William Davidson Institute Working Paper 402
8. The exchange rate policy
Since 1997 the leu fluctuates against the major currencies in a free market
where the NBR intervenes as any other trader. However, the volume and the
frequency of the transactions of the NBR in the foreign exchange market exceed what
we normally can see as specific to a managed float regime. In mature market
economies, the central bank resorts to interventions in the foreign exchange market
only in exceptional cases, and tries to influence the exchange rate by monetary policy,
in particular by managing short-term interest rates. But given that in Romania the
Treasury bonds market is quite thin and the banking sector does not demand
refinancing credits, the central bank has limited control over market determined short-
term interest rates. So, at a first sight, it seems that if the NBR wants to alter the
international value of the leu, it can (and should) rely on direct transactions in the
foreign exchange market. Let us take a closer look to this reasoning.
Figure 8 shows the evolution of the real exchange rate of the leu relatively to
the US dollar since 1992. During the early years of transition, there was a general
tendency of real appreciation of the leu. To a certain extent, such an evolution is
consistent with the Balassa-Samuelson paradigm19, but an excessive appreciation
would hamper export competitiveness. The structural current account deficit of
Romania throughout the last decade would point to such a weakness. Moreover, the
major difficulties faced by Romania in 1999 followed a period of sharp real
appreciation, and the recovery was accompanied by depreciation. So, what matter for
economic performance is not the dynamics of nominal, but of real exchange rates. In
low an inflation environment the difference is not so sharp; but Romania is not a low
inflation environment.
Real exchange rate ------Trend
Figure 8. Real dollar-leu exchange rate index, base 1.00 in December 1991. The trend
builds on Hodrick and Prescott filter. Price variation builds on consumer price indexes
in Romania and the US. Source: NBR and US Bureau of Labour Statistics
19 A note of caution should be kept in mind since rationing accompanied the functioning of the official
foreign exchange market until early 1997.
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