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

William Davidson Institute Working Paper 402

Balance sheet of bank i

The bank holds reserves with the central bank (Ri), lends to private agents (Ci)
and lends resources to the central bank (Ai). Di are the deposits of private agent with
this bank. Some ordinary banks have also benefited from restructuring credits or
normal refinancing credits, denoted by REFi.

The balance sheet of the NBR is :

Simplified balance sheet of NBR

On the liability side, we have now total central bank borrowing from ordinary
banks, in the amount A. We also have explained why the NBR has little margin for
altering REF. Hence, in order to sterilize the increase in reserves, a 1 leu increase in
RFX must be balanced by 1 leu increase in A (or a 1 leu reduction in TB).

If the initiative for buying dollars stays with the NBR, the initiative for lending
money to the NBR stays with the ordinary banks. To be sure that the banks want to
lend money, the NBR must offer an interest rate on these deposits higher than the
interest rate that banks can obtain from lending in the private market. So far, the
spread was about 10 percentage points.

Has the NBR carried out an effective sterilisation policy? Let us take a closer
look to the figures.¹⁸ From the trough of April 1999 to April 2001, net foreign assets
increased from 15600 billion lei to 82300 billion lei. In the meantime, net refinancing
(genuine repo reverse/repo - attracted deposits) barely varied around 2000 billion lei.
Only in October 1999, average outstanding attracted deposits rose sharply from 3000
billion lei to 7500 billion lei. But, throughout the year 2000, the NBR made little use
of this tool. However, the reduction in the stock of Treasury bonds by over 5000
billion lei between December 1999 and December 2000 (Table 1) may be interpreted
as an attempt to sterilise. The NBR seems now eager to recourse again to the deposit-
taking weapon, as, between March 2000 to February 2001 it increased by 6000 billion
lei the average stock of attracted deposits.

So, if the NBR wants to push toward the real depreciation of the leu, it should
continue to buy dollars and sterilise this intervention by attracting more and more
deposits. Assuming that the bank has enough resources to pay the high interest rates
needed to attract these deposits, what does such a policy entail? By offering high
interest rates on attracted deposits, the NBR crowds out credits to the productive
sector. While depreciation favours exporters, higher interest rates may harm
investment, thus firms that produce for the domestic market face only the adverse
effect. The aggregate effect is ambiguous.

¹⁸ Such as published in the Monthly Bulletin 4/2001 of the NBR.

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