William Davidson Institute Working Paper 402
should adopt currency boards not only during the intermediate period before joining
the EU, but should also maintain this mechanism during the two-year test period
which precedes the adoption of the single currency.1 Under such arrangement, in a
world of increased capital mobility, the country actually transfers the control over
monetary policy into the hands of the central bank issuing the reference currency (that
is, the Fed or the ECB). That would allow the small country to “import” the
credibility of this institution.
The basic rationale against fixed exchange rate regimes may be traced back to
the pioneering work of Milton Friedman (1953). According to his view, when a
country is hit by an adverse and specific output shock, the real exchange rate should
depreciate to restore competitiveness. While this may be achieved by a reduction in
the domestic price level, the price adjustment process may be too costly or too slow;
an adjustment of the nominal rate would achieve the same result less harmfully. In the
same line of reasoning, super-fixed exchange rate regimes may not be consistent with
the smooth structural real appreciation of the currency required by the would-be
productivity catch-up in the sector of tradable goods (Halpern and Wyplosz, 1997
develop on the Belassa-Samuelson principle as applied to transition economies).
One should notice that fully flexible rates are more a theoretical construct than
a real life experience. Indeed, central banks firmly supporting this principle, like the
Fed or the National Bank of Japan, and more recently the ECB, are far from letting
their currency being determined by market forces only. As put forward by Calvo and
Reinhart (2000), they follow some kind of “managed float” regime, given that the
monetary policy is not indifferent to changes in the international value of the domestic
currency. This leads to a relatively low variance in the exchange rate and a higher
variation in reserves and short-term rates. The two authors argue that sometimes the
difference between “managed float” and “not-credible peg” is quite negligible. Under
a not-credible peg, the government announces an exchange rate target, but would
discretionary change it, quite frequently.
This paper aims to introduce some basic elements of an analysis of monetary
and exchange rate policies, from a perspective related to the economic reality of
Southeast European transition economies; it analyses the role played by monetary
policy in Romania so far, the factors that contributed to poor inflation performances
and suggests some possible ways of improving the effectiveness of its monetary
policy. Special emphasis is placed on the relationship between monetary policy and
the exchange rate regime. The paper has a clear macroeconomic and financial bias. Of
course, many microeconomic, institutional, political and cultural factors may have
been brought into the picture, as there are many relevant variables during such a
complex phenomenon as transition. But focusing on one dimension at one time would
limit the risk of hiding or omitting the essential mechanisms and relationships. In
particular, it should be noticed that the paper does not explicitly address the question
of slow growth in Romania. If we implicitly assume that moderate inflation and a
stable currency could favour growth, other aspects, as the relationship between
investment and savings, the improvement of Romanian firm competitiveness in the
world market, the resource reallocation toward dynamic firms and sectors are not
dealt with.
The next section briefly recalls some basic difficulties that policy reform faced
at the beginning of the transition process in the most centralised economies. Section 3
1 It is however not obvious which would be then the role of this test period, if the exchange rate reveals
no information about economic performances and policies.