The Route to Dollarization in Curaçao: an Empirical Analysis

The route to dollarization in Curaçao: An empirical analysis

Master Thesis

by Chanty Corsen

Master of Economics

Tilburg University, the Netherlands

Supervised by Dr. Damjan Pfajfar

Table of Contents

CHAPTER 1 INTRODUCTION ...... 1 CHAPTER 2 THEORETICAL FRAMEWORK ...... 5 2.1 CURRENCY SUBSTITUTION THEORY ...... 5 2.2 OPTIMAL CURRENCY AREA APPROACH ...... 7 2.2.1 Labour mobility ...... 8 2.2.2 Fiscal integration ...... 8 2.2.3 Trade integration...... 9 2.2.4 Financial integration...... 9 2.3 Costs and Benefits of dollarization ...... 9 2.3.1 Elimination of transaction costs ...... 10 2.3.2 Elimination of currency risk ...... 10 2.3.3 Promoting macro-economic stability and soundness of financial sector ...... 11 2.3.5 Loss of Monetary Independence ...... 11 2.3.6 Loss of seigniorage revenue ...... 12 2.3.7 Loss of Lender’s Last Resort ...... 12 CHAPTER 3 DOLLARIZATION PROCESS IN CURAÇAO, 1995 -2010 ...... 13 3.1. BACKGROUND...... 13 3.2 MAGNITUDE OF DOLLARIZATION PROCESS IN CURAÇAO ...... 14 3.2.1. Indicators of dollarization in general ...... 19 3.3 ISSUES OF IMPLEMENTATION ...... 21 CHAPTER 4: EMPIRICAL MODEL ...... 23 4.1 DATA ...... 23 4.1.1 Dollarization Ratio ...... 24 4.1.2 Interest rate difference ...... 24 4.1.3 Inflation rate difference ...... 25 4.1.4 Government deficit ...... 25 4.1.5 Balance of payments...... 26 4.1.6 Inflation rate hysteresis ...... 26 4.1.7 Interest rate hysteresis ...... 27 4.2 ECONOMETRIC PROCEDURE ...... 28 CHAPTER 5 ESTIMATION RESULTS ...... 30 5.1 RESULTS MODEL I ...... 30 5.1.1 Signs and Significance ...... 31 5.1.2 Violations ...... 32 5.1.3 Conclusion ...... 34 5.2 RESULTS MODEL II ...... 34 5.2.1 Signs and Significance ...... 33 5.2.2 Violations ...... 36 5.2.3 Conclusion ...... 38 5.3 POLICY IMPLICATION ...... 38 5.3.1 Conduct on Monetary Policy...... 38 5.3.2 Conduct on Rates of Return ...... 40 5.3.3 Conduct on Institutional Factors ...... 40 5.3.4 Full dollarization or De-dollarization? ...... 41 CHAPTER 6 CONCLUSION ...... 43 REFERENCE ...... 45 APPENDIX ...... 48

Abstract

This paper examines dollarization process in Curaçao during the period 1995 until 2010. For the last decade, Curaçao suffered particularly from high inflation. The island also continued to have a large currency account deficit and a large governmental spending. As a result, a debate between policymakers and authorities has risen to the occasion to fully dollarize the economy of Curaçao. Using the models developed by Miles (1978) and Mundell (1961) as my reference point, I do a time-series regression to examine the relationships of macro-economic variables, such as interest rate, inflation level, balance of payments, government financing and hysteresis to dollarization ratio. The study relatively identified a strong influence between interest rate levels, balance of payments on the development of dollarization in Curaçao. Overall, the model explains dollarization in Curaçao. I also explore the validity on monetary and fiscal policy if authorities decide to fully dollarize Curaçao’s economy.

Chapter 1 Introduction

For the last past decades, financial market on the island of Curaçao has been experiencing unofficial dollarization. Curaçao among many other Caribbean islands increased their usage of foreign currency due to high inflation rates. On 10 October 2010, the islands of Curaçao and St. Maarten became autonomous in the Netherlands Kingdom. Both islands agreed to form a currency union with only one central bank and a single currency. The islands of Bonaire, Saba, and St. Eustatius have opted to fully dollarize their economies after leaving the Dutch Kingdom and introduced the U.S. dollar as legal tender on 1 January 2011. Since these islands are now fully dollarized, St. Maarten is now considering official dollarization as well, but has not yet taken the decision to do so. The President of the Central Bank of Curaçao and St. Maarten, Dr. Emsely Tromp, suggested that full dollarization will be a good approach for Curaçao since Bonaire, St. Eustatius, and Saba are fully dollarized. In addition, Dr. Emsely Tromp said the reason he believes it is necessary to dollarize Curaçao was “because of the deteriorating balance of payments of the Netherlands Antilles, and given that, if another crisis was to occur then it would hit the islands harder” (St.Maarten News, 2009, p.1). Consequently, a debate is going on whether Curaçao should fully dollarize. The choice for the U.S. dollar is based on the fact that the United States is Curaçao’s main trading partner and the U.S. dollar is used extensively for international transactions. Namely, 82 percent of the external cash flow is in U.S. dollars, and 75 percent of international transactions are made with the United States.

Dollarization had first little interest by policymakers. However, with time, more countries adopted the Euro or the U.S. dollar as their new national currencies, and a new discussion emerges on the consequences and determinants on dollarization. As mentioned before, similar patterns on dollarization has been observed by various countries in the Caribbean, Latin America, and Central America. Initially, official dollarization in Ecuador and El Salvador had gained popularity by policy makers during 2001. Ecuador had dollarized its financial market to reduce inflation and bring economic stability, whereas El Salvador to promote integration with international markets. Official dollarization studies have been primarily focusing on benefits and costs of adopting a foreign currency as legal tender rather than the issues of implementation. However, a few other studies answered questions on when and whether a country should dollarize its national currency (Eichengreen, 2002 and Calvo, 2002). Argentina, a high inflation

1 country, has also conducted a rapid dollarization process during the early 1990’s. The evidence of Reinhart et al (2003) and Levy-Yeyati (2004) suggest that many developing countries are experiencing dollarization by increasing their usage of the Euro or U.S. dollar, even though the inflation rates are declining. The government, banks, firms, and households are still holding a significant amount of assets and liabilities in foreign currencies. In addition, Levy-Yeyati (2004) argues that there is evidence that “financially dollarized economies tend to display higher inflation rates, higher propensity to suffer banking crises and slower and more volatile output growth, without significant gains in terms of domestic financial depth” (Levy-Yeyati, 2004, p.1).

The process of dollarization imposes both benefits and constraints on the economy. One of the benefits is that it limits currency crisis. Curaçao has a deficit on its current account for almost fifteen years. Between the year 2006 and 2009, the current account expanded rapidly and reached -22 percent of GDP in 2008 and improve back slightly in 2009. The improvement was the effect of a debt relief program. Without those debt relief grants, the current account on balance of payments of Curaçao would have reached -20.2 percent of GDP in 2010 (The Central Bank of Curaçao and St. Maarten, 2011). By rejecting inflationary measurements through dollarization, the domestic country may strengthen their financial institutions and create positive acknowledgment towards investments. Furthermore, a more integrated economy creates low transaction costs and imposes stability on prices and lower interest rates. On the other hand, a fully dollarized economy provides its government with a loss of seigniorage revenues, and limiting the role of the central bank as the lender of last resort. The dismantling of the Netherlands Antilles has increased vulnerability to external shocks, because of diminishing economies of scale. The financial market in Curaçao became more vulnerable during 1990’s. As the economic performance of Curaçao worsened, banks became more suppressed by high interest rates. The inflation rate of Curaçao increases with time. Due to Curaçao’s history of high inflation, the government’s task is to promise citizens a more compelling monetary reform.

In this paper I attempt to investigate dollarization process of Curaçao’s economy during the period 1995 until 2010. On one hand, it gives a broad overview of the existing literature on dollarization and the costs and benefits in general. On the other hand, by studying dollarization process of Curaçao, it provides new insights into the proposal of Dr. Emsely Tromp. Methodologically, I used Ordinary Least Squares and Generalized Method of Moments

2 techniques. In particular, my data set includes monthly entries beginning January 1995 until December 2010. I conducted two models to capture dollarization measurement namely, U.S. dollar deposits over Netherlands Antillean guilder deposits, and U.S. dollar deposits over money supply. Indicators such as interest rates, inflation rates, government deficit, and balance of payments are explained in the models. Additional two variables will capture hysteresis in the models. Hysteresis is a certain phenomenon of irreversibility. The results are varied for each model and are quite puzzling. The indicators having an amplified impact on dollarization process in Curaçao are the interest rate, government financing, balance of payments, and interest rate hysteresis. The results show that an increase of interest rate causes U.S. dollar deposits to be more attractive than Netherlands Antillean guilder deposits. This will eventually stimulate currency substitution. Furthermore, high interest rate causes lower investment levels, and eventually slows the economic growth. In addition, government imbalances may create fears of default on government deficit. Since Curaçao has a small open economy and a high degree of openness, a balance of payment crisis will confront monetary instability and soaring inflation. Curaçao has been augmented by the use of U.S. dollar, and this form of payment is accepted by almost all transactions. The level of stability of the U.S. dollar and its comfort has had an input for the continuation of the usage.

The question now is why should policy makers care about full dollarization in Curaçao? The major incline of inflation, widening of the current account, and a larger governmental deficit, has already deepened Curaçao into dollarization. It should be of great concern for policy makers since these factors create vulnerabilities of adverse shocks for a country. Empirical studies show that dollarization not only reduces high inflation rate on financial intermediation but also have an impact on financial fragility. So, the perspective on caring for dollarization in financial sectors is of good reason. Furthermore, if an economy is experiencing a sudden stop of capital inflows by a slowdown of economic activities and domestic currency depreciation, the fiscal situation will be unsustainable. Dollarization imposes an extra challenge on the effectiveness of the domestic monetary policy. However one must take into consideration that ones dollarization starts, it will almost be irreversible.

The remainder of the paper is organized as follows: Chapter 2 discusses the relevant literature review of Currency Substitution, Optimal Currency Area, and Cost and Benefit of dollarization.

Chapter 3 presents main stylized facts on the overview of the dollarization process of Curaçao. In Chapter 4, the data and model specifications will be discussed. Chapter 5 will highlight the results of applied analysis on the relationship between dollarization ratio and macro-economic determinants, and will also discuss some limitations of the research. Policy implications are also discussed in this chapter. Finally, Chapter 6 will draw the main conclusion, and present targets for future research.

Chapter 2 Theoretical framework

2.1 Currency Substitution Theory

Miles (1978) described the necessary requirements for a country to undergo currency substitution. Currency substitution can occur if a country has foreign denominated balances which fluctuate in change for economic variables. This fluctuation can be associated with high and volatile levels of inflation. For a country to substitute its currency, not all citizens need to have foreign and domestic currency, but only some individuals. Individuals holding a diversified portfolio of real money balances will vary the magnitude of each currency according to the opportunity cost of holding that particular currency (Rönnholm, 2007). So, if the opportunity cost of holding domestic currency rises relative to the opportunity cost of foreign currency, then individuals will reduce their real money balances denominated in domestic currency (Miles, 1978). Dollarization in a country occurs when citizens extensively use foreign currency instead of domestic currency. Dollarization can be in the form of de facto (unofficial) or de jure (official). There are different types of dollarization, namely currency or payments dollarization, real dollarization, and financial dollarization. To interpret and understand the main issues on different kinds of dollarization terms, Figure 1 illustrates the terminologies of dollarization. Currency or payment dollarization can be referred to currency substitution. In this case, the country uses foreign currency for financial transaction proposes. Real dollarization refers to indexing of wages and prices of foreign currency, whereas financial dollarization occurs when citizens hold financial assets and liabilities in foreign currency. Unofficial dollarization takes place when a country hold majority of their financial wealth in foreign assets, but yet not a form of legal tender (Schaub, 2009). Nevertheless, all different types of dollarization usually do not occur independently.

Figure 1: Terminology of dollarization

Source: Schaub, 2009

What drives unofficial dollarization? Causes of dollarization differ from country to country and from case to case. Many developing countries have already fully substituted their domestic currency for foreign currency. For example, Ecuador has dollarized its economy in order to reduce inflation and to maintain economic stability, whereas El Salvador dollarized to promote financial integration in international markets. The theory of currency substitution focuses primarily on the drivers of de facto dollarization. The Fischer equation1 explains the ratio between domestic and foreign money nominal balances as a function of domestic nominal interest rate and foreign currency. The Fischer equation is stipulated as follow:

(1) where is the nominal interest rate, denote the real interest rate, and denote the inflation rate.

The theory of currency substitution illustrates that the demand for domestic currency for transaction purposes is negatively correlated with domestic inflation. Another reason why countries dollarize is the implementation of quality of institutions. Calvo and Guidotti (1990) highlighted that weak governments may not be able to assure debt holders of infiltrating debt.

1 The Fisher equation illustrates that the nominal interest rate is equal to the sum of real interest rate and expected inflation rate. (Fischer, 1896, chapter 3)

Hence, the expectations of investors may lead to an increase in interest rates on domestic currency. In this case, the government can dollarize its debt obligations in order to achieve low inflation (Levy Yeyati, 2006). On the other hand, official dollarization2 takes place when a country ceases to issue domestic currency and adopt foreign currency as a legal tender. So, the dollarized country will give up its domestic monetary policy for foreign monetary policy.

After implementing dollarization, the domestic country faces financial integration as well. The dollarized country will now have to allow foreign financial institutions to compete with domestic institutions. For example, arbitrage keeps prices of similar goods within a narrow range (Rönnholm, 2007). There is a phenomenon called hysteresis which describes the continuation of dollarization process when domestic denominated currency is stabilized. Hysteresis occurs when individuals switch between currencies. This creates switching costs. Uribe (1995) stated that in a non-dollarized country it is more costly for citizens to allow transactions in foreign currency. But if the domestic country uses frequently foreign currency for transactions, then consumers will do also.

Dollarization can also be compared to a monetary union for example, the EMU; however there are some differences (Curutchet, 2001). In a monetary union, countries will deliberate to eventually form an agreement to maintain a fixed or managed exchange rate regime. There are two ways a country can fulfill dollarization namely under, unilateral decision, and bilateral decision. Unilateral agreement occurs when a country adopt the anchor currency unilaterally without any formal recognition of the government abroad. This type of agreement can be implemented immediately without negotiations. Bilateral agreement refers to a formal agreement by making a treaty with the foreign country which specific conditions. These conditions can be in the form of sharing seigniorage revenue between countries, voting rights. The bilateral agreement is more costly to implement.

2.2 Optimal Currency Area Approach

The definition of Optimal Currency Area is an area where exchange rates have a fixed relationship and where there is some degree of monetary integration. The literature review of

2 In the rest of the paper the term dollarization will be used as a substitute for official dollarization.

Optimal Currency Area focuses on several factors for countries to examine their position on whether it is better or worst to join a single currency agreement. These factors are price stability, labor and capital mobility, and external balance. Each factor is discussed below.

2.2.1 Labor mobility

Countries with high degree of labor mobility are better candidates for currency area membership. Consequently, labor mobility provides substitution for exchange rate flexibility in promoting external adjustment (Mundell, 1961). External adjustment can be accomplished by labor costs denominated in domestic currency. Competitiveness in a dollarized labor market is linked to economic performances in foreign currency. So, the domestic country is exposed to exogenous real shocks. In order to maintain flexibility in labor market, the dollarized country is allowed to adjust to new real adverse environment. Furthermore, high degrees of real wage flexibility and incentives for job creation can also be candidates for currency area membership.

2.2.2. Fiscal integration

Currency substitution changes fiscal integration in a country. Higher fiscal integration between two countries allows controlling diverse shocks through fiscal transfers (Dellas et al, 2001). When a central bank is not able to provide credits to the government, fiscal rules are implemented in order to maintain sound public finances. This can be done by introducing tax bases that controls stability of cash flows, consistent with a stable fiscal deficit. If government’s revenues are financed by an activity, stabilization is appropriate in order to implement a counter- cyclical fiscal policy. For example, “Ecuador, an oil-exporting economy, approved a fiscal responsibility law in 2002 which was aimed at maintaining fiscal deficits in check, reducing the burden of the public debt, and using extra revenues from oil exports to establish a stabilization fund” (Jácome and Lönnberg, 2010, p.18). Furthermore, reducing and maintaining public debt should be of importance on fiscal management. “Governments in a dollarized country should develop a public debt capacity with the aim of facilitating treasury management” (Jácome and Lönnberg, 2010, p.18). For example, governments in developing countries may need funds in order to finance shortages in tax revenues, whereas the central bank cannot provide that compensation.

2.2.3 Trade integration

Having a concentrated region with the main trading partner of a country, are better candidates for currency area membership. These countries save on transaction costs with the use of a single currency. Dollarized countries should aim to reduce trade tariffs and distortions to expand their trading regime. Furthermore, countries should approve a trade reform in order to foster capital inflows and foreign direct investment. In the short run, trade integration convergence domestic and world inflation. On the other hand, in the long run, a more open and integrated economy boosts economic growth. Countries can engage in trade negotiations with various countries in the world. Dollarization causes stable inflow of foreign currencies which facilitates domestic transactions. Open economies have a preference towards fixed exchange rate regimes. This is because in open economies frequent exchange rate adjustments encourage price instability (McKinnon, 1963). Furthermore, the smaller the size of the economy, the more open it can be.

2.2.4 Financial integration

Financial reform is crucial for adopting sound stability on financial system in a dollarized country. For example, financial surveillance, financial safety, deposit insurance mechanisms are all elements created to stabilize financial economics. In addition, foreign-owned financial institutions also strengthen dollarization. Foreign banks benefit from financial systems in developing countries by reducing their vulnerabilities to financial crises leading to a potential threat to the subsistence of an officially dollarized regime (Jácome and Lönnberg, 2010).

2.3. Costs and Benefits of dollarization

The feasibility of dollarization can be best assessed by a cost and benefit analysis (Stein et al, 1999). A fixed exchange rate implies that the domestic currency is fixed at the exchange rate of the foreign currency. However, it may hamper the government by using economic policy and also reduces the scope for conducting independent monetary policies (Curutchet, 2001). A fixed exchange rate regime works well when countries have similar economic goals such as price levels and economic growth. In addition, a fixed exchange rate regime is also appealing for countries that want to adopt monetary stability due to hyperinflation. On the other hand, it does not work well for countries which have conflict on their economical policies. Fixed rate regimes have two main benefits. These are lower transaction costs and lower interest rates. The costs of

9 obtaining a single currency board rely on the loss of monetary autonomy, seigniorage revenues, and the central bank’s lender of last resort. Not all costs and benefits will be the same for all countries. The magnitude of costs and benefits will rely on the magnitude of country’s characteristics and the relationship with the main trading partner.

2.3.1 Elimination of transaction costs

One of the benefits of a fixed exchange rate regime is the reduction of exchange rate risks and volatility of exchange rate. Still, even if the exchange rate risk is reduced, there will always be certain exchange rate risk, because the fixed exchange regime might be abandoned in the future. To modify, exchange rate variability have a negative effect on unstable exchange rate regimes that cannot be hedged. Hedging is expensive when a country has a weak currency. Conversely, dollarization eliminates the use of domestic currency which in turn implies total elimination of exchange rate risk (Stein et al, 1999). So, the exchange rate risk is eliminated only against the anchor foreign currency.

In addition, dollarization reduces transaction costs on exchange rate between trading countries with different currencies. Both exchange rate and currency conversion costs reduce transaction costs which in turn benefit bilateral trade and investment flows. The benefits of dollarization depend mainly on three characteristics. 1) The reduction of transaction cost will be high when exchange rate volatility is high, 2) the reduction of transaction costs is high when currency conversion is high, 3) foreign direct investment will be high when financial integration between the dollarized county and the anchor currency is high (Stein et al, 1999). It is important to note that trade and investment flows will not increase when transaction costs are reduced (Curutchet, 2001).

2.3.2 Elimination of currency risk

Dollarization eliminates currency risk and balance of payment crisis. Inflation variability is considerably reduced by adoption of a fixed exchange regime. It will prevent fear of devaluation of the domestic currency in the future. The two conditions in the fulfillment of benefits for a fixed exchange regime with the reduction in government’s ability to use exchange rate are presented in a discretionary way. The first condition emphasizes that the commitment of fixing

10 exchange rate must be a credible measure. The second condition argues that the chosen foreign currency must be a strong currency, with the reason on a trustworthy reputation in relation to its monetary policy management (Stein et al, 1999). According to Stein et al (1999), anchoring the domestic currency with a foreign currency has additional benefits. These additional benefits are presented by the reduction of inflation rate and inflation volatility. Dollarization implies that the country will adopt monetary policy of the foreign country and will therefore achieve lower inflation rate, but also lower real interest rate. Lower interest rate encourages investments in foreign assets. It will also reduce the devaluation risk and uncertainty in the economy. Volatility of real exchange rate will also be reduced. In the short run, real exchange rate volatility will be lower under fixed exchange regimes. Furthermore, countries with weak currency will deepen their financial systems by reducing their financial fragility as a consequence of reducing real interest rate and real exchange rate volatility.

2.3.3 Promoting macro-economic stability and soundness of financial sector

Dollarization encourages capital mobility. Capital flows promotes financial integration, competition, and efficiency among financial institutions. So, foreign institutions can now compete with domestic institutions. In addition, public finances of the domestic country must be monitored by a budget supervisor. Dollarization provides constraint on fiscal policy by eliminating printing money to finance fiscal deficits. Restriction on money supply will promote credibility on monetary policy.

2.3.5 Loss of Monetary Independence

The cost of implementation of dollarization is the loss of monetary independence. There are three main benefits for an economy with an independent monetary policy. The first benefit allows the independent monetary policy to isolate the domestic interest rate from foreign interest rates. Next, it allows monetary authorities to use monetary policy as an instrument of anti- cyclical management of aggregate demand. At last, independent monetary policy can be used to avoid severe deflationary adjustments (Curutchet, 2001). So, the central bank can always influence the inflation rate by increasing money supply.

2.3.6 Loss of seigniorage revenue

Seigniorage is the net revenue derived from issuing domestic currency. This net revenue represents the annual loss of the dollarized country and the annual gain of the currency issuing country (Rönnholm, 2007). This happens because it arises from the difference between the face value of a coin or bank note and the cost of producing, distributing, and eventually retiring it from circulation (Andrew et al, 2000). When domestic currencies are withdrawn from dollarization, the central bank must buy back these domestic currencies in order to return a part of seigniorage to citizens. Seigniorage is measured by the annual change in high-powered money. The domestic country will lose its stock and flow cost. Stock cost is defined as the one- time cost of obtaining the anchor foreign currency to replace the domestic currency in circulation. The stock cost can be calculated by the ratio of the domestic monetary base converted to GDP (Anthony and Hughes, 2000).

2.3.7 Loss of Lender’s Last Resort

The lender of last resort function is defined as the ability of the central bank to fully guarantee payment systems of bank deposits. If a country dollarizes, the lender of last resort function will be lost because of credibility of printing new money. So, the central bank will not be able to provide funds for financial institutions when they are in crisis. Instead, the central bank will maintain the soundness and efficiency in the financial system.

Chapter 3 Dollarization process in Curaçao, 1995 -2010

In order to explain the dollarization process in Curaçao, main developments during the period 1995-2010 is discussed.

3.1 Background

Curaçao is a relatively small island in the Caribbean. As of 1 January 2009, Curaçao has a population of 140 thousand inhabitants. The island of Curaçao is the largest and the most populated island of the three ABC islands (Aruba, Bonaire, and Curaçao). Curaçao was prior to 10 October 2010 one of the five islands in the Netherlands Antilles together with St. Maarten, Saba, St. Eustatius, and Bonaire. The Netherlands Antilles is not part of the European Union, but listed to as overseas countries and territories (OCT) of the Netherlands. The domestic currency is listed as the Netherlands Antillean Guilder (NAfl.), which is pegged since 1971 to the U.S. dollar by NAfl. 1.79. After the dismantling of the Netherlands Antilles, only St. Maarten and Curaçao use this guilder for transaction payments. The only two currencies accepted in Curaçao for payment transactions are the U.S. dollar and the Netherlands Antillean guilder. On 1 January 2011, the guilder was replaced by the U.S. dollar for Saba, St. Eustatius, and Bonaire. As of 1 January 2012, the Netherlands Antillean guilder will be replaced by the newly created Caribbean guilder. The island of Curaçao has a small open economy but has one of the highest standards of living than the other islands in the Caribbean. As of 1 January 2009, Curaçao has a GDP per capita of 20.5 thousands U.S. dollar. The main industries on the island of Curaçao are oil refining, tourism, offshore finance, and international trade. Almost all consumer and capital goods are imported from Venezuela, USA, and Mexico. The Venezuelan oil company (PDVSA) has established its operations on Curaçao since 1985. PDVSA has resulted into a large investment. The Dutch government supports Curaçao with development aid. Furthermore, the government of Curaçao wants to make the economy more diverse by attracting more foreign direct investment (FDI). In addition, USA, Venezuela, and European Union are the main business partners of Curaçao.

3.2 Magnitude of dollarization process in Curaçao3

During the period of 1997, Curaçao had an economic downturn due to deceleration of the inflation rate in the year 1995 and 1996. This economic situation was caused by a fading effect of the measures on government’s revenues, and the inflation rates of the main trading partners. The international financial sectors activities peaked in 1995, but soon after that it declined in 1997. Tax transfers to the domestic government declined during this period as well. This decline can be explained by the changes in tax arrangements with the Netherlands. It affected the competition position of the Netherlands Antilles as a result the introduction of the Captive Insurance Association of Curaçao by the Central Bank of Curaçao. The money supply expanded in 1997 by an increase of net international reserves. Authorities had tightened the monetary policy in 1997 and it reflected the introduction of intermediate targets for credit expansion to private sectors. Curaçao had reached its lowest level of inflation in the year 1998 since 1995, and international financial sector activities continued to decline.

In 2000, Curaçao’s inflation rate accelerated to 5 percent for domestic and foreign factors. The main factors causing an increase in inflation rate was the increase in oil prices and inflation rates of main trading partners. Furthermore, monetary aggregate expanded in 2000. The private sector accounted an expansion in the credit market in Curaçao. Money supply increased by 2.2 percent in 2000 compared to an increase in 1999 by 7.1 percent. Foreign currency denominated deposits expanded in 1999 by 26.5 percent while in 2000 it contracted by 12.5 percent.

The economy of the Netherlands Antilles continued to grow in 2003. The GDP per capita of Curaçao increased from 0.4 percent in 2002 to 1.4 percent in 2003. Inflation also increased by 1.9 percent in 2003 in comparison to 0.4 percent in 2002. Inflation continued to increase due to acceleration of oil prices. However, there was still a decline in activities of international financial sectors. The current account of Curaçao had a small surplus due to mainly higher earnings from bunker sales and tourism. The monetary expansion by the government slowed in 2003.

3 The information on the development of the economy of Curaçao has been obtained from the Quarterly Bulletins and Annually Reports published by the Central Bank of Curaçao and St. Maarten (1995-2010).

The economy of the Netherlands Antilles continued to grow in 2004 but at a slower pace. The economical developments causing growth in 2004 were primarily in activities in the wholesale and retail trade, tourism, and financial sectors. The expansion of financial sectors was primarily of the good performance of domestic banking system, whereas the international financial sector performed poorly due to the slow progress in new tax treaties. The main idea of the new tax treaties was to compensate disadvantages created by the elimination of the distinction between onshore and offshore activities.

In 2005, the economy of the Netherlands Antilles continued to grow as a result that GDP per capita increased by 1.5 percent for 2005 compared to 1.1 percent in 2004. Similar to 2004, the economy expansion in 2005 was accounted for entirely by domestic spending. The expansion was the reason of a decline in net foreign demand, which resulted from a balance of payments deficit due to higher oil prices and domestic demands. The growth in domestic spending was primarily led by the private sector. Private investment started to amplify due to several infrastructural expansion projects. Monetary aggregates proceeded to extent in 2005. Government spending continued to grow also. All in all, the economy of the Netherlands Antilles grew at the same pace in 2006 as in 2005. For both years, the expansion in real GDP was estimated at 1.5 percent.

The economy of the Netherlands Antilles had a robust growth in 2007. The acceleration growth was followed by strengthening of the domestic economy. Private investment increased rapidly and was accompanied by the supplement of leniencies programs towards lending standards. It resulted into deterioration in non-performing loans. The balance of payments noted a budget surplus in 2007, reflected by further accumulation of net international reserves. The current account deficit also doubled more than in 2007 compared to 2006, due to widening of the trade deficit. The trade deficit expanded because of the augmentation in tourism, higher overall international fuel prices, and the further appreciation of the euro vis-à-vis the Netherlands Antillean guilder. The current account deficit was financed mainly by direct investment and net borrowing from abroad (The Central Bank of Curaçao and St.Maarten, 2007).

The world financial crisis in 2008 imposed a huge impact on economic developments in Curaçao. GDP per capita grew with 2 percent compared to 3.7 percent in 2007. Private demand

15 continued to withdraw, which was noticeable at the declining in consumption. The domestic triggers of the decline of GDP per capita in Curaçao were of weak fiscal management which led to a failure of paying-off external public debt. On the other hand, the financial sector maintained its growth rate by good performances of the domestic banking system. The banks highly monitored non-performing loans and the growth of credit extension remained strong. Furthermore, the deterioration of the balance of payments continued in 2008 but at a slower pace. The money supply in Curaçao grew slightly faster in 2008 than in 2007. The reason of this expansion was due to the acceleration of net foreign assets accompanied by a balance of payments surplus and revaluation of gold stocks. Another cause influencing the poor economic performance in Curaçao has been the economy’s vulnerability towards oil. Oil prices have increased drastically over the past years. Over time, the rise of international oil prices affected consumption level, investment level, and trade balance in Curaçao.

In 2009, the Netherlands Antilles measured a contraction of 0.2 percent on economic activities, which complemented entirely to lower domestic demand. The decrease in domestic demand was accompanied by a decline in private demand. The private demand declined because consumers had decreased their spending on consumption. Furthermore, the deficit on the current account have narrowed in 2009 as a result of an increase in net current transfers from abroad and a decline in the trade deficit.

In 2010, the Netherlands Antilles experienced an economic growth of merely 0.1 percent in comparison to a contraction of 0.5 percent in 2009. This nearly economic expansion came mainly from an increase of government spending. The augmentation on government spending was caused by the expansion of goods and services related to the dismantling of the Netherlands Antilles. Moreover, consumer spending increased while private demand lessened as a result of lower investments in 2010. Also, Curaçao experienced a decline in net foreign demand and a deficit on its balance of payments. Over the year of 2010, Curaçao experienced high inflation due to high international oil and food prices. Inflation in the Netherlands Antilles rose from 1.6 percent in 2009 to 2.8 percent in 2010. As of 10 October 2010, the islands of Curaçao and St. Maarten became autonomous in the Netherlands Kingdom. Both islands agreed to form a currency union with only one central bank and a single currency. However, the Dutch Kingdom retains responsibility for defence and foreign policy. On 1 of January 2012, the new common

16 currency of Curaçao and St. Maarten is planned to come into the currency circulation namely, the Caribbean guilder (CMf). This currency will also be pegged to the U.S. dollar by CMf.1.79. The dismantling of the Netherlands Antilles has increased vulnerability to external shocks, because of diminishing economies of scale.

Figure 2 illustrates the development of real GDP per capita, and inflation under the period 2003- 2010 in Curaçao. The increase of the real GDP per capita has been modest, but in the year 2008 it declined drastically as a result of external shocks and domestic factors. The year 2008 is when the economic crisis occurred resulting into an escalation of inflation.

Figure 2: Real GDP per capital and inflation in Curaçao during period 2003-2010

Source: The Central Bank of Curaçao and St. Maarten, Economic key figure, 2011 III

The balance of payments of Curaçao is namely financed by capital inflows from abroad with the U.S. dollar as the highest. Figure 2 illustrates the trajectory of balance of payments of Curaçao annually. Between 2006 and 2009 the current account expanded rapidly and reached -22 percent of GDP in 2008. Furthermore, the external private sector peaked at 22.3 percent of GDP in 2008 causing a drop in net foreign wealth. As mentioned above, the current account of Curaçao improved slightly in 2009. The reason was due to an inflow of a grant of the debt relief program. This program was especially designed for the Netherlands Antilles. In 2010, the current account continued to have a deficit because of lesser cash inflow of the debt relief program. As shown in figure 3, the developments of the financial sector masked with a debt relief program in the year 2009, and 2010. Without those debt relief grants, the current account on balance of payments of

Curaçao would have reached -20.2 percent of GDP in 2010 (The Central Bank of Curaçao and St. Maarten, 2011). The implementation of the debt relief program is financed by the Dutch government. For the debt relief program to work well, Curaçao and St. Maarten have to agree to some budgetary rules in order to maintain sound public finance.

Figure 3: Balance of Payments of Curaçao

Balance of Payments Curaçao - -200.0 -400.0 -600.0 -800.0 -1,000.0 -1,200.0 -1,400.0 -1,600.0 -1,800.0

current account balance

Source: The Central Bank of Curaçao and St. Maarten, Economic key figure, 2011 III

Consequently, the development of Curaçao’s balance of payments has undermined the confidence of the Netherlands Antillean guilder. Because of the lack of confidence in domestic currency and vulnerabilities on the balance of payments of Curaçao, dollarization became an alternative. The vulnerabilities have been mitigated by the implementation of the debt relief program. Table 1 illustrates a scenario with and without debt relief on the balance of payments of Curaçao. Without debt relief, the deficit on current account would have been higher in both 2009 and 2010. In addition, external financing would have been much higher without a debt relief.

Table 1: Balance of Payments with and without debt relief in Curaçao for year 2009 and 2010

With Debt Relief Without Debt Relief

2009 2010 2009 2010 Current Account -669.3 -1080.7 -1456.9 1487.5

Capital Account 200.6 90.7 200.6 90.7

External Financing 873.4 970.5 1373.8 1301.6

Direct Investments -196.2 198.5 196.2 90.7

Loans and Credits 706.3 1263.2 116.1 1168.7

Portfolio Investments -188.9 -215.6 61.3 -65.6

Change in reserves -538.9 -116.3 252.0 -41.3

Source: The Central Bank of Curaçao and St. Maarten, 2011

3.2.1. Indicators of dollarization in general

The extent to capture the amount of dollarization in Curaçao is to develop some ratios. These indicators of dollarization are the ratio of U.S. dollar deposits to total liquidity (which is known as M2), and ratio of U.S. dollar deposits to NAfl. deposits in Curaçao.4

Deposits to M2 Ratio:

4 The indicators of dollarization in general are constructed in the paper of Kikut and Mendez (2003).

Deposits Ratio:

Figure 4 and 5 illustrate how the ratios of dollarization in general have evolved over the past fifteen years. In both figures we can detect more or less the same growth. For DolR, the distribution of growth is more smoothly than for DolmR. Nevertheless, it is interesting to discover the sudden kick in the year 2010 for the dollarization ratio. This can be explained by the growth of net foreign cash inflows in Curaçao. Both ratios capture this tendency. All in all, these ratios will help to measure the dollarization process in Curaçao. All in all, it is clear that there is evidence of dollarization process in Curaçao.

Figure 4: Deposits to M2 Ratio (DolmR)

DolmR 3 2.5 2 1.5 1 0.5

Jan Jan

Sep

- -

May

1995 1997

1999/Jan 2001/Jan 2003/Jan 2005/Jan 2007/Jan 2009/Jan

1995

1997/Sep 1999/Sep 2001/Sep 2003/Sep 2005/Sep 2007/Sep 2009/Sep

1996

1998/May 2000/May 2002/May 2004/May 2006/May 2008/May 2010/May

Source: The Central Bank of Curaçao and St. Maarten, Database

Figure 5: Deposits Ratio (DolR)

DolR 4 3.5 3 2.5 2 1.5 1 0.5

Jul Jul

Jan Jan Jan

- -

- - -

1996 1995

1997/Jul 1998/Jul 1999/Jul 2000/Jul 2001/Jul 2002/Jul 2003/Jul 2004/Jul 2005/Jul 2006/Jul 2007/Jul 2008/Jul 2009/Jul 2010/Jul

1996 1997 1995

1999/Jan 2000/Jan 2001/Jan 2002/Jan 2003/Jan 2004/Jan 2005/Jan 2006/Jan 2007/Jan 2008/Jan 2009/Jan 2010/Jan 1998/Jan Source: The Central Bank of Curaçao and St. Maarten, Database

3.3 Issues of implementation

Up to the year 1954, Curaçao was in fact already semi-dollarized. As mentioned before, the choice for U.S. dollar is based on the fact that the Unites States is Curaçao’s main trading partner. In addition, the U.S. dollar is also used extensively in international payment transactions. Dollarization process in Curaçao progressed slowly at first but became pervasive during 2005 – 2008. The trajectory of capital inflow of U.S dollar in Curaçao is shown in Figure 6. If Curaçao decided to dollarize, transaction costs were be lower. This would have benefit trade including tourism and foreign direct investments. As mentioned in the literature review in chapter 2, a dollarized country loses the possibility of having an autonomous monetary and exchange rate policy. However, given Curaçao’s currency is pegged to the U.S. dollar; this loss of autonomy is likely to be limited. Due to the perceived currency risk in Curaçao, local financial institutions might be more intrigued to invest in foreign assets. However, dollarization allows local financial institutions to be more inclined to invest in domestic capital. Furthermore, if Curaçao dollarized its economy, it eliminates the constraint on balance of payments. There is no need to hold foreign exchange reserves to maintain the peg, resulting that the Central Bank can now invest foreign exchange reserves, thereby preserving the profitability of the Bank. (The Central Bank of Curaçao and St. Maarten, 2011).

Figure 6: Capital inflow of U.S. dollar in Curaçao

Capital inflow U.S. dollar 8,000.0 7,000.0 6,000.0 5,000.0 4,000.0 3,000.0 2,000.0 1,000.0 - 2004 2005 2006 2007

Source: The Central Bank of Curaçao and St. Maarten, Database

Chapter 4: Empirical model

In this chapter I will discuss endogenous and exogenous variables performed in the econometric analysis. First, I will do a review on the macro-economic variables. Each variable is described and not only is the calculation of the variables presented, but also the economic theory behind them. Second, I will summarize the main expectations on the outcome of the models.

4.1 Data

In order to explain the determinants of dollarization process of Curaçao, a sample frame is constructed. The information needed to determine the factors of dollarization development was obtained from the Central Bank of Curaçao and St. Maarten (CBCS) database, and the U.S. Federal Reserve System database. All series were entered monthly data’s from January 1995 until December 2010. All data contained from the databases were converted to U.S. dollar denominations by dividing the pegged exchange rate of Nafl. 1.79. Taking the time span into consideration, the data consists of 192 entries. This time span covers fluctuations and movements towards the high inflation rate. Furthermore, both the implementation of the debt relief program in 2008 and the autonomous status of Curaçao in 2010 are covered in the time span. The regressions were carried out by the software Econometric Views (E-Views 6.0). However, not all the data’s were displayed monthly in the databases of CBCS and U.S. Federal Reserve System. Some of them were quarterly quoted. To convert these data’s into monthly data’s, I used the method of Cubic Spline Interpolation in the software Matrix Laboratory (Matlab). This method will however introduce a systematic source of serial correlation in the model. I will elaborate on this later in the sub-chapter violations. As already mentioned in chapter 3, there are two methods to calculate dollarization in general. So, I introduced two regression models with different dependent variables. Consider the following equations.

The empirical Model I is specified in the following form:

where is the dollarization ratio of U.S. dollar deposits over Nafl. deposits in Curaçao, denote the interest rate difference between U.S. Treasury rate and Curacao’s money market rate,

denote the inflation rate difference between U.S. consumer price inflation and Curaçao’s consumer price inflation rate, is the government deficit, is the balance of payments,

denote the inflation rate hysteresis, denote the interest rate hysteresis, is the error term, and the subscripts t represents the time period.

The empirical Model II is specified in the following form:

where is the dollarization ratio U.S. dollar deposits over money supply in Curaçao, denote the interest rate difference between U.S. Treasury rate and Curacao’s money market rate,

denote the inflation rate difference between U.S. consumer price inflation and Curaçao’s consumer price inflation rate, is the government deficit, is the balance of payments,

denote the inflation rate hysteresis, denote the interest rate hysteresis, is the error term, and the subscripts t represents the time period.

In total, five regressions were run for both models. The calculations of the dependent and independent variables are discussed below with their reasoning and expectations of the relationships on dollarization development.

4.1.1 Dollarization Ratio (DolR) and (DolmR)

The dependent variable will be defined as the ratio of deposits described in chapter 3 equations (2) and (3). The data’s conducted for these ratios were taken from the CBCS and the Federal Reserve System database. The total domestic denominated currency deposits in Curaçao had to be converted into monthly data’s using the Matlab software.

4.1.2 Interest Rate Difference (Rt)

The independent variable Rt is included in the model to interpret the interest rate pattern in Curaçao’s banking system. This variable helps to capture hysteresis in the economy. Hysteresis is known as the phenomenon called irreversibility of foreign5 currency; in this case the U.S.

5 In the rest of the paper the term foreign currency will be indicated as the U.S. dollar currency.

24 dollar. The data for this variable is published monthly in the CBCS and Federal Reserve System databases. The interest rate difference variable is calculated by subtracting Curaçao’s money market rate from U.S. Treasury rate. The Curacao’s money market rate was converted to U.S. dollar denomination. If the interest rate difference increases, U.S. dollar deposits will be more attractive than Netherlands Antillean guilder deposits. This will also stimulate currency substitution from domestic currency deposits towards foreign currency deposits in order to achieve high rate of return of foreign currency deposits. So, the relationship between dollarization ratio and interest rate difference is expected to be positive (

4.1.3 Inflation Rate Difference (It)

The consumer price inflation rate is necessary to include since it captures the change of purchasing power of domestic currency. This data is published monthly as well by the CBCS and was also converted to U.S. dollars. In order to obtain the inflation rate difference variable, the inflation rate is needed. The inflation rate is calculated by subtracting the consumer price index (CPI) of Curaçao of time period t-1 from CPI of time period t, and dividing by CPI time period t- 1. The same was performed for the U.S. inflation rate. To obtain the inflation rate difference, the U.S. consumer price inflation is subtracted by the Curaçao’s consumer price inflation rate. The higher the inflation rate in Curaçao, the lower the value of the Netherlands Antillean guilder will be. Therefore, to substitute the Netherlands Antillean guilder for the U.S. dollar will be more desirable for citizens. When Curaçao’s inflation rate is higher than the U.S. inflation rate, dollarization ratio will increase. The high inflation rate explains the desirability of the relative opportunity cost of holding U.S. dollars towards the Netherlands Antillean guilders. Therefore, I expect that the relationship between inflation rate difference variable and dollarization ratio is positive (

4.1.4 Government Deficit (GDt)

The CBCS monitors government spending through fiscal reform. Government budget is calculated by subtracting a period’s revenues from a period’s expenses. If this number is negative, then we have a deficit. As discussed in chapter 3, the government in Curaçao had an increasing budget deficit over the past years. If the government is able to commit to fiscal reform, then citizens will be more willing to hold Netherlands Antillean guilders instead of U.S.

25 dollars. I include the variable of government deficit to show the commitment of the government of Curaçao for price stabilization. The government deficit information is presented quarterly in the database of CBCS, and was converted to monthly data’s. The government deficit variable is calculated by dividing the Curaçao’s budget deficit by the U.S. Consumer Price index. The relationship between dollarization ratio and government budget deficit is expected to be negative

( < 0).

4.1.5 Balance of Payments (BPt)

The balance of payment data was also presented quarterly in the CBCS database and was converted into monthly data’s. This variable also captures the commitment of price stabilization in Curaçao. Since in 2009 the current account of Curaçao improved slightly due to the fact of an inflow of a grant of the debt relief program. So, it is interesting to find evidence on the trajectory of balance of payments relationship to dollarization. The relationship between dollarization ratio and balance of payments is expected to be negative ( < 0).

4.1.6 Inflation Rate Hysteresis ( )

Because of high inflation in Curaçao, currency substitution to U.S. dollars is desirable due to the fact that transactions are paid in either domestic currency or U.S. dollar. Even if inflation in Curaçao stabilizes, citizens will not switch back to Netherlands Antillean guilders. Their faith in the government’s commitment to stabilize inflation will not be strong enough, with a consequence that citizens will fear the repetition of high inflation and will avoid switching to Netherlands Antillean guilder during stable periods and U.S. dollar during unstable periods (Daniel, 2001). Citizens will only return to Netherlands Antillean guilders when inflation rate is permanently stabilized. All in all, dollarization is positively related to both acceleration and deceleration of inflation rate. I expect that dollarization ratio will be less positive when inflation rate is decelerating. So, as inflation rate decreases, dollarization ratio slightly increases.

With this in mind, I created a dummy variable to capture this expectation. This variable allow to examine the relationship on past period’s inflation rates on current dollarization ratio. The inflation rate difference variable (It) will remain the same as defined in previous paragraphs. The inflation rate hysteresis dummy variable is equal to one when the difference between

26 current period inflation difference and past period inflation difference variables, is less than or equal to zero, whereas the inflation rate hysteresis dummy variable will be equal to zero when the current inflation difference is larger than the past inflation difference. When the dummy variable is equal to one, hysteresis theory suggests that citizens will remember the high levels of inflation in the past periods and not the low level of inflation in the current period. The regression equation is presented below controlling only for inflation rate difference and inflation rate hysteresis. As mentioned, five regressions are run for both models. Regression one does not include the inflation rate hysteresis variable. Regression two includes the hysteresis’ variables by controlling the current period decision minus the last period decision. Regression three include the hysteresis’ variables for current period difference minus past period difference for six months prior, while regression four include hysteresis’ variables for current period difference minus past period difference for twelve months prior. Regression five include current period difference plus the period difference for 1 month before. The regressions may be viewed below.

= 1, when ( )

= 0, when ( ) >

Definitions for :

Regression 2: = It-1

Regression 3: = It-6

Regression 4: = It-12

Regression 5: = It+1

4.1.7 Interest Rate Hysteresis )

The interest rate hysteresis dummy variable is also included in the model to allow past period’s interest rates to be determined in the dollarization ratio. The dummy variable ) is equal to one when the difference between current period’s interest rate difference and past period’s interest rate difference, is less than or equal to zero, whereas the interest rate hysteresis dummy variable will be equal to zero when the current interest rate difference is larger than the past interest rate difference. Higher interest rate difference will induce a positive relationship for dollarization ratio. Citizens tend to remember past fluctuations of interest rates and affect decisions made in the present. The regression equation is presented below. Furthermore, the five

27 regressions discussed will be applied the same for interest rate hysteresis variable. The regressions may be viewed below.

= 1, when ( )

= 0, when ( >

Definitions for :

Regression 2: = Rt-1

Regression 3: = Rt-6

Regression 4: = Rt-12

Regression 5: = Rt +1

4.2 Econometric procedure

Ordinary Least Squares (OLS) was the statistical method used for this model to capture one possible outcome of the stochastic process. Since one or more variables are to affect the dependent variable with a lag, the OLS suites best. The OLS was performed for the impact on regression 1, 2, 3 and 4 for Model I and II. In addition, Generalized Method of Moment’s (GMM) principle presented by Hansen (1982) was also estimated to derive moment of conditions. With time-series data, moment of conditions can be added by assuming that past values of explanatory and even dependent variables are not correlated with the error term. In this case, GMM was performed only for regression 5 for both Model I and Model II. In regression 5, the coefficients indicate that the analysis cannot be reported as the only effects on dollarization process because in all likelihood, the causality between the exogenous and endogenous variables runs in both directions. For example, an increase in the dollarization ratio is expected to destroy “confidence”. Its effect may be ambiguous for other indicators. To address the independent effect on indicators on dollarization ratios, GMM procedure suites best. First, instrumental variables (IV) have to be identified. These are usually used to deal with endogeneity of explanatory variables. Also, instrumental variables are used to construct the problem of the new error term correlated with lagged independent variables. Instrumental variables are included to draw accuracy from data. I used internal instrumental variables to correct for potential statistical bias. These instruments are lagged values of regressors in different levels. Given that often the total instrumental variables are greater than exogenous parameters, GMM weighs the instrumental variables optimally in order to obtain the most efficient estimates. The GMM

28 estimator depends on the validity of instruments. Before examine the results using GMM estimation, it is important to note some advantages and disadvantages of this approach. If heteroskedasticity is present, the GMM approach is more efficient than IV approach. A consequence of an efficient GMM estimator is that there can be signs of poor small sample property. In addition, a more appropriate estimator would be proxies for different variables in the models, but these are sometimes difficult to find. For example, a good proxy for CPI inflation in the model would be wage inflation. There are some omitted variables that may contribute to poor results. Although some of the exogenous variables were lagged in the regression, the selection of how many lags were made ad hoc.

Chapter 5 Estimation Results

The estimated results of the regressions for Model I and Model II is presented in this chapter. Signs and significance of each regression are discussed as well. Further detailed information can be found in the appendix in the section entitled Model I and Model II. In addition, some policy considerations are discussed at the end of this chapter.

5.1 Results Model I The results of Model I in Table 2 are based on Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) techniques. More information on the results can be obtained in appendix I.

Table 2: Model I results on OLS and GMM a b

Note: t-statistics appear in parentheses and probabilities of p-value of coefficients in brackets. Instruments: lagged values of independent variables. *** denotes significance at the 1 percent level, **denotes significance at the 5 percent level and * denotes significance at the 10 percent level. a. In the regressions 1, 2, 3, and 4, the OLS estimation is performed. b. In regression 5, the GMM estimation is performed.

5.1.1 Signs and Significance

The econometric analysis provides an opportunity to capture the effect of macro-economic determinants on dollarization process in Curaçao. An interesting result emerges from Table 2.

Concerning regressions 1, 2, 3, and 4, the interest rate difference (Rt) and the inflation rate difference (It) variables remain consistence with the theory discussed in chapter 4. The significance of interest rate coefficient indicates that the CBCS is trying to control monetary policy in Curaçao. However, if interest rate increases, Curaçao’s citizens are more attractive to U.S. dollar deposits than their own national currency denominated deposits. This will stimulate currency substitution. Surprisingly, inflation rate difference (It) variable is not significant. In addition, the negative sign on balance of payments coefficient remains as expected. As the balance of payments in Curaçao increases, the ratio of U.S. dollar deposits over Nafl. deposits will decrease by about 22 percent. Coefficients associated with interest rate, government financing, and hysteresis are weakly significant on dollarization ratio. In regression 4, the interest rate hysteresis coefficient shows an unexpected negative sign, whereas in regression 2 and 3 it indicate that the more hysteresis, the more attraction for dollarization. Furthermore, approximately 37 percent of the coefficients are determined in the OLS model.

Regression 5 creates an outlook for the period t+1. The exogenous variables remain as expected, except the balance of payments has now a positive coefficient. The four significant variables are interest rate difference, balance of payments, interest rate hysteresis, and inflation rate hysteresis coefficients. The test statistics for GMM regression is the J-statistic. To control validity of the model, the J-test is performed. The J-statistic equals to 0.056. The null hypothesis H0 : (θ)=0 ( the model is valid), and alternative hypothesis H1: (θ) 0 ( the model is invalid). The J-statistic is asymptotically chi-squared with k-l degrees of freedom. k is the number of moment of conditions, and l is the number of estimated parameters. The critical value for 5 percent level is equal to 42.557. The J statistic is smaller than 42.557, so the null hypothesis is not rejected.

Since the macro-economic determinants sometimes take time to adjust its full effect on dollarization process, I have included lags of the independent variables. These results help to monitor and capture the relationship more closely. All in all, the results indicate that the effect of

31 the independent variables have an immediate effect on the dependent variable and does not take more than two months to adjust. The results of the lags can be obtained in appendix II.

5.1.2 Violations

The phenomenon multicollinearity increases variances and standard errors of coefficient estimates. However it does not reduce reliability of the model. Mulicollinearity induces that the t-values of coefficient estimates may not be accurate. So, in the presence of multicollinearity it may be facility to conclude that there is no linear relationship between the independent and dependent variables. There are several ways to detect multicollinearity. One of them is to ensure that simple correlation between any variables is not significant. A remedy for multicollinearity in this group of variables is to test the variables for Variance Inflation Factors (VIF). If the VIF is greater than five then there is multicollinearity between the independent variables. The VIF analysis is performed in Eviews. None of the independent variables in the five regressions are tested with a VIF higher than 1.61. Therefore, multicollinearity is not a major problem in the accuracy of the regressions.

Serial correlation or autocorrelation occurs when errors terms are not correlated with each other. It is usually the case that serial correlation is present in time-series data. Serial correlation causes the standard errors of the coefficients to be underestimated and therefore overestimates the F- values, t-values and J-values. To test for serial correlation, I will use the Durbin-Watson test

(DW). The DW tests for null hypothesis denote null hypothesis H0 : ρ 0 when there is no positive serial correlation; and alternative hypothesis H1 : ρ > 0 when positive serial correlation is present. If d < dL then H0 is rejected. If d > dU then H0 is not rejected. If dL d dU , the test is inconclusive. With a sample size of 192 entries and K equals four in regression 1, and six in the other four regressions, the dL is approximately 1.613 and dU is approximately 1.735. The Durbin-Watson test ranges between 0.075 and 0.095 for regressions 1, 2, 3, and 4. The Durbin- Watson statistics for all these four regressions are below the critical points of lower d statistics of 1.613. So, the no positive serial correlation is rejected. In order to correct serial correlation in the model, generalized least squares (GLS) is applied. The results for GLS are presented in Table 3. More information can be obtained in appendix I.

Table 3: GLS results for regression 1, 2, 3, and 4 for Model I a

Note: t-statistics appear in parentheses and probabilities of p-value of coefficients in brackets. a. In the regressions 1, 2, 3, and 4, the GLS estimation is performed. *** denotes significance at the 1 percent level, **denotes significance at the 5 percent level and * denotes significance at the 10 percent level.

The results obtained by Generalized Least Square are more or less the same as the predicted signs for regressions with OLS technique. The only independent variable changing in sign is the inflation difference coefficient. This variable changed for a negative sign for all regressions. For regression1, 2, and 3, the coefficients BPt, Rt , and GDt are significant. For regression 4, the interest rate difference variable (Rt) and balance of payments variable (BPt) are significant. 98 percent of the coefficients are determined in this model for GLS.

For regression 5, the Durbin-Watson test equals 1.277. This means that the Durbin-Watson statistics for regressions 5 is below the critical points of lower d statistics of 1.613. So, the no

33 positive serial correlation is rejected. However, GMM generally suffers from finite sample problems, when one add to much moment of conditions that do not add sufficient information (Wooldridge, 2001). Since the explanatory variables include lagged independent variables, the Durbin’s h statistics is used instead of Durbin- Watson test. Unfortunately, this test is not valid because the denominator of the Durbin’s h statistics is not positive.

5.1.3 Conclusion

All in all, the evidence supports that dollarization process in Curaçao is controlled by interest rate, balance of payments, and government spending. These variables will be an indication that the strive towards dollarization in Curaçao is caused by lack of confidence in the national currency, low investments, increase of vulnerabilities on widening of the current account, and government spending. Government fiscal imbalances may create fears of default on the government account. As a result, if the deficit declines in price, it weakens the bank’s balance sheet and lead to a contraction in lending. Because of adverse selection, lenders will no longer want to provide loans. This will lead to a decline in investments and economic activities. On the other hands, individuals and firms with the riskiest investment projects are willing to pay more interest rate. Furthermore, an increase in interest rate decreases cash flows of firms. This decline deteriorates the balance sheet of banks. It seems clear that confidence on fiscal policy is a key determinant of the dollarization process in Curaçao.

5.2 Results Model II

The results for Model II in Table 4 are based on the Ordinary Least Squares and Generalized Method of Moments techniques. More information on the results can be obtained in appendix I.

Table 4: Model II results on OLS and GMM a b

5.2.1 Signs and Significance

The inflation rate difference and the interest rate difference coefficients remain consistence with the expectations discussed in chapter 4. The government deficit coefficient remains the same negative sign as expected. Similarly to Model I, regression 2, 3, and 4 in Model II carry an expected positive sign for inflation rate hysteresis and interest rate hysteresis variables. Surprisingly, the balance of payments coefficient has positive estimate which was not predicted by the theory. So the intuition behind this result points out that as balance of payments in Curacao increase, the U.S. dollar will not become more attractive. To test this hypothesis, the null hypothesis denote H0 : β4 > 0; and the alternative hypothesis denote H1 : β4 = 0. The t- statistic conducted from the balance of payments variable ranges from 2.78 to 3.16 for the first

35 four regressions. The t-value for a one-sided test with 5 percent level of significance is 1.652. As a result, the t-statistics are bigger than 1.652 and the null hypothesis is not rejected. Furthermore, all the other signs are as predicted in the theory discussed in chapter 4. In addition, approximately 14 percent of the coefficients are determined in the Model II for regression 1, 2, 3, and 4.

The signs of the coefficients in regression 5 in Model II are quite different than for Model I. Here, the inflation rate difference and the inflation rate hysteresis are significant with the expected signs. The J-statistics in Model II for regression 5 is 0.052. The null hypothesis denote

H0 : (θ)=0 ( the model is valid), and the alternative hypothesis denote H1: (θ) 0 ( the model is invalid). The J-statistic is asymptotically chi-squared with k-l degrees of freedom. k is the number of moment of conditions, and l is the number of estimated parameters. The critical value for 5 percent level is equal to 42.557. The J statistic is smaller than 42.557, so the null hypothesis is not rejected.

As mentioned in the sub-chapter of Model I, the macro-economic determinants sometimes take time to adjust its full effect on dollarization in Curaçao. For Model II, I also included lags of the independent variables. The results of the lags can be obtained in appendix II.

5.2.2 Violations

Multicollinearity may be also presence in Model II. As a result, the t-statistic scores may not be accurate. In order to check for multicollinearity in the model, the Variance Inflation Factors (VIF) is used. If the VIF is greater than five then there is multicollinearity between the independent variables. The VIF analysis is performed in Eviews. None of the independent variables in the five regressions resulted with a VIF higher than 1.130. Therefore, multicollinearity is not a major problem in the accuracy of the regressions.

In addition, the errors terms in Model II may also be not correlated with each other. To test for serial correlation, I will use the Durbin-Watson test. The DW tests for null hypothesis H0 : ρ 0 when there is no positive serial correlation; and the alternative hypothesis H1 : ρ > 0 when positive serial correlation is present. If d < dL then H0 is rejected. If d > dU then H0 is not rejected. If dL d dU , the test is inconclusive. With a sample size of 192 entries and K equals

36 four in regression 1, and six in the other four regressions, the dL is approximately 1.613 and dU is approximately 1.735. The Durbin-Watson test ranges between 0.129 and 0.150 for regressions 1, 2, 3, and 4. The Durbin-Watson statistics for all these four regressions are below the critical points of lower d statistics of 1.613. So, the null hypothesis of no positive serial correlation is rejected. In order to correct serial correlation in the model, GLS is applied. The results for GLS are presented in Table 5. More information can be obtained in appendix I.

Table 5: GLS results for regression 1, 2, 3, and 4 for Model II

The results obtained with the GLS technique are very interesting. The coefficient estimates inflation rate difference (It), interest rate hysteresis (RhysDt), inflation rate hysteresis (IhysDt)

37 have all negative signs, and the t-scores associated with these variables were all reduced and were no longer significant. Balance of payments coefficient is significant in all four regressions. However, in regression 3, the variables balance of payments, government deficit, and interest rate hysteresis are significant. Furthermore, the coefficient of determination with GLS is 95 percent in Model II for all four regressions.

For regression 5, the Durbin-Watson test equals to 0.254. This means that the Durbin-Watson statistics for regressions 5 is below the critical points of lower d statistics of 1.613. So, the no positive serial correlation is rejected. As mentioned before, the Durbin’s h statistics is much better to use for regression 5. Unfortunately, this test is not valid because of a non-positive denominator, and does not obtain any significant variables.

5.2.3 Conclusion

Model II regressions performed with OLS technique, result in a lower coefficient of determination than in Model I. All in all, the evidence supports that dollarization process Curaçao’s is controlled by interest rate, balance of payments, and inflation. Again, confidence in the domestic currency is lacking. The CBCS can only set the level of interest rate for domestic currency, while the market interest rate is hardly controllable for investment decisions and consumption. Furthermore, the method GLS causes the relationship between the variables and dollarization to change and the significance of the estimates to decline. So, GLS is set not to be an optimal method of a misspecification problem or omitted variables. In this case it is better to use the OLS method.

5.3 Policy Implication

This paper has shown that Curaçao is dollarized to a considerable extent, with semi-dollarization being driven by inflation, interest rate, government financing, balance of payments, and hysteresis. The main points on policy implication are discussed below.

5.3.1 Conduct on Monetary Policy

According to Barro (1997), countries with lower inflation rate on average appears to grow more rapidly. If authorities do not want to dollarize Curaçao, the ultimate goal to pursue is for citizens to hold Netherlands Antillean guilders. A stable macro-economic environment is sustainably

38 preferred for both dollarization and de-dollarization. Curaçao has not yet achieved macro- economic stability. Over the past decade, Curaçao suffered from high inflation, and fiscal imbalances. Authorities should aim to achieve macro-economic stability by establishing credibility on monetary policy. While credibility takes time to develop, authorities should constantly discover appropriate policy decisions given economic developments. So, how to reach price stability in Curaçao? This can be done either by monetary targeting or inflation targeting. For successful monetary targeting policy, the demand for money functions should be stable; the monetary aggregate should be under control by the CBCS. The advantage of monetary targeting is that it enables the central bank to choose goals to cope with domestic considerations. In order to produce less inflation, policymakers should send immediate signals to the public and markets about the stance of monetary policy. However, monetary targeting will not work if the relationship between monetary aggregates and the goal is weak. Goals for monetary policy are to achieve high employment, economic growth, price stability, interest rate stability, stability of financial markets, and stability foreign exchange market (Eijffinger and de Haan, 2000). Inflation targeting can be implemented like Canada with formal bands of reducing inflation rate. However, a concern often raised with inflation targeting is that its effectiveness is hardly to assess. Interest rate has an effect on inflation through many different channels and the monetary policy has to rely on them. In addition, inflation is not entirely controlled by authorities. An advantage of implementing inflation targeting is that it enables monetary policy to focus on domestic considerations and respond to shocks to domestic economy (Eijffinger and de Haan, 2000).

Hence, the money market in Curaçao will need to develop further to help to reduce risks if authorities allow dollarization. Policymakers should focus on strengthening monetary policy mechanism. This can be done by forecasting liquidity on the money market. Having a high reserve requirement on foreign currency makes liabilities more costly and at the same time imposes liquidity risks related to deposits. A lower reserve requirement on domestic currency will create simultaneously an incentive to intermediate on the domestic financial market. So, a reason to promote holdings of Netherlands Antillean guilders is to maintain a low reserve requirement. Furthermore, the availability of an insurance deposit scheme helps to cover the insurance of the national currency denominated deposits much higher than the foreign currency

39 denominated deposits. In addition, a sufficient level of international reserves has to be maintained.

Is the Netherlands Antillean guilder a perfect substitute for the U.S dollar? Policy makers should address this question on the decision of dollarization in Curaçao. If the currencies are perfect substitutes, then the economy of Curaçao remains with the loss of its nominal anchor. The endogeneity of the money supply in the domestic country implies that the authority may be unable to reduce inflation by tightening the money supply. In principle, the extent to dollarize Curaçao relies on factors of the degree of openness of the economy, the degree of foreign currency deposits on the determinants of inflation, and the rates of return.

5.3.2 Conduct on Rates of Return

Higher inflation leads to more uncertainty in the economy. This uncertainty introduces costs on the interest rate channel. Uncertainty may lead to a risk premium on interest rate and possibly lowering investment levels. It will also undermine the decision making in markets. Interest rate stability is desirable because fluctuation creates uncertainty in the economy. There are indeed some costs on adaptation of dollarization which makes it costly to reverse. A fall in domestic inflation rate will have an effect on rates of return. De-dollarization will result in high rates of return on domestic-denominated assets, while dollarization stimulates low rates of return. Alternatively, if foreign-denominated deposits are held in Curaçao mainly as a store of value, then it could be argued that higher rates of return on domestic-denominated deposits relative to foreign-denominated deposits have contributed to attract more domestic-denominated assets. Dollarization leads to lower interest rate and transaction costs. In this case, this effect will be limited for Curaçao since the domestic currency is pegged for many years to the U.S. dollar.

5.3.3 Conduct on Institutional factors

Public finances of Curaçao and St.Maarten are currently closely monitored by the budget supervisor “College Financiële Toezicht” (CFT). Indeed, dollarization would provide a long run constraint for fiscal policy. This constraint allows CBCS to eliminate the possibility of printing money to finance fiscal deficits. Hence, restrictions on increasing money supply can improve policy credibility given the long history of troubled adjustment programs and fiscal deficits. For successful dollarization, Curaçao need to create a sound, competitive, well-supervised and well-

40 regulated banking system. Like the European council adopted the Stability and Growth Pact to regulate the excessive deficit procedure, Curaçao should create and adopt one too. This Pact can enhance price stability, because high level of government debt may increase inflationary bias.

Most importantly, the sustainability of a fully dollarized economy depends on how successful the government implements fiscal discipline. The smaller the budget deficit, the smaller is the risk that dollarization might fail (The Central Bank of Curaçao and St. Maarten, 2011). Given the introduction of the debt relief program coupled with an enhanced monitoring system, Curaçao may already set a solid foundation for sustainable sound public finances.

5.3.4 Full dollarization or De-dollarization?

De facto dollarization may create a reason for policy makers to abandon the domestic currency for a foreign currency. A benefit of this strategy is that currency mismatches caused by an economic crisis cannot happen under full dollarization as all assets and liabilities are denominated in the foreign currency (Reinhart and Calvo, 2001). Therefore, balance sheet vulnerabilities could be eliminated entirely. The adoption of a common currency will increase the volume of trade. However by increasing the reserve requirements, this instrument will eliminate liquid assets of commercial banks. This leads to a decrease of imports and therefore less outflow of foreign capital. This instrument will improve the position on balance of payments in Curaçao. On the other hand, as discussed above, low reserve requirement on domestic currency will promote holdings of Netherlands Antillean guilders. Since the results in chapter 5 indicate that the balance of payment coefficient has a strong negative relationship on dollarization, I suggest that Curaçao promote a high reserve requirement condition.

Authorities should restore the confidence in the inflation rate in Curaçao. As mentioned before, Curaçao has not been maintaining a stable macro-economic condition on inflation rate. The prerequisite to deal with dollarization is to adapt a sound macro-economic policy. The poor financial instability has been the cause of the CBCS financing the budget deficit, and increasing the money supply. Authorities should make an effort to adapt fiscal discipline by allowing the budget spending not to increase. Financing the budgetary deficit should be dismantled. By introducing the debt relief program, authorities have already done so. Given the high level of dollarization process in Curaçao, monetary authorities should consider prioritizing the objective

41 to maintain low inflation rate. Because of a small domestic monetary base, a stabilization program on output is unlikely to work. Furthermore, seigniorage may create high costs in terms of inflation, capital flight, and may increase dollarization further. A policy designed to decrease dollarization and increase the domestic monetary aggregates is unlikely to be effective for legal restrictions and regulations. Most importantly, authorities should encourage stabilization by promoting a larger domestic monetary base. Starting by a stable macro-economic stimulates low inflation and eventually promotes confidence in the national currency. In addition, monetary targets are directly controlled by the central bank and thus can allow citizens to regain the confidence of the national currency.

What effects will the Caribbean guilder has on dollarization process in Curaçao when it enters the circulation in 2012? According to the CBCS President Dr. Tromp, “ Curaçao and St. Maarten will miss 90 million Netherlands Antillean guilders on compensations by introducing their own currency (17.7 million guilders) and foreign exchange provision for financial transactions in U.S. dollars (72.2 million guilders) due to the dollarization; in other words, approximately 90 million guilders per year” (CPL, 2010, p.1). To compensate the losses, a financial compensation scheme on all import and export transactions can be created. To withdraw the attractiveness of the U.S. dollar denominated currency, authorities should encourage the new Caribbean currency in all transactions, and allow the U.S. dollar to be the only banknotes in circulation. Furthermore, all transactions performed by banks and financial institutions should be enforced in the domestic currency. License fee will have to be paid by all business transactions.

At the end, full dollarization might turn into something good or bad for Curaçao. The future remains uncertain for the economy of Curaçao. The switch of the Netherlands Antillean guilder or Caribbean guilder to the U.S. dollar can involve into a substantial risk like the Greece experience. The currency account deficit will continue to grow for Curaçao if no measures are taken. However, I recommend that any plans for full dollarization should wait until competitiveness and stability have enhanced in both the economies of Unites States and Curaçao. There is no urgency to dollarize. There has been no pressure yet on the domestic currency on the concerns of the current account deficit in Curaçao. Under the current economic circumstances in Curaçao I will stress that macro-economic stability is the most important factor to establish right now.

Chapter 6 Conclusion

For the past fifteen years, Curaçao began to experience the process of dollarization. Recently, political leaders in Curaçao have been weighing the possibilities to officially adopt the U.S. dollar as a legal tender. Officially adopting the U.S. dollar not only generates benefits but also costs on the economy. The opposition for not officially dollarizing Curaçao emphasizes the loss of seigniorage revenue, monetary dependence, and the lender of last resort. On the other hand, supporters anticipate the importance of the elimination of currency risk, which remains a huge concern on the high inflation rate in the history of Curaçao’s economy. Whether Curaçao will adopt the U.S. dollar as their national currency, dollarization process began a decade ago and most importantly infiltrated the economy of Curaçao. Many citizens in Curaçao are holding U.S. dollar- denominated deposits and Netherlands Antillean-denominated deposits. The degree of these currencies depends solely on its opportunity costs. Changes in the magnitude of opportunity cost may incur changes in interest rates, transaction costs, and inflation rates. Fluctuations on these macro-economic determinants cause adjustment in the money supply and real money balances. Hence, if interest rate increases, citizens in Curaçao will find holding U.S dollars more attractive than Netherlands Antillean guilders. As a result, the rate of return increases. If inflation in Curaçao increases, citizens should increase the degree of U.S. dollar holdings when the opportunity cost of Netherlands Antillean guilders increases also. Furthermore, if the transaction cost of holding U.S dollar increases, citizens will not be willing to hold more U.S. dollars than their own national currency. These relationships discuss the concept of currency substitution.

Establishing econometrical models to capture dollarization process in Curaçao, I incorporated some of the relationships described above. To add new elements in the models, I added the balance of payments variable, government deficit variable, and hysteresis to capture the importance of confidence in the national currency’s stability. The econometric results are inline with the predictions on the literature review. Evidence shows that dollarization process in Curaçao’s has a negative relationship between dollarization ratio and interest rate, and there is a positive relationship between dollarization ratio and balance of payments, and government financing. These variables indicate that dollarization process is emerging in Curaçao due to lack of confidence in the national currency and rise of vulnerabilities. The loss of confidence in

Curaçao’s currency will also lower the inflow of capital from abroad, while investors would demand higher returns on domestic investments. I have found that interest rate, balance of payments are the two most dominant variables explaining dollarization process in Curaçao. In Curaçao, the financial system is already highly dollarized. There is substantial an amount of capital inflows of short-term borrowing; as a result the devaluation of the national currency will worsen the balance sheet of banks. Devaluation in the private sector can damage financial activities. Dollarization affects also macro-economic stability in financial markets.

Several factors may have adversely affected the estimation of Model I and Model II. These include serial correlation, multicollinearity, and omitted variables. GMM technique has its drawbacks. The GMM estimator may not be an efficient estimator. A more appropriate estimator would be proxies for different variables, but these are sometimes difficult to find.

According to currency substitution theory, Curaçao can be referred to currency dollarization and operates in a monetary union. Finally, it would be interesting to aim the essence of how costly the policy of encouraging Curaçao’s citizens will be on the usage of Netherlands Antillean guilders by keeping interest rates stabilized. Also, on how much these costs will have on inflation rates. As discussed, on 1 January 2012, the new common currency of Curaçao and St. Maarten is planned to come into the currency circulation. Since the Caribbean guilder will also be pegged to the U.S. dollar by the same amount as the Netherlands Antillean guilder, it is interesting to analyze the effect on dollarization process.

To conclude, Curaçao should not implement official dollarization right now. The effects of recent political reforms, fiscal programs, and the adoption of a new currency in 2012 in Curaçao will all have significant influences on the stabilization of the economy. These reforms need time to adjust and time to fulfill their purposes, and only then we may be able to focus on the certainty of dollarization in Curaçao.

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Appendix I Results Model I Model I: Regression 1 OLS

Model I: Regression 1 GLS

Model I: Regression 2 OLS

Model I: Regression 2 GLS

Model I: Regression 3 OLS

Model I: Regression 3 GLS

Model I: Regression 4 OLS

Model I: Regression 4 GLS

Model I: Regression 5 GMM

Results Model II Model II: Regression 1 OLS

Model II: Regression 1 GLS

Model II: Regression 2 OLS

Model II: Regression 2 GLS

Model II: Regression 3 OLS

Model II: Regression 3 GLS

Model II: Regression 4 OLS

Model II: Regression 4 GLS

Model II: Regression 5 GMM

Appendix II Results Lags Model I Model I Regression 1 Lag 1 Model I Regression 1 Lag 2

Model I Regression 1 Lag 3 Model I Regression 1 Lag 4

Model I Regression 2 Lag 1 Model I Regression 2 Lag 2

Model I Regression 2 Lag 3 Model I Regression 2 Lag 4

Model I Regression 3 Lag 1 Model I Regression 3 Lag 2

Model I Regression 3 Lag 3 Model I Regression 3 Lag 4

Model I Regression 4 Lag 1 Model I Regression 4 Lag 2

Model I Regression 4 Lag 3 Model I Regression 4 Lag 4

Results Lags Model II Model II Regression 1 Lag 1 Model II Regression 1 Lag 2

Model II Regression 1 Lag 3 Model II Regression 1 Lag 4

Model II Regression 2 Lag 1 Model II Regression 2 Lag 2

Model II Regression 2 Lag 3 Model II Regression 2 Lag 4

Model II Regression 3 Lag 1 Model II Regression 3 Lag 2

Model II Regression 3 Lag 3 Model II Regression 3 Lag 4

Model II Regression 4 Lag 1 Model II Regression 4 Lag 2

Model II Regression 4 Lag 3 Model II Regression 4 Lag 4