Subduing High Inflation in Romania. How to Better Monetary and Exchange Rate Mechanisms?

William Davidson Institute Working Paper 402

first in 1997, then after January 1999. Hence, the relative stability of the base
multiplier in the late 1990s may be explained by a rise in compulsory and excess
reserves.

So, given that the money multiplier has not risen steadily (currently, it gets
back to its “historical” value), the large increase in the money stock should be
analysed in close relation with positive variations in the monetary base. We know that
the monetary base responds to countervailing changes in the central bank assets. In
the following, we take a closer look to NBR assets.

7.3 The NBR balance sheet: asset side

The Table 1 below shows the main posts of the asset side of the balance sheet
of the NBR: net foreign assets (foreign assets - liabilities) also called reserves of
foreign exchange (RFX), credits to the government (mainly Treasury bonds) and
credits to the banking sector. Normal credits to the banking sector are made up of
genuine refinancing credits with a pure monetary purpose, and of a special credit line.
The genuine refinancing operations are mainly realized through repo/reverse repo
operations with one month maturity.

Table 1. NBR main asset positions in billions of lei. Source: NBR.

As can be seen, between December 1997 and December 2000, the largest
increases were recorded in the positions “Net foreign assets” and “Special credits and
other bank funding”.

These special credits deserve more scrutiny. Until 1997, state-owned banks
often granted easy credits to various sectors (energy, agriculture, heavy industry, etc)
and firms in trouble. They did it either following the reflexes of central planning and
the instructions of the government, or as a result of obscure deals between their
managers and various clients. Some banks also get involved in trouble affairs,
financing dodgy projects, most notorious being the Bancorex case (the former
socialist bank for foreign trade, which, after tearing down all its large amount of
capital, accumulated large debts, then went bankrupt). Arguably, state support to
banks would have limited the risk of a generalised failure of a too fragile banking
system. One may nevertheless suspect that some vested interests may have motivated
this decision too. Although the government took over a large amount of bad debts
(Bancorex, Banca Agricola), the central bank was systematically solicited to bail out
some of the banks that went in deep financial trouble (Dragulin and Radulescu, 2000).
Some Romanian policymakers may have lived with the illusion that the measure
“insulates” the public deficit. Actually, it led to an almost automatic monetization of
what normally were public expenses. In addition, the NBR was asked to provide small
savers in the failing banks with a minimum capital. Such a huge amount of “special”
central bank credits (10000 billion lei by December 2000) clearly undermined the

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