William Davidson Institute Working Paper 402
Box: an unpleasant experience
In late 1991, against the background of a tough winter, the energy producing sector (made up
of state owned firms) run out of foreign reserves needed to purchase coal and oil, and the Government
and the NBR imposed that foreign exchange deposits of the enterprises be converted into lei deposits at
the official (overvalued) rate, a move that deeply affected the confidence of private agents in the
banking sector. In order to oppose the ensuing capital flight, a full-retention regime of foreign
exchange was introduced in mid-1992. Administrative controls over the official exchange rate were
maintained until the end of 1996, which led to the existence of three main exchange rates: an official
rate for firms, which was fixed by the NBR; an implicit free rate set by firms, which used linked import
and export transactions; and another free rate, for individuals. Most of this period, the official rate vas
overvalued; cheap energy was an indirect way to subsidise energy intensive industries, but also
contributed to a deterioration of the current account.
In mid-1999 the country faced major difficulties with the reimbursement of the
foreign debt. The possibility of partial default was mentioned, but the crisis was
avoided and the financial situation of the country improved soon afterwards.
Arguably, the default was avoided due, also, ironically, to the underdevelopment of
domestic financial markets (including the absence of a large stock of T-bills held by
foreign investors, which can be explained by the non-functioning of a secondary
market). In the spring of 2001, Standard & Poor improved Romania’s rating from B-
to B. Actually, difficulties turn the other way round, as with steady capital inflows,
some policymakers start fearing an excessive appreciation of the national currency
that would hamper competitiveness. The good news was that the central bank was
able to restore quite fast its reserves of foreign exchange, but at a cost (to be explained
later on).
7. Money, the monetary base and the base multiplier
7.1 Some relevant stylised facts
In general, the money stock is defined in this text as M2. This aggregate
includes cash in circulation, checkable (sight) deposits, time and saving deposits and
other short-term contractual savings, as well as foreign currency denominated
deposits. There are two distinctive features of the Romanian composition of M2 with
respect to EU countries. The first is the existence of foreign currency denominated
deposits: private agents may and do hold dollar (or other important currency)
accounts. The second is the relative small size of checkable deposits as compared to
cash. As already mentioned, this latter feature is a consequence and an indication of
the atrophy of the Romanian banking sector in general.
The figure 4 below depicts the large increase in the money stock, which was
roughly multiplied by a factor of seven in five years. Is this change due to an
extensive development of bank credit, or to an increase in the monetary base with the
NBR14? The development of bank credit may have been welcomed, as it would imply
the development of the banking sector and the much needed financing of economic
development. To provide an answer, we plot the base multiplier (i.e. the ratio between
M2 and the monetary base) and the money stock M2 on the same graph. If in 1997-
1998 the multiplier was relatively high, since 1999 it has gone back to its beginning-
14 Monetary base includes cash (bank notes and coins) and banks deposits with the NBR (also called
reserves).
14