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Eesti PankBank of Estonia
15 years of currency board in Estonia
Ülo Kaasik
Ülo Kaasik CBA in Estonia 2
Eesti PankBank of Estonia
Outline
Currency Board Arrangement in Estonia• History
• Framework and results
• Recent developments and challenges
Ülo Kaasik CBA in Estonia 3
Eesti PankBank of Estonia
Why choosing CBA?
• Need for stabilising anchor in the beginning of 1990s
• Creating a simple and reliable monetary system, effective since 1992
• Small open economy with free capital mobility
Ülo Kaasik CBA in Estonia 4
Eesti PankBank of Estonia
Monetary system
• Fixed exchange rate against euro (since 1999, formerly since 1992 equivalently against the DEM)
• Full convertibility of Estonian kroon
• Base money is fully backed by high quality foreign assets
Ülo Kaasik CBA in Estonia 5
Eesti PankBank of Estonia
Operational framework
• Smooth liquidity management through unlimited EUR-EEK exchange with the central bank (forex window)
• High liquidity buffers in the form of required reserves (reserve ratio currently 15%)
• No domestic monetary policy interest rate: monetary stance is determined by European Central Bank monetary policy decisions
Ülo Kaasik CBA in Estonia 6
Eesti PankBank of Estonia
Other policies supporting CBA
• Fiscal policy based on a balanced budget principle
• Tax system – motivating, transparent, simple
• Liberal trade and investment regime since 1991
• Flexible labour market
• Strong banking system
• Preparations for EU membership
Ülo Kaasik CBA in Estonia 7
Eesti PankBank of Estonia
What are the results?
Ülo Kaasik CBA in Estonia 8
Eesti PankBank of Estonia
Relatively quick stabilisation of the economy
0%
20%
40%
60%
80%
100%
The introduction of the currency board was crucial in achieving disinflation
During the last 8 years the average CPI has been 3.7 %
CPI (1991-2007)
1991 -- 257%
1992 -- 1077%
Ülo Kaasik CBA in Estonia 9
Eesti PankBank of Estonia
A
A-
BBB+
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
3M EURIBOR (3M DEM LIBOR) 3M TALIBOR Sovereign Rating (Standard & Poor's)
The interest rates have converged to the interest rate level in euro-area countries
Ülo Kaasik CBA in Estonia 10
Eesti PankBank of Estonia
Fast capital inflow, through FDI and banking system
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
FDI stock, % of GDP
FDI inflow, % of GDP
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
domestic banks, total assets % of GDP
banks with foreign ownership, total assets % of GDP
net foreign assets of banks, % of GDP
Ülo Kaasik CBA in Estonia 11
Eesti PankBank of Estonia
Very rapid income convergence
0
2000
4000
6000
8000
10000
12000
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
10
20
30
40
50
60
70
GDP per capita (EUR, nominal), left scale GDP vs EU-25 (%, PPP), right scale
Source: Eurostat
Ülo Kaasik CBA in Estonia 12
Eesti PankBank of Estonia
… and current account deficit
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
% o
f G
DP
goods balance services balanceincome balance current transfers balancetotal current account
Ülo Kaasik CBA in Estonia 13
Eesti PankBank of Estonia
Pace have accelerated during last years
• Double digit GDP growth
• Rapid credit growth
• Deepening CAD
• Inflation well above Maastricht criterion
Ülo Kaasik CBA in Estonia 14
Eesti PankBank of Estonia
How to avoid overheating of the economy under CBA? Case of Estonia
• Flexibility: in economic policies and markets
• Reducing cost and price pressures of the government
• Reminding conservative financial decisions
• More reserves in the financial system
• Close cooperation with supervisors and central banks of the host countries
Ülo Kaasik CBA in Estonia 15
Eesti PankBank of Estonia
CBA ensures high liquidity buffers
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
02/0
2/19
98
02/0
8/19
98
02/0
2/19
99
02/0
8/19
99
02/0
2/20
00
02/0
8/20
00
02/0
2/20
01
02/0
8/20
01
02/0
2/20
02
02/0
8/20
02
02/0
2/20
03
02/0
8/20
03
02/0
2/20
04
02/0
8/20
04
02/0
2/20
05
02/0
8/20
05
02/0
2/20
06
02/0
8/20
06
02/0
2/20
07
02/0
8/20
07
mln
EE
K reserve requirement
deposits in Bank of Estonia
market value of foreign assets liquidity portfolio
Ülo Kaasik CBA in Estonia 16
Eesti PankBank of Estonia
Flexible labour markets is crucial for economic adjustment
0%
5%
10%
15%
20%
25%
30%
35%
40%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
nominal wage growth
real productivity growth
Ülo Kaasik CBA in Estonia 17
Eesti PankBank of Estonia
CBA cannot operate without conservative fiscal policy
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
General government deficit/surplus,% of GDP
Ülo Kaasik CBA in Estonia 18
Eesti PankBank of Estonia
Is inflation too high?
Ülo Kaasik CBA in Estonia 19
Eesti PankBank of Estonia
Lower level of convergence implies faster growth rate
0123456789
20 40 60 80 100 120GDP per capita in PPS (2000), EU25=100
Ave
rage
ann
ual r
eal G
DP
grow
th (
2001
-200
5),
%
LV EELT
Ülo Kaasik CBA in Estonia 20
Eesti PankBank of Estonia
Income and price levels tend to correlate i.e. converge together
Price level and GDP per capita in PPS in European Union (except Luxembourg)Source: Eurostat
R2 = 0,9101
0
20
40
60
80
100
120
140
0 20 40 60 80 100 120 140 160
gdp per capita
pri
ce
lev
el
Ülo Kaasik CBA in Estonia 21
Eesti PankBank of Estonia
Apart from conjunctural price increases current inflation rate also reflects price convergence
-2%
0%
2%
4%
6%
8%
10%
12%
2000 2001 2002 2003 2004 2005 2006 2007
CPI Services Manufactured goods excl fuel
Ülo Kaasik CBA in Estonia 22
Eesti PankBank of Estonia
Economy has started to cool down, 2007 Q2 growth was 7.6%
-4%
-2%
0%
2%
4%
6%
8%
10%
12%
14%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
difference GDP growth Estonia GDP growth euroarea
Ülo Kaasik CBA in Estonia 23
Eesti PankBank of Estonia
Credit cycle has turned
• Monthly credit growth has not declined to a too low level – it remained around 2% during the whole summer
Credit growth in the non-financial sector
0%
10%
20%
30%
40%
50%
60%
I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV
2001 2002 2003 2004 2005 2006 2007 2008 2009
Credit growth y-o-y Spring forecast 2007
Ülo Kaasik CBA in Estonia 24
Eesti PankBank of Estonia
The external balance has not widened any further
-20%
-18%
-16%
-14%
-12%
-10%
-8%
-6%
-4%
-2%
0%
I II III IV I II III IV I II III IV I II IIIIV I II III IV I II III IV I II III IV I II* III IV I II IIIIV I II III IV
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Current account Spring forecast 2007
Current account (% of GDP)
* Flash estimate
Ülo Kaasik CBA in Estonia 25
Eesti PankBank of Estonia
No big impact of financial turbulences
0,0
0,1
0,2
0,3
0,4
0,5
0,6
0,7
0,8
31.1
0.0
6
14.1
1.0
6
28.1
1.0
6
12.1
2.0
6
26.1
2.0
6
09.0
1.0
7
23.0
1.0
7
06.0
2.0
7
20.0
2.0
7
06.0
3.0
7
20.0
3.0
7
03.0
4.0
7
17.0
4.0
7
01.0
5.0
7
15.0
5.0
7
29.0
5.0
7
12.0
6.0
7
26.0
6.0
7
10.0
7.0
7
24.0
7.0
7
07.0
8.0
7
21.0
8.0
7
04.0
9.0
7 -1
0
1
2
3
4
5
6
7
3M Talibor-Euribor (l.s) 6M Talibor-Euribor (l.s)3M Rigibor-Euribor (r.s) 6M Rigibor-Euribor (r.s)
Ülo Kaasik CBA in Estonia 26
Eesti PankBank of Estonia
Euro adoption as the ultimate exit clause
• Adoption of the euro as soon as possible, targeting 2011
• Central role of the government in reducing inflation:
– Avoiding additional cost and price pressures
– Managing regulated prices
• No changes expected in the monetary environment due to euro adoption
Ülo Kaasik CBA in Estonia 27
Eesti PankBank of Estonia
Conclusions• CBA can be an effective corner stone for the
economy
• However, CBA cannot be successful without supportive economic policies
• CBA offers the closest monetary environment to the euro area, preparing the economy for the euro adoption