Business cycle and monetary policy in Romania
Lucian Croitoru National Bank of Romania The second ERMAS Confrence, 29-31 August 2015 Cluj Napoca Content
I. Macroeconomic overview II. Economic freedom and real convergence III. GDP dynamics and its features IV. The fiscal deficit and the cycle V. The current account VI. Inflation developments VII. Monetary policy VIII. Is a new monetary policy rate dilemma emerging?
I. Macroeconomic overview Before the crisis Rapid GDP growth in 2001-2008 (6.5% average annual growth) fuelled by large capital inflows: A real-estate and consumption boom emerged as wage and credit were increasing rapidly An expansionary fiscal policy further contributed to the overheating of the economy starting in 2005 Large imbalances were building up, rendering the economy vulnerable to negative shocks Unsustainable structural fiscal imbalances doomed Romania to fiscal consolidation when the crisis hit Sizeable external disequilibrium (the current account deficit peaked at 13.4% of GDP in 2007) External debt increased from euro bn. 30.9 in 2005 to euro bn. 72.4 in 2008 Adjustments in the wake of the crisis
The current account deficit plunged to sustainable levels (4.4% of GDP in 2012, 0.4% of GDP in 2014) Sharp fiscal consolidation brought the deficit from 9% of GDP in 2009 to 1.5% of GDP in 2014 The public debt-to-GDP ratio increased rapidly during the crisis, but it is still one of the lowest in the EU and is estimated to stabilize below 40% of GDP over the medium term Total external debt increased to euro bn. 100 in 2012 and decreased to euro bn. 63 in 2014.
Outlook for 2015 and beyond Expected economic outcomes in 2015 if fiscal plans receive approval: GDP growth estimated at 4.4% in 2015 and 4.1% in 2016 (beyond potential in both cases) O-Y-A inflation estimated at - 0.2% in December 2015 and 0.7% in December 2016. Annual average inflation of -0.2% in 2015 and -0.8% in 2016 The CA deficit, expected to deepen to -1.5 percent of GDP Budget deficit moves at 4 percent in 2016 and 5 percent in 2017 if both the Fiscal Code and the wage bill are approved Weakened macroeconomic fundamentals would not support strong growth and would lead to further delayes in joining the Banking Union and the euro area
II. Economic freedom and real convergence EU economies became more liberal in 2014 as compared to 1996 (see detailed charts at the end of the presentation) Economic freedom in 1996 Economic freedom in 2014 180 180 Source: author’s computations;
160 160 Source: author’s computations;
AMECO; Heritage Foundation AMECO; Heritage Foundation 140 140 120 FR 120 100 IT 100 IT 80 80 60 GR 60 GR LI ES RO
40 HU 40 worked (PPS,EU15=100) worked LI EU15=100) (PPS, worked PO
GDP at current priceshourper current at GDP 20 20 RO hourpricesper current at GDP 0 0 40 60 80 40 50 60 70 80 Overall index of freedom Overall index of freedom EU countries migrate to upper clusters as regards property freedom. Slow progress for Romania
Unclear property rights in Romania has made little progress until Romania in 1996 2014; Italy and Greece show regression 1996 2014 180 180
Source: author’s computations;
160 AMECO; Heritage Foundation 160 Source: author’s computations; AMECO; Heritage Foundation 140 140 FR 120 FR IT 120 100 100 IT 80 80 GR 60 GR 60
40 40 RO worked (PPS, EU15=100) (PPS, worked
20 EU15=100) (PPS, worked 20 GDP at current prices per hourpricesper current at GDP RO hourpricesper current at GDP 0 0 20 40 60 80 100 20 40 60 80 100 Property rights Property rights Some developed countries have lost part of their freedom from corruption
Greece and Italy have the lowest freedom Romania was among countries with the from corruption in 2014 among EA lowest freedom from corruption in 1996 countries 1996 2014 180 180
Source: author’s computations;
Source: author’s computations; 160 AMECO; Heritage Foundation 160 AMECO; Heritage Foundation 140 140 DE 120 DE 120 IT 100 IT 100 80 80 GR 60 GR 60 CZ 40 40 PO
PO RO worked (PPS,EU15=100) worked worked (PPS, EU15=100) (PPS, worked 20
RO 20 GDP at current priceshourper current at GDP GDP at current prices per hourpricesper current at GDP 0 0 20 30 40 50 60 70 80 90 100 20 30 40 50 60 70 80 90 100 Freedom from corruption Freedom from corruption Gross domestic product at current prices per hour worked (PPS, EU15=100): Change in positions (index) 2.4 Belgium Bulgaria 2.2 Romania has increased 2.21 Czech Republic Denmark 2 times its GDP/hour worked as a percentage of the EU 15 Germany Estonia 1.8 Ireland Greece 1.6 Spain Source: author’s computations; AMECO France 1.4 Italy Cyprus 1.2 Latvia Lithuania Luxembourg 1 Hungary Malta 0.8 Netherlands 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 Gross domestic product at current prices per hour worked (PPS, EU15=100)
180 Source: author’s 160 computations; AMECO Note: * indicates that the indicator`s 140 value refers to the year 2000, not to the year 1996 120 100 80 60 1996 40 2014 20
0
EA*
Italy Italy
Spain Spain
France France
Cyprus Cyprus
Poland Poland
Greece Greece
Ireland Ireland
Malta* Malta*
Latvia* Latvia*
Austria Austria
Finland
Sweden Sweden
Belgium
Bulgaria Bulgaria
Slovakia Slovakia
Hungary Hungary Portugal
Slovenia Slovenia
Estonia* Estonia*
Romania Romania
Germany Germany
Denmark Denmark
Lithuania
Netherlands Netherlands
Luxembourg Luxembourg
Czech Republic Republic Czech United Kingdom Kingdom United Romania`s scoreboard indicators in 2013 • Public debt: 37.9 % of GDP • Curent account (CA) deficit (average over the past 3 years): 1.9 % of GDP • Net international investment position: -61.5 % of GDP • Real effective exchange rate (percentage change over the past 3 years): 0.3 • Market share of exports of goods and services (percentage change over the last 5 years): 16.4 • Unit labor cost (percentage change over the past 3 years): 0.7 • Houses price index (annual percentage change): -4.6 • Private sector debt: 66.4 % of GDP • Credit flow to the private sector: -1.5 % of GDP • Unemployment rate: 7 % • Financial sector total liability (annual change): 3.1 % Lucian Croitoru 13
Romania’s indices of economic freedom for 2015 compare well to those of Germany, except for property rights, freedom from corruption, and financial freedom Indicator Romania (66.6; ranks 57) Germany (73.8; ranks 16)
• Property Rights (RoL) 40.0 ~ 90.0 ~ • Freedom From Corruption (RoL) 43.0 + 78.0 - • Business Freedom (RE) 69.8 - 88.2 - • Labor Freedom (RE) 68.6 + 51.2 + • Monetary Freedom (RE) 77.3 + 81.5 + • Government Spending (LG) 62.3 + 40.1 + • Fiscal Freedom (LG) 86.9 - 60.8 - • Trade Freedom (OM) 88.0 + 88.0 + • Investment Freedom (OM) 80.0 ~ 90.0 ~ • Financial Freedom (OM) 50.0 ~ 70.0 ~ Source: Heritage Foundation RoL=rule of law; RE=regulatory efficiency; LG=low government; OM=open markets; - indicates a decrease as compared to the previous year; + indicates an increase as compared to the previous year; ~ = stable
Lucian Croitoru 14
III. GDP dynamics and its features ROMANIA: Annual GDP growth rates (%) 10 Financial repression 1990-1996 5 Moderate and high capital inflows 2000-2008
0
1990 2006 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2007 2008 2009 2010 2011 2012 2013 2014 2015f -5 Recession II
Recession III Financial and economic -10 crises: Asia 1997; Russia The financial and 1998; Argentina 1999-2001 economic crisis of -15 2007 Recession I Source: data from the National
Institute of Statistics -20 Global recession of 1991 Romania’s GDP growth: some features
High dependency on capital inflows Three distinctive periods of positive growth: The financial repression period: 1990-1996 The boom period: 2000-2008 (high capital inflows fuelled high growth) The “free” growth period (no implicit subsidies, no high capital inflows): 2011-until now. GDP growth averaged 2 percent a year
In Romania, GDP growth depends on capital inflows (%) (Source: NIS and author`s calculations) Average Cumulated growth over Period growth rate the period Comments low private capital 1990-1992 -10.7 -27.8* inflows low private capital 1993-1996 4.08 17.2 inflows low private capital 1997-1999 -2.4 -7.2 inflows MODERATE PRIVATE 2000-2004 5.4 29.8** CAPITAL INFLOWS HIGH PRIVATE CAPITAL 2005-2008 6.9 30.6 INFLOWS high public external 2009-2010 -4.0 -7.9 borrowings 2011- low private capital
2014*** 2.0 8.3 inflows 18 * 3 years; ** 5 years; ***growth for 2014 estimated at 2.9 percent Lucian Croitoru IV. The fiscal deficit and the cycle Procyclical fiscal policy before and after the 2008 crisis 10 4 Excess demand, 8 Fiscal impulse (rhs, % % of PGDP 3 of GDP) 6 Implicit cyclical balance if at MTO, % of GDP 2 4 Implicit GG balance, 1 2 if MTO, % of GDP 0 0
-2 -1 -4 -2 -6 Structural balance, GG balance, -3 -8 Source: AMECO and % of PGDP % of GDP author's computation
-10 -4
2001 1995 1996 1997 1998 1999 2000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Cumulated percentage growth of wages, labor productivity (2000=100), and public pensions (2001=100)
300 Pensions in the public sector
250 Wages in the budgetary *Includes the public sector* administratin, education , health, and recreative activities 200 Wages in the private sector 2001-2004: average real pension growth = 7,4 % Labor productivity 2001-2004: average real wage growth in the public sector = 150 (Real GDP per hour 6,9 % 2005-2009: average real pension growth = 21,7 % worked) 2005-2009: average real wage growth in the public sector = 12,4 % Source: author's computation based on data from National Institute for Statistics,
100 and AMECO
2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2011 2012 2013 2014 Public debt as a percent of GDP in the EU in 2014. Romania has a enviable position Estonia 10.6 Luxembourg 23.6 Bulgaria 27.6 Romania 39.8 Latvia 40.0 Lithuania 40.9 Czech Republic 42.6 Sweden 43.9 Denmark 45.2 Poland 50.1 Slovakia 53.6 Finland 59.3 Malta 68.0 Netherlands 68.8 Germany 74.7 Hungary 76.9 Slovenia 80.9 Austria 84.5 Croatia 85.0 European Union 88.6 United Kingdom 89.4 Euro area 94.2 France 95.0 Spain 97.7 Belgium 106.5 Cyprus 107.5 Ireland 109.7 Portugal 130.2 Italy 132.1 Greece 177.1 0 20 40 60 80 100 120 140 160 180 Changes in public debt in the EU from 2007 to 2014 (percentage points). Significant upward adjustment in the case of Romania, but low by comparison to other countries Malta 5.7 Sweden 5.7 Poland 5.9 Estonia 7.0 Bulgaria 11.0 Germany 11.0 Hungary 11.1 Czech Republic 14.8 Luxembourg 16.5 Denmark 17.9 Belgium 19.6 Austria 19.7 Slovakia 23.7 Lithuania 25.0 Finland 25.3 Netherlands 26.1 Romania 27.1 Euro area 29.3 France 30.6 European Union 30.7 Latvia 31.6 Italy 32.4 United Kingdom 45.7 Croatia 47.9 Cyprus 53.4 Slovenia 58.2 Portugal 61.7 Spain 62.2 Greece 74.0 Ireland 85.7 0 10 20 30 40 50 60 70 80 90 Changes in cyclically adjusted GG balances (percentage points): Roamania performed the second largest adjustment („-” means a increase in the fiscal deficit) Sweden -3.6 Estonia -2.0 Finland -1.9 Cyprus -0.2 Luxembourg -0.1 Hungary 0.1 Malta 0.1 Bulgaria 0.6 Slovenia 1.2 Germany 1.8 Austria 1.9 Belgium 1.9 Italy 2.3 Latvia 2.8 United Kingdom 3.0 France 3.3 Euro area 3.4 Czech Republic 3.6 Denmark 3.7 Netherlands 3.8 Lithuania 4.0 Poland 5.3 Slovakia 5.6 Portugal 6.3 Spain 6.8 Ireland 7.3 Romania 7.7 Greece 16.2 -5 0 5 10 15 Cyclically adjusted GG balances: Romania compared badly to other EU countries before 2008 and compares well prezently. Adjustments made in 2010 were key to reaching the present good positin
4
-1
-6 2014 -11 2009 2007
-16
Italy
Spain
Malta
Latvia
France
Cyprus
Poland
Greece
Ireland
Austria
Estonia
Finland
Sweden
Belgium
Bulgaria
Slovakia
Hungary Portugal
Slovenia
Romania
Germany
Denmark
Lithuania
Euro area Euro
Netherlands
Luxembourg
Czech Republic Czech United Kingdom United Cyclical fiscal balance in EU countries (% of GDP). Almost each country was imprudently enjoying good times
7.0 6.2
5.0 4.3 3.8 3.4 3.0 2.5 2.3 2.6 3.0 2.2 2.4 2.2 2.4 1.7 1.8 1.9 1.7 1.9 1.5 1.7 1.5 1.4 1.4 1.1 1.0 1.3 1.0 1.0 0.6 0.4 2014 -1.0 2009
-3.0 2007
-5.0
Italy
Spain
Malta
Latvia
France
Cyprus
Poland
Greece
Ireland
Austria
Estonia
Finland
Sweden
Belgium
Bulgaria
Slovakia
Hungary Portugal
Slovenia
Romania
Germany
Denmark
Lithuania
Euro area Euro
Netherlands
Luxembourg
Czech Republic Czech United Kingdom United V. The current account Significant changes in current account balances (percentage points). „-” indicates a reduction in the CA deficit Bulgaria -26.1 Latvia -19.3 Estonia -16 Greece -15.5 Lithuania -14.5 Romania -13.1 Slovenia -11.2 Hungary -11.2 Spain -10.8 Portugal -10.7 Malta -9.5 Ireland -9 Croatia -7.8 Cyprus -6.7 Slovakia -5.4 Poland -4.9 Denmark -4.9 Czech Republic -4.9 Netherlands -4.2 Italy -3.2 France -0.2 Germany -0.2 Belgium 0.3 Sweden 2.5 Austria 2.7 United Kingdom 3.5 Luxembourg 5 Finland 6.1 -30 -20 -10 0 10 Current account balances in EU countries (% of GDP)
10.1 9.3 9 7.4 6.7 3.5 4.3 4 1.9 1.4
-1 -1.0 -1.3 -2.4 -4.3 -4.2 -6 -5.3 -5.3 -6.2 -6.2 -7.2 -7.3 -11 -10.0 -10.1 -11.8 -13.5 -16 -14.6 -14.4 -15.9 -21 -22.4
-26
-25.2
Italy
Spain
Malta
Latvia
France
Cyprus
Poland
Ireland
Austria
Greece
Croatia
Estonia
Finland
Sweden
Bulgaria
Slovakia
Belgium
Slovenia
Portugal
Hungary
Romania
Germany
Denmark
Lithuania
Netherlands Luxembourg
Czech Republic Czech 2007 2014 United Kingdom United In Romania, the current account was mostly financed by debt creation during the boom phase of the cycle (EUR bn.) 20
15 13.1 12.4
10 2.9 5 2.0 4.4 3.6 3.3 2.2 4.5 6.6 4.3 5.4 2.4 2.1 2.2 2.8 5.3 6.3 0 -4.0 -5.4 -5 Source: author’s computations based on NBR data -10 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 NON DEBT-CREATING FLOWS DEBT-CREATING FLOWS NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT 30 Financing of the current account by instruments in Romania (EUR bn.) 20
10
0
-10
Source: author’s computations based on NBR data -20 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Direct investment CAPITAL ACCOUNT Currency and deposits Trade credits and advances NET ERRORS AND OMISSIONS Portfolio investment Financial derivatives Loans Other accounts receivable/payable Reserve assets (- increase/+ decrease) CURRENT ACCOUNT DEFICIT Romania: the current account deficit was mostly ascribable to the private sector external deficit during the boom (% of GDP)
5 4.4
1.1 0 -0.4 -1.5
-5
-8.9 -10 -10.5 Source: author's estimation based on data from EUROSTAT, NBR and UNCTAD -13.4
-15
2000 1995 1996 1997 1998 1999 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 The current account deficit The GG deficit The private sector deficit Romania: public savings and investment (% of GDP) 8 Decreasing 6.7 investment during 6 recession Higher investment without much progress in 4 infrastructure 4.3 3.4 2.8 2
0
-2 Source: author's estimation based on data -2.9 from EUROSTAT, NBR and UNCTAD -4
savings Investment Romania: the private sector reduced savings and increased investment during the boom and reduced them both in the aftermath (% of GDP) 35 31.7 30 25.8 25
20 21.2
15 17.7 13.0 10 Source: author's estimation based on data from EUROSTAT, NBR and UNCTAD 5
0
2008 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2009 2010 2011 2012 2013 2014 Savings investment VI. Inflation developments A few features of the HICP consumer basket in Romania • 32 percent of consumer bascket are given by food and volatile prices • Had the NBR chosen the core inflation to be targeted, it would have been difficult for the public to understand the concept • By choosing the headline inflation to be targeted, the NBR exposed itself to the reputational risk of missing the target because of high volatility of too many prices The share of food items in the HICP consumer basket, 2015
percent 35
32.4 30
27.9 27.7 25 25.8 24.9 22.8 22.3 20
15
10
5
0 Romania Latvia Lithuania Bulgaria Hungary Poland Czech Republic
Source: Eurostat
10 20 30 40 50 60 0
Source: Source: NIS Romania: percent 2005 41.7
56.3
2006 40.7
54.0 the share of food share offood the itemsin theconsumer basket
2007 38.9
52.2
2008 37.5
49.7
2009 37.6
47.6 CPI 2010 37.4
46.7 2011
37.5 CORE3
47.7 2012 37.2
48.6
2013 37.7
50.0
2014 37.6
50.3
2015 37.5
50.1 percent 2008 H2: Romania: O-Y-A CPI inflation (%) - increase of 2010 H2: administered 2011 H1: 2007 H2 - 2008 H1: - VAT tax raised prices - increase in domestic and international agri-food - poor food supply - increase in 10 commodity prices - increase of administered, food - increase of oil price administered prices and oil prices 9 and of oil price 2009 Q1: - tobacco excise increase - leu depreciation 2012 H2: 8 - poor harvest - increase of 2013 Q1: 7 administered - increase in electricity prices prices - poor food supply 6 - excise increase
5
4
3
2 2013 H2 - 2014 H1: Multi-annual flat target: 2.5% - good harvest - bread VAT decrease 1 2014 H2 : - decrease of oil price 0 - abundance of food dec.05 dec.06 dec.07 dec.08 dec.09 dec.10 dec.11 dec.12 dec.13 dec.14 dec.15 dec.16
Note: Variation band of the target is ±1 percentage point. Source: NIS, NBR VII. Monetary policy Five distinct periods of inflation deviation from the target prior to the downturn 1. The period up to the closing of the output gap (2003 Q1- 2004 Q2); 2. The following period up to the adoption of inflation targeting (2004 Q3-2005 Q3); 3. The period between the shift to inflation targeting and the surge in capital inflows (2005 Q4-2006 Q3); 4. The period of massive capital inflows, up to the outbreak of the global crisis (2006 Q4-2007 Q3); 5. The period between the global crisis setting in until the domestic economy entered recession (2007 Q4-2008 Q3), when the contribution of CORE3 inflation to the deviation of CPI inflation from the target was positive and relatively high for the first time. Measures aimed at taming capital inflows before downturn in 2008 Q4. Did they work? NO! (I)
Capital account liberalization (March 2003; last stage Sep.2006) Introduction of restrictions on mortgage lending (February 2004) Stricter eligibility criteria for consumer loans (February 2004) Larger exposures to one debtor from 20% to 25% (July 2004)) MRR on fx liabilities, from 25% to 30% (August 2004) MRR lei from 18% to 16% (August 2005) MRR on fx liabilities from 30% to 35% (January 2006) MRR on fx liabilities from 35% to 40% (March 2006) MRR lei, from 16% to 20% (July 2006)
Measures aimed at taming capital inflows before downturn in 2008 Q4. Did they work? NO! (II)
Stricter criteria for household lending (LTV and Debt Service To Income) Forex exposures limited to three times own funds (September 2005) Unhedged borrowers (natural persons) cannot be classified into the top grade (A) of financial performance (October 2005) Regulation and supervision of non-bank financial institutions (February 2006) Higher capital requirements since January 2007 Stricter eligibility criteria for the components of own funds (January 2007) Loosening of credit standards for lending to households (March 2007) Stricter provisioning requirements for loans to unhedged borrowers (natural persons) (March 2008) Exclusion of intermediate profit from own funds calculation (August 2008) Adjustment of max DTI within internal procedures approved by the NBR (August 2008)
High annual credit growth rates in Romania indicating huge private capital inflows in 2004-2008 (%) 100 80 60 40 20 0 -20
-40 Source: author’s computations; NBR data
-60
2000Q1 2000Q3 2001Q1 2001Q3 2002Q1 2002Q3 2003Q1 2003Q3 2004Q1 2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 Total credit (nominal growth rate) Total credit (growth rate adjusted for FX variation and inflation) FX loans (growth rate adjusted for FX variation and inflation) Faced with high capital inflows, the NBR increased minimum reserve requirements (MRR) in Romania (%). When the crisis hit Romania, the NBR reduced the MRR
50 40 30 20 10
0
03 06 07 10 13 14
08 08 15
04 05 07 09 11 12 14
12 03 05 10
04 11
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- - - - -
-10 -
Jul Jul
Jan Jan
Jun
Oct Oct
Feb Feb
Apr Apr
Sep Sep
Dec Dec
Aug Aug
Nov
Mar Mar
May May CPI annual inflation Core 3 inflation Monetary policy interest rate MRR lei MRR foreign currency A policy interest rate dilemma emerged late in 2006: should the NBR increase the interest rate to curb inflation or lower it to tame capital inflows?
10 Source: author’s computations; NBR data 10 8 9 6 8 7 4 6 2 5 0 4 -2 3
-4 2
2013T2 2014T3 2005T1 2005T2 2005T3 2005T4 2006T1 2006T2 2006T3 2006T4 2007T1 2007T2 2007T3 2007T4 2008T1 2008T2 2008T3 2008T4 2009T1 2009T2 2009T3 2009T4 2010T1 2010T2 2010T3 2010T4 2011T1 2011T2 2011T3 2011T4 2012T1 2012T2 2012T3 2012T4 2013T1 2013T3 2013T4 2014T1 2014T2 2014T4 2015T1 2015T2 CPI annual inflation (%) Annual GDP gap (%) Nominal leu/euro exchange rate (quarterly average, rhs) Annual inflation target (rhs) Contributions to the deviation of CPI annual inflation from the targer (pp): the monetary policy was not 10 procyclical 8 The real effective policy 6 interest rate (RRDPM) 4 2 -1 -3 -5 The gap of the real effective policy
Source: Croitoru (2014) interest rate (GRRDPM)
2003 T4 2003 T2 2007 T1 2012 2003 T1 2003 T2 2003 T3 2003 T1 2004 T2 2004 T3 2004 T4 2004 T1 2005 T2 2005 T3 2005 T4 2005 T1 2006 T2 2006 T3 2006 T4 2006 T1 2007 T3 2007 T4 2007 T1 2008 T2 2008 T3 2008 T4 2008 T1 2009 T2 2009 T3 2009 T4 2009 T1 2010 T2 2010 T3 2010 T4 2010 T2 2012 T3 2012 T4 2012 T1 2013 T2 2013 T3 2013
2011 T2 2011 T3 2011 T4
-7 2011 T1
Inflation persistence GDP gap Imported inflation VAT Inflation expectations Other factors Administered prices VFE Fuel prices Tobacco, cigarettes and alcohol Deviation from the target (%) The history of contributions to the deviation of CPI annual inflation from the targer (pp)(old 10 coefficients of the supply curve, new NIS GDP 8 data)
6 The policy real interest rate
4
2
0
-2
-4 The policy real interest rate gap
-6
-8
2009 2009 T3 2003 2003 T1 2003 T3 2004 T1 2004 T3 2005 T1 2005 T3 2006 T1 2006 T3 2007 T1 2007 T3 2008 T1 2008 T3 2009 T1 2010 T1 2010 T3 2012 T1 2012 T3 2013 T1 2013 T3 2014 T1 2014 T3
2011 T1 2011 T3
Core-3 inflation persistence GDP gap VAT Imported inflation Inflation expectations Other factors Administered prices VFE Fuel prices Tobacco, cigarettes and alcohol Deviation from target of annual CPI inflation (%) An explanation for the criticism that the central bank did not increase the policy rate more aggressively prior to the downturn
Critics were ignoring:
• “Distortion”-type shocks in the supply equation, such as variations in taxation rates, changes in markups pursued by firms or “cost-push shocks” (Clarida, Galí and Gertler, 2001; Smets and Wouters, 2003; Benigno and Woodford, 2003 and 2005; Woodford and Cúrdia, 2009)
• Endogenous responses (fluctuations) of the output gap to shocks (Erceg, Henderson and Levin, 2000)
• Endogenous responses of the gap between the natural level and the efficient level of output to supply-side shocks and to preference shocks (Blanchard and Galí, 2007 and 2008)
• Financial frictions, the banking sector (Bernanke, Gertler, Gilchrist, 1998; Woodford and Curdia, 2009) and real wage rigitities (Christiano et al., 2011)
The contribution to inflation of demand-pull inflation became positive in 2007 Q4-2008 Q3 Period Deviation Contribut Contribut Real Real Real of annual ion of ion of monetary monetary effective CPI non- CORE3 policy policy monetary inflation CORE3 inflation rate (%) rate gap policy (pp) inflation (pp) (%) rate gap (pp) (%) (1) (2) (3) (4) (5) (6) (7) 2005 Q4-2007 0.25 1.58 -1.33 1.78 -0.57 -1.24 Q3 2007 Q4-2008 3.95 2.39 3.20 0.69 0.42
Q3 1.56
Table 1: The contributions of non-CORE3 inflation and CORE3 inflation to the deviation of annual CPI inflation from the target and the real monetary policy rate Source: Macroeconomic Modelling and Forecasting Department, NBR’s quarterly forecasting model, and the author’s calculations. “Unconventional” monetary policy in the immediate aftermath of the crisis 25 (i) a speculative attack fended off also via foreign exchange market 20 intervention, not by higher interest rate, as indicated in theory (Christiano, Braggion and 15 Roldos,2009) (ii) lower money market 10 interest rates as compared to the monetary policy rate
5 Source: NBR data
0
07 08 14
07 09 14
04 11
10 03 05 12
04 11
03 06 08 10 13 15
05 12
- - -
-
- - - -
- - - -
- -
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- -
Jul Jul
Jan Jan
Jun
Oct Oct
Feb Feb
Apr Apr
Sep Sep
Dec Dec
Aug Aug
Nov
Mar Mar
May May Average interest rate on money market Monetary policy interest rate Prudential measures implemented during October 2008-December 2012. Will they work? I doubt! (I)
MRR ratio on lei liabilities, from 20% to 18% (November 2008) Reduction of loan loss provisions by considering max 25% of collateral in case of loans classified as Loss 2 (April 2009) Introduction of audited intermediate profit within own funds calculation (May 2009) Introduction of the “First Home” program (June 2009) MRR ratio on lei liabilities, from 18% to15%; MRR ratio on fx liabilities, from 40% to 35% (July 2009) Balance-sheet current accounts at accounting value instead of adjusted value (July 2009) MRR ratio on fx liabilities, from 35% to 30% (August 2009)
Prudential measures implemented during October 2008-December 2012. Will they work? I doubt! (II)
MRR on fx liabilities from 30% to 25% (Nov. 2009) Improvements to the regulatory framework on managing liquidity risk (Dec. 2009) Government Emergency Ordinance 50/2010 on consumer lending (June 2010). Removes abusive clauses from loan contracts MRR on fx liabilities, from 25% to 20% (Apr. 2011) Limits on exposures to unhedged borrowers; higher coefficients for stress- testing fx loans (Oct. 2011) From Romanian Accounting Standards to IFRS adoption (Jan. 2012) Improvements to the regulatory framework on managing liquidity risk (Jan. 2012) Banks’ aggregate exposure limits vis-à-vis unhedged non-financial companies (Dec. 2012)
Higher inflation delayed the start of the policy rate-cutting cycle in Romania
Annual inflation rate Policy interest rates
Sourc: ECB, National Central Banks, and 10 NBR`s computations 14 8 12 Source: National Central Banks 6 10 4 8 2 6 0 4
-2
2
08 10 13 14
11 12
07
09
- - - -
- - -
- 0
Jul
08
12
07
14 09
10 13
11
Jan
Jun
-
-
-
-
- - -
-
Feb
Apr
Aug
Mar
May
Jul
Jan
Jun
Feb
Apr
Aug Mar EA HICP CZ CPI HU CPI May PL CPI RO CPI EA CZ HU PL RO Interest rates on newly-extended loans decrease 25
Sursa: ECB, National Central Banks, 20 and NBR`s computations
15
10
5
0
09 14
07 07 12 12
08 10 13
09 14
07 11 12
08 09 11 13 14
10 15
- -
- - - -
- - -
- -
- - -
- - - - -
- -
Jul Jul
Jan Jan
Jun Jun
Oct
Feb Feb
Apr Apr
Sep Sep
Dec Dec
Aug
Nov Nov
Mar
May May EA CZ HU PL RO VIII. Is a new monetary policy rate dilemma emerging? The hypothesis of secondarity and implications for monetary policy in Romania
• Secondarity: the global surplus of savings is generated in an increasing number of countries, whereas the overwhelming part of the global deficit of savings is located in the US (Croitoru, 2015b and 2015d)
• The US are far better equipped to accommodate swift capital outflows, currency depreciation, an abrupt decline in domestic asset prices, banking system weakening, and the flagging domestic demand
Illustrated secondarity: the history of savings- investment imbalances across major countries and regions (USD mill., current prices)
1700000 UK West Africa (WA) 1200000 North Africa (NA) Africa (excl. NA and WA) Former Soviet Union 700000 Eastern European Countries other developed countries 200000 Germany Euro area (excl. Germany) Latin America and the Caribbean -300000 West Asia (WAS) China Emerging Asia (excl. China and WAS) -800000 Japan Source: author’s calculations US based on UNCTAD data
-1300000 Asia (total)
Global excess savings
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 The Romanian conundrum (I)
• The current account deficit plunged from 4.5 percent of GDP in 2012 to 0.4 percent of GDP in 2014 • GDP growth accelerated over that period • How was it possible?
– One of the implications of shifting to excess savings is the reduction in the natural rate of interest. Mutatis mutandis, the plunge in the current account deficit in Romania to almost zero was reflected in the lower natural rate of interest
– The swift narrowing of the savings deficit suggests that the natural rate has declined at a quick pace as well
The Romanian conundrum (II)
Inflation: a downward path, largely reflecting the fall in inflation expectations. Hence, the NBR cut the monetary policy rate from 5.25 percent in December 2012 to 1.75 percent in May 2015
Thus, it is possible that, during 2013, 2014 and 2015, the nosedive of the current account deficit, the monetary policy rate cuts and liquidity management may have resulted in the money market rate running below the natural rate
A new policy dilemma?
Actual growth rates above potential will, probably, close the GDP gap in 2016
GDP growth rates above potential and low global interest rates will pose again a dilemma to monetary policy in Romania (Croitoru, 2015c):
A higher policy rate would be needed to tame inflationary pressure from the positive GDP gap
A lower policy rate would be needed to avoid the leu appreciation
If a current account surplus emerged, as the secondarity suggests, the policy rate dilemma would not appear
However, the new Fiscal Code based on tax cuts together with wage increases up to 70 percent would lead to fiscal deficits of 4-5 percent in 2016 and 2017, eliminating the issue of the interest rate dilemma, but creating other serious problems to the macroeconomic stability of Romania
Thank you! Bibliography
Bernanke, Ben; Gertler, Mark; Gilchrist, Simon (1999), „The Financial Accelerator in a Quantitative Business Cycle Framework”
Blanchard, Olivier; Jordi, Gali (2007), “Real Wage Rigidities and the New Keynesian Model”, (2007), Journal of Money, Credit and Banking, Supplement to Vol. 39, No. 1 (February).
Blanchard, Olivier; Jordi, Gali (2008), “Labor Market and Monetary Policy: A new Keynesian Model with Unemployment”, Working Paper 13897, Nationla Bureau of Economic Research (March).
Erceg, J. Christopher; Henderson, W. Dale; Levin, T. Andrew (2000) “Optimal monetary policy with staggered wage and price contracts”, Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
Christiano, J. Lawrence; Trabandt, Mathias; Walentin, Karl (2011),” Introducing financial frictions and unemployment into a small open economy model”, Journal of Economic Dynamics and Control, Elsevier, vol. 35 (12), pp. 1999-2041.
Clarida, H., Richard; Jordi Galí;Mark, Gertler (1999), “The Science of Monetary Policy:A New Keynesian Perspective” Journal of Economic Literature,Vol. XXXVII (December), pp. 1661–1707.
Clarida, H., Richard; Jordi Galí;Mark, Gertler (2001), “Optimal Monetary Policy in Closed Versus Open Economies: An Integrated Approach”, NBER Working Paper 8604, pp. 5-6.
Croitoru, Lucian (2014), „Teoria și critica politicii monetare în România”, în Despre economie: cu și fără formule, forthcomoing, Curtea Veche Publishing.
Croitoru, Lucian (2015b), „Tendința spre secundaritate în administrarea dezechilibrelor globale”, www.bnro.ro.
Croitoru, Lucian (2015c), „The Romanian Conundrum”, www.bnro.ro, NBR’s blog.
Croitoru, Lucian (2015d), „Monetary policy and the global imbalances”, www.bnro.ro, NBR’s blog.
Fig.1: Labor productivity and the general index of economic freedom in 1996 180 Source: author’s computations; AMECO; Heritage Foundatoin 160
Luxemburg
(PPS,
140 Belgia
120 Danemarca Germania Suedia Franța Olanda 100 Italia Austria Spania Finlanda Marea Britanie
80 Irlanda EU15=100) Grecia Cipru 60 Slovacia Portugalia Cehia 40 Slovenia Ungaria Polonia Lituania Bulgaria 20 România GDP at current prices per hour worked hourpricesper current at GDP Repressed eeconomies Mostly unfree Moderately free Mostly free economies economies (EPNL) economies(EML) 0 (ER) (EPL) 40 45 50 55 60 65 70 75 80 General index of economic freedom Fig. 2: Labor productivity and the general index of economic freedom in 2014 180
Luxemburg
160
(PPS,
140
120 Belgia Olanda Irlanda Franța Germania Danemarca Suedia 100 Austria Finlanda Italia Spania Marea Britanie 80 Slovacia
EU15=100) Cipru Slovenia Cehia Grecia Malta 60 Portugalia Ungaria Polonia Lituania Estonia RomaniaLetonia 40 Bulgaria
20
GDP at current prices per hour worked hourpricesper current at GDP Repressed economies Mostly unfree Moderately free Mostly free economies (ER) economies (EPNL) economies(EML) (EPL) 0 40 45 50 55 60 65 70 75 80 General index of economic freedom Fig. 3: Labor productivity and property freedom in 1996
180 Source: author’s computations; AMECO; Heritage Foundatoin 160
Luxemburg
(PPS,
140 Belgia 120 Danemarca Germania Franța Olanda 100 Italia Austria Suedia Marea Britanie Spania Finlanda
80 Irlanda EU15=100) Cipru 60 Grecia Slovacia Portugalia Slovenia Cehia 40 Ungaria Polonia România Lituania
20 Bulgaria GDP at current prices per hour worked hourpricesper current at GDP ER EML Economii libere 0 EPNL 20 30 40 50 60 70 80 90 100 Property freedom Fig.4: Labor productivity and property freedom in 2014
180 Source: author’s computations; AMECO; Heritage Foundatoin
160 Luxemburg
(PPS,
140 Olanda Danemarca 120 Belgia Germania
Franța Irlanda Suedia 100 Austria
Italia Spania Finlanda Marea Britanie 80
Slovacia Cipru EU15=100) Grecia Slovenia Malta 60 Lituania Cehia Polonia Portugalia Estonia Letonia România Ungaria 40 Bulgaria
20 GDP at current prices per hour worked hourpricesper current at GDP ER EPNL EML EPL Economii libere 0 20 30 40 50 60 70 80 90 100 Property freedom Fig. 5: Labor productivity and freedom from corruption in 1996
180 Source: author’s computations; AMECO; Heritage Foundatoin
(PPS, 160 Luxemburg 140 Belgia 120 Olanda Danemarca Germania Franța 100 Italia Spania Suedia Irlanda Austria 80 Marea Britanie
EU15=100) Cipru Finlanda Grecia 60 Slovacia Cehia Portugalia 40 Slovenia Ungaria Lituania Polonia Bulgaria 20 România
GDP at current prices per hour worked hourpricesper current at GDP ER EPNL EML Economii libere 0 20 30 40 50 60 70 80 90 100 Freedom from corruption Fig. 6: Labor productivity and freedom from corruption in 2014
180 Source: author’s computations; AMECO; Heritage Foundatoin
160 (PPS,
Luxemburg
140
Belgia 120 Irlanda Olanda Franța Germania Danemarca 100 Suedia Austria Finlanda Spania Italia Marea Britanie 80 Slovacia Cipru EU15=100) Slovenia Grecia Cehia Malta 60 Lituania Portugalia Polonia Estonia LetoniaUngaria România 40 Bulgaria 20
GDP at current pricesworked hourper current at GDP ER EPNL EML EPL Economii libere 0 20 30 40 50 60 70 80 90 100 Freedom from corruption Financing of the current account: mostly from the financial account (bn. EUR) 20.0
15.0
10.0
5.0
0.0
-5.0 Source: author’s computations based on NBR data -10.0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 CAPITAL ACCOUNT FINANCIAL ACCOUNT NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT