate, as indicated in theory (Christiano, Braggion and Roldos,2009)

(ii) lower money market interest rates as compared to the monetary policy rate

Source: NBR data

Prudential measures implemented during

October 2008-December 2012. Will they

work? I doubt! (I)

MRR ratio on lei liabilities, from 20% to 18% (November 2008)

Reduction of loan loss provisions by considering max 25% of

collateral in case of loans classified as Loss 2 (April 2009)

Introduction of audited intermediate profit within own funds

calculation (May 2009)

Introduction of the “First Home” program (June 2009)

MRR ratio on lei liabilities, from 18% to15%; MRR ratio on fx

liabilities, from 40% to 35% (July 2009)

Balance-sheet current accounts at accounting value instead of

adjusted value (July 2009)

MRR ratio on fx liabilities, from 35% to 30% (August 2009)

Prudential measures implemented

during October 2008-December 2012.

Will they work? I doubt! (II)

MRR on fx liabilities from 30% to 25% (Nov. 2009)

Improvements to the regulatory framework on managing liquidity risk

(Dec. 2009)

Government Emergency Ordinance 50/2010 on consumer lending (June

2010). Removes abusive clauses from loan contracts

MRR on fx liabilities, from 25% to 20% (Apr. 2011)

Limits on exposures to unhedged borrowers; higher coefficients for stress-

testing fx loans (Oct. 2011)

From Romanian Accounting Standards to IFRS adoption (Jan. 2012)

Improvements to the regulatory framework on managing liquidity risk (Jan.

2012)

Banks’ aggregate exposure limits vis-à-vis unhedged non-financial

companies (Dec. 2012)

Higher inflation delayed the start of the policy rate-cutting cycle in Romania

Annual inflation rate Policy interest rates

-2 0 2 4 6 8

10

Jan

-07

Feb

-08

Mar

-09

Ap

r-1

0

May

-11

Jun

-12

Jul-

13

Au

g-1

4

EA HICP CZ CPI HU CPI

PL CPI RO CPI

Sourc: ECB, National Central Banks, and NBR`s computations

0

2

4

6

8

10

12

14

Jan

-07

Feb

-08

Mar

-09

Ap

r-1

0

May

-11

Jun

-12

Jul-

13

Au

g-1

4

EA CZ HU PL RO

Source: National Central Banks

0

5

10

15

20

25 Ja

n-0

7

Jun

-07

No

v-0

7

Ap

r-0

8

Sep

-08

Feb

-09

Jul-

09

De

c-0

9

May

-10

Oct

-10

Mar

-11

Au

g-1

1

Jan

-12

Jun

-12

No

v-1

2

Ap

r-1

3

Sep

-13

Feb

-14

Jul-

14

De

c-1

4

May

-15

Interest rates on newly-extended loans decrease

EA CZ HU PL RO

Sursa: ECB, National Central Banks, and NBR`s computations

VIII. Is a new monetary policy rate dilemma emerging?

The hypothesis of secondarity and implications for monetary policy in Romania

• Secondarity: the global surplus of savings is generated in an increasing number of countries, whereas the overwhelming part of the global deficit of savings is located in the US (Croitoru, 2015b and 2015d)

• The US are far better equipped to accommodate swift capital outflows, currency depreciation, an abrupt decline in domestic asset prices, banking system weakening, and the flagging domestic demand

-1300000

-800000

-300000

200000

700000

1200000

1700000

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

Illustrated secondarity: the history of savings-investment imbalances across major countries and

regions (USD mill., current prices)

UK

West Africa (WA)

North Africa (NA)

Africa (excl. NA and WA)

Former Soviet Union

Eastern European Countries

other developed countries

Germany

Euro area (excl. Germany)

Latin America and the Caribbean

West Asia (WAS)

China

Emerging Asia (excl. China and WAS)

Japan

US

Asia (total)

Global excess savings

Source: author’s calculations

based on UNCTAD data

The Romanian conundrum (I)

• The current account deficit plunged from 4.5 percent of GDP in 2012 to 0.4 percent of GDP in 2014

• GDP growth accelerated over that period • How was it possible?

– One of the implications of shifting to excess savings is the reduction in the natural rate of interest. Mutatis mutandis, the plunge in the current account deficit in Romania to almost zero was reflected in the lower natural rate of interest

– The swift narrowing of the savings deficit suggests

that the natural rate has declined at a quick pace as well

The Romanian conundrum (II)

Inflation: a downward path, largely reflecting the fall in inflation expectations. Hence, the NBR cut the monetary policy rate from 5.25 percent in December 2012 to 1.75 percent in May 2015

Thus, it is possible that, during 2013, 2014 and 2015, the nosedive of the current account deficit, the monetary policy rate cuts and liquidity management may have resulted in the money market rate running below the natural rate

A new policy dilemma?

Actual growth rates above potential will, probably, close the GDP gap in 2016

GDP growth rates above potential and low global interest rates will

pose again a dilemma to monetary policy in Romania (Croitoru, 2015c):

A higher policy rate would be needed to tame inflationary

pressure from the positive GDP gap A lower policy rate would be needed to avoid the leu

appreciation If a current account surplus emerged, as the secondarity suggests, the

policy rate dilemma would not appear However, the new Fiscal Code based on tax cuts together with wage

increases up to 70 percent would lead to fiscal deficits of 4-5 percent in 2016 and 2017, eliminating the issue of the interest rate dilemma, but creating other serious problems to the macroeconomic stability of Romania

Thank you!

Bibliography

Bernanke, Ben; Gertler, Mark; Gilchrist, Simon (1999), „The Financial Accelerator in a Quantitative Business Cycle Framework” Blanchard, Olivier; Jordi, Gali (2007), “Real Wage Rigidities and the New Keynesian Model”, (2007), Journal of Money, Credit and Banking, Supplement to Vol. 39, No. 1 (February). Blanchard, Olivier; Jordi, Gali (2008), “Labor Market and Monetary Policy: A new Keynesian Model with Unemployment”, Working Paper 13897, Nationla Bureau of Economic Research (March). Erceg, J. Christopher; Henderson, W. Dale; Levin, T. Andrew (2000) “Optimal monetary policy with staggered wage and price contracts”, Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October. Christiano, J. Lawrence; Trabandt, Mathias; Walentin, Karl (2011),” Introducing financial frictions and unemployment into a small open economy model”, Journal of Economic Dynamics and Control, Elsevier, vol. 35 (12), pp. 1999-2041.

Clarida, H., Richard; Jordi Galí;Mark, Gertler (1999), “The Science of Monetary Policy:A New Keynesian Perspective” Journal of Economic Literature,Vol. XXXVII (December), pp. 1661–1707. Clarida, H., Richard; Jordi Galí;Mark, Gertler (2001), “Optimal Monetary Policy in Closed Versus Open Economies: An Integrated Approach”, NBER Working Paper 8604, pp. 5-6. Croitoru, Lucian (2014), „Teoria și critica politicii monetare în România”, în Despre economie: cu și fără formule, forthcomoing, Curtea Veche Publishing. Croitoru, Lucian (2015b), „Tendința spre secundaritate în administrarea dezechilibrelor globale”, www.bnro.ro. Croitoru, Lucian (2015c), „The Romanian Conundrum”, www.bnro.ro, NBR’s blog. Croitoru, Lucian (2015d), „Monetary policy and the global imbalances”, www.bnro.ro, NBR’s blog.

http://www.bnro.ro/

http://www.bnro.ro/

http://www.bnro.ro/

Belgia

Bulgaria

Cehia

Danemarca Germania

Irlanda

Grecia

Spania

Franța

Italia

Cipru

Lituania

Luxemburg

Ungaria

Olanda

Austria

Polonia

Portugalia

România

Slovacia

Slovenia

Finlanda

Suedia

Marea Britanie

0

20

40

60

80

100

120

140

160

180

40 45 50 55 60 65 70 75 80

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

General index of economic freedom

Fig.1: Labor productivity and the general index of economic freedom in 1996

Mostly unfree economies (EPNL)

Moderately free economies(EML)

Repressed eeconomies (ER)

Mostly free economies (EPL)

Source: author’s computations; AMECO; Heritage Foundatoin

Belgia

Bulgaria

Cehia

Danemarca Germania

Estonia

Irlanda

Grecia

Spania

Franța

Italia

Cipru

Letonia Lituania

Luxemburg

Ungaria

Malta

Olanda

Austria

Polonia Portugalia

Romania

Slovacia

Slovenia

Finlanda

Suedia

Marea Britanie

0

20

40

60

80

100

120

140

160

180

40 45 50 55 60 65 70 75 80

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

General index of economic freedom

Fig. 2: Labor productivity and the general index of economic freedom in 2014

Repressed economies (ER)

Mostly unfree economies (EPNL)

Moderately free economies(EML)

Mostly free economies (EPL)

Belgia

Bulgaria

Cehia

Danemarca Germania

Irlanda

Grecia

Spania

Franța Italia

Cipru

Lituania

Luxemburg

Ungaria

Olanda Austria

Polonia

Portugalia

România

Slovacia

Slovenia

Finlanda Suedia Marea Britanie

0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Property freedom

Fig. 3: Labor productivity and property freedom in 1996

ER EPNL EML Economii libere


Belgia

Bulgaria

Cehia

Danemarca Germania

Estonia

Irlanda

Grecia

Spania

Franța

Italia

Cipru

Letonia

Lituania

Luxemburg

Ungaria

Malta

Olanda

Austria

Polonia Portugalia

România

Slovacia Slovenia

Finlanda

Suedia

Marea Britanie

0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)

Property freedom

Fig.4: Labor productivity and property freedom in 2014

ER EPNL EML EPL Economii libere


Belgia

Bulgaria

Cehia

Danemarca Germania

Irlanda

Grecia

Spania

Franța Italia

Cipru

Lituania

Luxemburg

Ungaria

Olanda

Austria

Polonia

Portugalia

România

Slovacia

Slovenia

Finlanda

Suedia

Marea Britanie

0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)


Fig. 5: Labor productivity and freedom from corruption in 1996

EPNL ER

Economii libere

EML


Belgia

Bulgaria

Cehia

Danemarca Germania

Estonia

Irlanda

Grecia

Spania

Franța

Italia

Cipru

Letonia

Lituania

Luxemburg

Ungaria

Malta

Olanda

Austria

Polonia Portugalia

România

Slovacia Slovenia

Finlanda Suedia

Marea Britanie

0

20

40

60

80

100

120

140

160

180

20 30 40 50 60 70 80 90 100

GD

P a

t cu

rre

nt

pri

ces

pe

r h

ou

r w

ork

ed

(P

PS,

EU

15

=10

0)


Fig. 6: Labor productivity and freedom from corruption in 2014

ER EPNL EML EPL

Economii libere


-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Financing of the current account: mostly from the financial account (bn. EUR)

CAPITAL ACCOUNT FINANCIAL ACCOUNT

NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT


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