Business cycle and monetary policy

in Romania

Lucian Croitoru
National Bank of Romania
The second ERMAS Confrence, 29-31 August 2015
Cluj Napoca
 Content
I. Macroeconomic overview
II. Economic freedom and real convergence
III. GDP dynamics and its features
IV. The fiscal deficit and the cycle
V. The current account
VI. Inflation developments
VII. Monetary policy
VIII. Is a new monetary policy rate dilemma
emerging?
I. Macroeconomic overview
 Before the crisis
 Rapid GDP growth in 2001-2008 (6.5% average
annual growth) fuelled by large capital inflows:
A real-estate and consumption boom emerged as
wage and credit were increasing rapidly
An expansionary fiscal policy further contributed to
the overheating of the economy starting in 2005
 Large imbalances were building up, rendering the
economy vulnerable to negative shocks
Unsustainable structural fiscal imbalances doomed
Romania to fiscal consolidation when the crisis hit
Sizeable external disequilibrium (the current account
deficit peaked at 13.4% of GDP in 2007)
External debt increased from euro bn. 30.9 in 2005 to
euro bn. 72.4 in 2008
 Adjustments in the wake of the crisis
 The current account deficit plunged to
sustainable levels (4.4% of GDP in 2012, 0.4% of
GDP in 2014)
 Sharp fiscal consolidation brought the deficit
from 9% of GDP in 2009 to 1.5% of GDP in 2014
 The public debt-to-GDP ratio increased rapidly
during the crisis, but it is still one of the lowest in
the EU and is estimated to stabilize below 40% of
GDP over the medium term
 Total external debt increased to euro bn. 100 in
2012 and decreased to euro bn. 63 in 2014.
 Outlook for 2015 and beyond
 Expected economic outcomes in 2015 if fiscal plans
receive approval:
 GDP growth estimated at 4.4% in 2015 and 4.1% in 2016
(beyond potential in both cases)
 O-Y-A inflation estimated at - 0.2% in December 2015 and
0.7% in December 2016. Annual average inflation of -0.2%
in 2015 and -0.8% in 2016
 The CA deficit, expected to deepen to -1.5 percent of GDP
 Budget deficit moves at 4 percent in 2016 and 5 percent in
2017 if both the Fiscal Code and the wage bill are
approved
 Weakened macroeconomic fundamentals would not
support strong growth and would lead to further
delayes in joining the Banking Union and the euro
area
II. Economic freedom and real
convergence
 EU economies became more liberal in 2014 as
compared to 1996 (see detailed charts at the
end of the presentation)
Economic freedom in 1996 Economic freedom in 2014
180 180
GDP at current prices per hour

160 Source: author’s computations;

GDP at current prices per hour

AMECO; Heritage Foundation
160 Source: author’s computations;
AMECO; Heritage Foundation
worked (PPS, EU15=100)

worked (PPS, EU15=100)

140 140
120 FR 120
100 IT 100
IT
80 80
60 GR 60 GR
LI ES
40 40 RO
HU
LI
20 PO 20
RO
0 0
40 60 80 40 50 60 70 80
Overall index of freedom Overall index of freedom
 EU countries migrate to upper clusters as
regards property freedom. Slow progress for
Romania
Unclear property rights in Romania has made little progress until
Romania in 1996 2014; Italy and Greece show regression
1996 2014
180 180
GDP at current prices per hour

Source: author’s computations;

GDP at current prices per hour

160 AMECO; Heritage Foundation 160 Source: author’s computations;
worked (PPS, EU15=100)

worked (PPS, EU15=100)

AMECO; Heritage Foundation
140 140
FR
120 FR IT 120
100 100 IT
80 80
GR
60 GR 60
40 40 RO
20 20
RO
0 0
20 40 60 80 100 20 40 60 80 100
Property rights Property rights
 Some developed countries have lost part of
their freedom from corruption
Romania was among countries with the
lowest freedom from corruption in 1996
Greece and Italy have the lowest freedom
from corruption in 2014 among EA
countries

1996 2014
180 180

GDP at current prices per hour

GDP at current prices per hour

Source: author’s computations;

160 160 Source: author’s computations;

worked (PPS, EU15=100)

AMECO; Heritage Foundation
worked (PPS, EU15=100)

AMECO; Heritage Foundation

140 140
DE
120 DE 120
100 100 IT
IT
80 80 GR
60 GR 60
CZ PO
40 40
PO RO
20 20
RO
0 0
20 30 40 50 60 70 80 90 100 20 30 40 50 60 70 80 90 100
Freedom from corruption Freedom from corruption
 Gross domestic product at current prices per hour
worked (PPS, EU15=100): Change in positions (index)
2.4
Belgium
Bulgaria
2.2
Romania has increased 2.21 Czech Republic
times its GDP/hour worked Denmark
2 Germany
as a percentage of the EU 15
Estonia
1.8 Ireland
Greece
1.6 Spain
Source: author’s computations;
AMECO France
1.4 Italy
Cyprus
1.2 Latvia
Lithuania
Luxembourg
1
Hungary
Malta
0.8 Netherlands
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
 Gross domestic product at current prices per hour
worked (PPS, EU15=100)
180 Source: author’s
160 computations; AMECO
Note: * indicates that the indicator`s
140 value refers to the year 2000, not to
120 the year 1996

100
80
60
1996
40
2014
20
0

EA*
Germany

Lithuania

Romania
Luxembourg

Slovakia
Bulgaria

Austria
Belgium

Italy
Denmark

Poland
Portugal

Slovenia

Finland
Czech Republic

Spain
France
Ireland
Estonia*

Malta*
Greece

Cyprus

Hungary

Netherlands
Latvia*

Sweden
United Kingdom
 Romania`s scoreboard indicators in
2013
• Public debt: 37.9 % of GDP
• Curent account (CA) deficit (average over the past 3 years): 1.9 % of
GDP
• Net international investment position: -61.5 % of GDP
• Real effective exchange rate (percentage change over the past 3
years): 0.3
• Market share of exports of goods and services (percentage change
over the last 5 years): 16.4
• Unit labor cost (percentage change over the past 3 years): 0.7
• Houses price index (annual percentage change): -4.6
• Private sector debt: 66.4 % of GDP
• Credit flow to the private sector: -1.5 % of GDP
• Unemployment rate: 7 %
• Financial sector total liability (annual change): 3.1 %
Lucian Croitoru 13
Romania’s indices of economic freedom for 2015 compare well
to those of Germany, except for property rights, freedom from
corruption, and financial freedom
Indicator Romania (66.6; ranks 57) Germany (73.8; ranks 16)

• Property Rights (RoL) 40.0 ~ 90.0 ~

• Freedom From Corruption (RoL) 43.0 + 78.0 -
• Business Freedom (RE) 69.8 - 88.2 -
• Labor Freedom (RE) 68.6 + 51.2 +
• Monetary Freedom (RE) 77.3 + 81.5 +
• Government Spending (LG) 62.3 + 40.1 +
• Fiscal Freedom (LG) 86.9 - 60.8 -
• Trade Freedom (OM) 88.0 + 88.0 +
• Investment Freedom (OM) 80.0 ~ 90.0 ~
• Financial Freedom (OM) 50.0 ~ 70.0 ~
Source: Heritage Foundation
RoL=rule of law; RE=regulatory efficiency; LG=low government; OM=open
markets; - indicates a decrease as compared to the previous year; + indicates
an increase as compared to the previous year; ~ = stable
Lucian Croitoru 14
III. GDP dynamics and its features
 ROMANIA: Annual GDP growth rates (%)
10
Financial repression
1990-1996
5
Moderate and high
capital inflows 2000-2008
0

2015f
1990

2006
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005

2007
2008
2009
2010
2011
2012
2013
2014
-5
Recession II
Recession III
-10 Financial and economic
crises: Asia 1997; Russia
The financial and
1998; Argentina 1999-2001
economic crisis of
-15 2007
Recession I
Source: data from the National
-20 Institute of Statistics
Global recession of 1991
Romania’s GDP growth: some features

High dependency on capital inflows

Three distinctive periods of positive growth:
The financial repression period: 1990-1996
The boom period: 2000-2008 (high capital inflows
fuelled high growth)
The “free” growth period (no implicit subsidies,
no high capital inflows): 2011-until now. GDP
growth averaged 2 percent a year
 In Romania, GDP growth depends on capital
inflows (%) (Source: NIS and author`s calculations)
Average Cumulated growth over
Period growth rate the period Comments
low private capital
1990-1992 -10.7 -27.8* inflows
low private capital
1993-1996 4.08 17.2 inflows
low private capital
1997-1999 -2.4 -7.2 inflows
MODERATE PRIVATE
2000-2004 5.4 29.8** CAPITAL INFLOWS
HIGH PRIVATE CAPITAL
2005-2008 6.9 30.6 INFLOWS
high public external
2009-2010 -4.0 -7.9 borrowings
2011- low private capital
2014*** 2.0 8.3 inflows 18
* 3 years; ** 5 years; ***growth for 2014 estimated at 2.9 percent Lucian Croitoru
IV. The fiscal deficit and the cycle
 Procyclical fiscal policy before and after the 2008 crisis
10 4
Excess demand,
8 Fiscal impulse (rhs, %
% of PGDP 3
of GDP)
6 Implicit cyclical balance
if at MTO, % of GDP 2
4
Implicit GG balance, 1
2 if MTO, % of GDP
0 0

-2
-1
-4
-2
-6
Structural balance, GG balance,
Source: AMECO and % of PGDP -3
-8 % of GDP
author's computation
-10 -4
2001
1995
1996
1997
1998
1999
2000

2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
 Cumulated percentage growth of wages, labor
productivity (2000=100), and public pensions (2001=100)
300 Pensions in the public
sector

250 Wages in the budgetary

*Includes the public sector*
administratin, education ,
health, and recreative
activities
200
Wages in the private
sector
2001-2004: average real pension growth = 7,4 %
Labor productivity 2001-2004: average real wage growth in the public sector =
150 (Real GDP per hour 6,9 %
2005-2009: average real pension growth = 21,7 %
worked) 2005-2009: average real wage growth in the public sector =
12,4 %
Source: author's computation based on data from National Institute for Statistics,
100 and AMECO

2010
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2011

2012

2013

2014
 Public debt as a percent of GDP in the EU in 2014.
Romania has a enviable position
Estonia 10.6
Luxembourg 23.6
Bulgaria 27.6
Romania 39.8
Latvia 40.0
Lithuania 40.9
Czech Republic 42.6
Sweden 43.9
Denmark 45.2
Poland 50.1
Slovakia 53.6
Finland 59.3
Malta 68.0
Netherlands 68.8
Germany 74.7
Hungary 76.9
Slovenia 80.9
Austria 84.5
Croatia 85.0
European Union 88.6
United Kingdom 89.4
Euro area 94.2
France 95.0
Spain 97.7
Belgium 106.5
Cyprus 107.5
Ireland 109.7
Portugal 130.2
Italy 132.1
Greece 177.1

0 20 40 60 80 100 120 140 160 180

 Changes in public debt in the EU from 2007 to 2014 (percentage
points). Significant upward adjustment in the case of Romania, but
low by comparison to other countries
Malta 5.7
Sweden 5.7
Poland 5.9
Estonia 7.0
Bulgaria 11.0
Germany 11.0
Hungary 11.1
Czech Republic 14.8
Luxembourg 16.5
Denmark 17.9
Belgium 19.6
Austria 19.7
Slovakia 23.7
Lithuania 25.0
Finland 25.3
Netherlands 26.1
Romania 27.1
Euro area 29.3
France 30.6
European Union 30.7
Latvia 31.6
Italy 32.4
United Kingdom 45.7
Croatia 47.9
Cyprus 53.4
Slovenia 58.2
Portugal 61.7
Spain 62.2
Greece 74.0
Ireland 85.7
0 10 20 30 40 50 60 70 80 90
 Changes in cyclically adjusted GG balances (percentage
points): Roamania performed the second largest
adjustment („-” means a increase in the fiscal deficit)
Sweden -3.6
Estonia -2.0
Finland -1.9
Cyprus -0.2
Luxembourg -0.1
Hungary 0.1
Malta 0.1
Bulgaria 0.6
Slovenia 1.2
Germany 1.8
Austria 1.9
Belgium 1.9
Italy 2.3
Latvia 2.8
United Kingdom 3.0
France 3.3
Euro area 3.4
Czech Republic 3.6
Denmark 3.7
Netherlands 3.8
Lithuania 4.0
Poland 5.3
Slovakia 5.6
Portugal 6.3
Spain 6.8
Ireland 7.3
Romania 7.7
Greece 16.2

-5 0 5 10 15
 -16
-11
-6
-1
4
Euro area
Belgium
Bulgaria
Czech Republic
Denmark
Germany
Estonia
Ireland
Greece
Spain
France
Italy
Cyprus
Latvia
Lithuania
Luxembourg
Hungary
good positin

Malta
Netherlands
Austria
Poland
Portugal
Romania
Slovenia
Slovakia
Finland
Sweden
Adjustments made in 2010 were key to reaching the present
Cyclically adjusted GG balances: Romania compared badly to
other EU countries before 2008 and compares well prezently.

United Kingdom
2007
2009
2014
 Cyclical fiscal balance in EU countries (% of GDP). Almost each
country was imprudently enjoying good times
7.0 6.2

5.0 4.3
3.8
3.4
2.3 3.0
3.0 2.5 2.2 2.4 2.2 2.4 2.6
1.7 1.8 1.9 1.7 1.9
1.5 1.7 1.3 1.5 1.4 1.4
1.1 1.0 1.0
1.0 0.6 0.4

2014
-1.0
2009

-3.0 2007

-5.0

Sweden
Slovenia
Malta
Netherlands

Slovakia
Estonia

Italy
Denmark

Poland
Austria
Bulgaria

France
Belgium

Germany

Cyprus
Latvia

Finland
Portugal
Greece

Lithuania
Ireland

Spain

Luxembourg
Hungary

Romania
Euro area

Czech Republic

United Kingdom
V. The current account
 Significant changes in current account balances
(percentage points). „-” indicates a reduction in
the CA deficit
Bulgaria -26.1
Latvia -19.3
Estonia -16
Greece -15.5
Lithuania -14.5
Romania -13.1
Slovenia -11.2
Hungary -11.2
Spain -10.8
Portugal -10.7
Malta -9.5
Ireland -9
Croatia -7.8
Cyprus -6.7
Slovakia -5.4
Poland -4.9
Denmark -4.9
Czech Republic -4.9
Netherlands -4.2
Italy -3.2
France -0.2
Germany -0.2
Belgium 0.3
Sweden 2.5
Austria 2.7
United Kingdom 3.5
Luxembourg 5
Finland 6.1

-30 -20 -10 0 10

 -26
-21
-16
-11
-6
-1
4
9

1.9
Belgium
Bulgaria

-25.2
-4.3
Czech Republic
1.4
Denmark
7.4

Germany
Estonia

-15.9
-5.3
Ireland
Greece

-14.6
Spain
-10.0
-1.0

France
-7.2

Croatia
-1.3

Italy
Cyprus
-11.8

2007
Latvia
Lithuania -22.4
-14.4
10.1

Luxembourg

2014
-7.3

Hungary
-6.2

Malta
6.7

Netherlands
3.5

Austria
-6.2

Poland
Portugal
-10.1

Romania
-13.5
-4.2
Current account balances in EU countries (% of GDP)

Slovenia
-5.3

Slovakia
4.3

Finland
9.3

Sweden
-2.4

United Kingdom
 In Romania, the current account was mostly financed by
debt creation during the boom phase of the cycle
(EUR bn.)
20

15 13.1 12.4

10
2.9
5 2.0 4.4
3.6 3.3 2.2
4.5 6.6 4.3 5.4 2.4 2.1 2.2 2.8 5.3 6.3
0
-4.0
-5.4
-5
Source: author’s computations based on NBR data
-10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
NON DEBT-CREATING FLOWS DEBT-CREATING FLOWS
NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT
30
Financing of the current account by instruments in
Romania (EUR bn.)
20

10

-10
Source: author’s computations based on NBR data
-20
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Direct investment CAPITAL ACCOUNT
Currency and deposits Trade credits and advances
NET ERRORS AND OMISSIONS Portfolio investment
Financial derivatives Loans
Other accounts receivable/payable Reserve assets (- increase/+ decrease)
CURRENT ACCOUNT DEFICIT
 Romania: the current account deficit was mostly ascribable to
the private sector external deficit during the boom
(% of GDP)

5
4.4

1.1
0
-0.4
-1.5

-5

-8.9
-10
-10.5
Source: author's estimation based on data from
EUROSTAT, NBR and UNCTAD -13.4
-15
2000
1995
1996
1997
1998
1999

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
The current account deficit The GG deficit The private sector deficit
 Romania: public savings and investment (% of GDP)
8 Decreasing
6.7 investment during
6 recession
Higher investment without
much progress in
4 infrastructure 4.3
3.4
2.8
2

-2
Source: author's estimation based on data -2.9
from EUROSTAT, NBR and UNCTAD
-4

savings Investment
 Romania: the private sector reduced savings and increased
investment during the boom and reduced them both in the
aftermath
(% of GDP)
35
31.7
30
25.8
25
21.2
20

15 17.7
13.0
10 Source: author's estimation based on data from
EUROSTAT, NBR and UNCTAD
5

2008
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

2009
2010
2011
2012
2013
2014
Savings investment
VI. Inflation developments
 A few features of the HICP consumer
basket in Romania
• 32 percent of consumer bascket are given by
food and volatile prices
• Had the NBR chosen the core inflation to be
targeted, it would have been difficult for the
public to understand the concept
• By choosing the headline inflation to be
targeted, the NBR exposed itself to the
reputational risk of missing the target because
of high volatility of too many prices
 The share of food items in the HICP consumer basket, 2015
percent
35

32.4
30

27.9 27.7
25 25.8
24.9
22.8 22.3
20

15

10

0
Romania Latvia Lithuania Bulgaria Hungary Poland Czech
Republic

Source: Eurostat
 Romania: the share of food items in the consumer basket
percent
60
CPI CORE3
56.3

54.0

52.2
50

50.3

50.1
50.0
49.7

48.6
47.7
47.6

46.7
40
41.7

40.7

38.9

37.7

37.6
37.6
37.5

37.5
37.5
37.4

37.2
30

20

10

0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Source: NIS
 percent 2008 H2:
- increase of 2010 H2:
Romania: O-Y-A CPI inflation (%)
administered - VAT tax raised 2011 H1:
2007 H2 - 2008 H1:
prices - increase in - increase in domestic and international agri-food
10 - poor food supply
administered, food commodity prices
- increase of
and oil prices - increase of oil price
administered prices
9 and of oil price 2009 Q1:
- tobacco excise increase
- leu depreciation 2012 H2:
8 - poor harvest
- increase of 2013 Q1:
7 administered - increase in electricity
prices prices
- poor food supply
6 - excise increase

2013 H2 - 2014 H1: Multi-annual flat target: 2.5%

2
- good harvest
- bread VAT decrease
1 2014 H2 :
- decrease of oil price
0 - abundance of food
dec.05 dec.06 dec.07 dec.08 dec.09 dec.10 dec.11 dec.12 dec.13 dec.14 dec.15 dec.16

Note: Variation band of the target is ±1 percentage point.

Source: NIS, NBR
VII. Monetary policy
 Five distinct periods of inflation deviation from
the target prior to the downturn
1. The period up to the closing of the output gap (2003 Q1-
2004 Q2);
2. The following period up to the adoption of inflation
targeting (2004 Q3-2005 Q3);
3. The period between the shift to inflation targeting and
the surge in capital inflows (2005 Q4-2006 Q3);
4. The period of massive capital inflows, up to the outbreak
of the global crisis (2006 Q4-2007 Q3);
5. The period between the global crisis setting in until the
domestic economy entered recession (2007 Q4-2008 Q3),
when the contribution of CORE3 inflation to the deviation
of CPI inflation from the target was positive and relatively
high for the first time.
 Measures aimed at taming capital inflows before
downturn in 2008 Q4. Did they work? NO! (I)

 Capital account liberalization (March 2003; last stage

Sep.2006)
 Introduction of restrictions on mortgage lending (February
2004)
 Stricter eligibility criteria for consumer loans (February 2004)
 Larger exposures to one debtor from 20% to 25% (July 2004))
 MRR on fx liabilities, from 25% to 30% (August 2004)
 MRR lei from 18% to 16% (August 2005)
 MRR on fx liabilities from 30% to 35% (January 2006)
 MRR on fx liabilities from 35% to 40% (March 2006)
 MRR lei, from 16% to 20% (July 2006)
 Measures aimed at taming capital inflows before
downturn in 2008 Q4. Did they work? NO! (II)

 Stricter criteria for household lending (LTV and Debt Service To Income)
 Forex exposures limited to three times own funds (September 2005)
 Unhedged borrowers (natural persons) cannot be classified into the top grade (A)
of financial performance (October 2005)
 Regulation and supervision of non-bank financial institutions (February 2006)
 Higher capital requirements since January 2007
 Stricter eligibility criteria for the components of own funds (January 2007)
 Loosening of credit standards for lending to households (March 2007)
 Stricter provisioning requirements for loans to unhedged borrowers (natural
persons) (March 2008)
 Exclusion of intermediate profit from own funds calculation (August 2008)
 Adjustment of max DTI within internal procedures approved by the NBR
(August 2008)
 High annual credit growth rates in Romania indicating
huge private capital inflows in 2004-2008 (%)
100
80
60
40
20
0
-20
-40 Source: author’s computations; NBR data

-60
2000Q1
2000Q3
2001Q1
2001Q3
2002Q1
2002Q3
2003Q1
2003Q3
2004Q1
2004Q3
2005Q1
2005Q3
2006Q1
2006Q3
2007Q1
2007Q3
2008Q1
2008Q3
2009Q1
2009Q3
2010Q1
2010Q3
2011Q1
2011Q3
2012Q1
2012Q3
Total credit (nominal growth rate)
Total credit (growth rate adjusted for FX variation and inflation)
FX loans (growth rate adjusted for FX variation and inflation)
 Faced with high capital inflows, the NBR increased
minimum reserve requirements (MRR) in Romania (%).
When the crisis hit Romania, the NBR reduced the MRR

50
40
30
20
10
0
Aug-03

Jul-06
Feb-07

Aug-10

Jul-13
Feb-14
Apr-08
Nov-08

Apr-15
Oct-04
May-05

Sep-07

Jun-09

Oct-11
May-12

Sep-14
Jan-03

Jan-10

Dec-12
Dec-05
Mar-04

Mar-11
-10

CPI annual inflation Core 3 inflation

Monetary policy interest rate MRR lei
MRR foreign currency
 A policy interest rate dilemma emerged late in 2006:
should the NBR increase the interest rate to curb
inflation or lower it to tame capital inflows?
10 Source: author’s computations; NBR data 10
8 9
6 8
7
4
6
2
5
0 4
-2 3
-4 2

2013T2

2014T3
2005T1
2005T2
2005T3
2005T4
2006T1
2006T2
2006T3
2006T4
2007T1
2007T2
2007T3
2007T4
2008T1
2008T2
2008T3
2008T4
2009T1
2009T2
2009T3
2009T4
2010T1
2010T2
2010T3
2010T4
2011T1
2011T2
2011T3
2011T4
2012T1
2012T2
2012T3
2012T4
2013T1
2013T3
2013T4
2014T1
2014T2
2014T4
2015T1
2015T2
CPI annual inflation (%)
Annual GDP gap (%)
Nominal leu/euro exchange rate (quarterly average, rhs)
Annual inflation target (rhs)
 Contributions to the deviation of CPI annual inflation
from the targer (pp): the monetary policy was not
10
procyclical
8 The real effective policy
6 interest rate (RRDPM)
4
2
-1
-3
-5 The gap of the real effective policy
-7 Source: Croitoru (2014) interest rate (GRRDPM)
2003 T1
2003 T2
2003 T3
2003 T4
2004 T1
2004 T2
2004 T3
2004 T4
2005 T1
2005 T2
2005 T3
2005 T4
2006 T1
2006 T2
2006 T3
2006 T4
2007 T1
2007 T2
2007 T3
2007 T4
2008 T1
2008 T2
2008 T3
2008 T4
2009 T1
2009 T2
2009 T3
2009 T4
2010 T1
2010 T2
2010 T3
2010 T4

2012 T1
2012 T2
2012 T3
2012 T4
2013 T1
2013 T2
2013 T3
2011 T1
2011 T2
2011 T3
2011 T4
Inflation persistence GDP gap
Imported inflation VAT
Inflation expectations Other factors
Administered prices VFE
Fuel prices Tobacco, cigarettes and alcohol
Deviation from the target (%)
 The history of contributions to the deviation of
CPI annual inflation from the targer (pp)(old
10 coefficients of the supply curve, new NIS GDP
8 data)
6 The policy real interest rate
4

-2

-4 The policy real interest rate gap

-6

-8
2003 T1

2003 T3

2004 T1

2004 T3

2005 T1

2005 T3

2006 T1

2006 T3

2007 T1

2007 T3

2008 T1

2008 T3

2009 T1

2009 T3

2010 T1

2010 T3

2012 T1

2012 T3

2013 T1

2013 T3

2014 T1

2014 T3
2011 T1

2011 T3
Core-3 inflation persistence
GDP gap VAT
Imported inflation Inflation expectations
Other factors Administered prices
VFE Fuel prices
Tobacco, cigarettes and alcohol Deviation from target of annual CPI inflation (%)
An explanation for the criticism that the central bank did not
increase the policy rate more aggressively prior to the
downturn
 Critics were ignoring:

• “Distortion”-type shocks in the supply equation, such as variations in

taxation rates, changes in markups pursued by firms or “cost-push shocks”
(Clarida, Galí and Gertler, 2001; Smets and Wouters, 2003; Benigno and
Woodford, 2003 and 2005; Woodford and Cúrdia, 2009)

• Endogenous responses (fluctuations) of the output gap to shocks (Erceg,

Henderson and Levin, 2000)

• Endogenous responses of the gap between the natural level and the
efficient level of output to supply-side shocks and to preference shocks
(Blanchard and Galí, 2007 and 2008)

• Financial frictions, the banking sector (Bernanke, Gertler, Gilchrist, 1998;

Woodford and Curdia, 2009) and real wage rigitities (Christiano et al.,
2011)
 The contribution to inflation of demand-pull inflation
became positive in 2007 Q4-2008 Q3
Period Deviation Contribut Contribut Real Real Real
of annual ion of ion of monetary monetary effective
CPI non- CORE3 policy policy monetary
inflation CORE3 inflation rate (%) rate gap policy
(pp) inflation (pp) (%) rate gap
(pp) (%)
(1) (2) (3) (4) (5) (6) (7)
2005 Q4-2007 0.25 1.58 -1.33 1.78 -0.57 -1.24
Q3
2007 Q4-2008 3.95 2.39 3.20 0.69 0.42
Q3
1.56
Table 1: The contributions of non-CORE3 inflation and CORE3 inflation to the deviation of annual CPI inflation
from the target and the real monetary policy rate
Source: Macroeconomic Modelling and Forecasting Department, NBR’s quarterly forecasting model, and the author’s
calculations.
 “Unconventional” monetary policy in the immediate
aftermath of the crisis
25
(i) a speculative attack fended off
also via foreign exchange market
20 intervention, not by higher interest
rate, as indicated in theory
(Christiano, Braggion and
15 Roldos,2009)
(ii) lower money market
10 interest rates as compared to
the monetary policy rate
5 Source: NBR data

0
Feb-07

Nov-08

Feb-14
Sep-07

Jun-09

Sep-14
Oct-04

Jan-10

Oct-11
Jan-03

Dec-05

Dec-12
Mar-04

Jul-06

Mar-11

Jul-13
Aug-03

Apr-08

Aug-10

Apr-15
May-05

May-12
Average interest rate on money market Monetary policy interest rate
 Prudential measures implemented during
October 2008-December 2012. Will they
work? I doubt! (I)
 MRR ratio on lei liabilities, from 20% to 18% (November 2008)
 Reduction of loan loss provisions by considering max 25% of
collateral in case of loans classified as Loss 2 (April 2009)
 Introduction of audited intermediate profit within own funds
calculation (May 2009)
 Introduction of the “First Home” program (June 2009)
 MRR ratio on lei liabilities, from 18% to15%; MRR ratio on fx
liabilities, from 40% to 35% (July 2009)
 Balance-sheet current accounts at accounting value instead of
adjusted value (July 2009)
 MRR ratio on fx liabilities, from 35% to 30% (August 2009)
 Prudential measures implemented
during October 2008-December 2012.
Will they work? I doubt! (II)
 MRR on fx liabilities from 30% to 25% (Nov. 2009)
 Improvements to the regulatory framework on managing liquidity risk
(Dec. 2009)
 Government Emergency Ordinance 50/2010 on consumer lending (June
2010). Removes abusive clauses from loan contracts
 MRR on fx liabilities, from 25% to 20% (Apr. 2011)
 Limits on exposures to unhedged borrowers; higher coefficients for stress-
testing fx loans (Oct. 2011)
 From Romanian Accounting Standards to IFRS adoption (Jan. 2012)
 Improvements to the regulatory framework on managing liquidity risk (Jan.
2012)
 Banks’ aggregate exposure limits vis-à-vis unhedged non-financial
companies (Dec. 2012)
 Higher inflation delayed the start of the policy
rate-cutting cycle in Romania

Annual inflation rate Policy interest rates

10 Sourc: ECB, National Central Banks, and
NBR`s computations
14
8 12 Source: National Central Banks

6 10
4 8
2 6
0 4
-2 2
Feb-08

Apr-10

Jul-13
Aug-14
May-11
Jun-12
Jan-07

Mar-09

Feb-08

Jun-12
Jan-07

Aug-14
Mar-09
Apr-10

Jul-13
May-11
EA HICP CZ CPI HU CPI
PL CPI RO CPI EA CZ HU PL RO
 10
15
20
25

0
5
Jan-07
Jun-07
Nov-07
Apr-08
Sep-08
Feb-09
Jul-09

EA
Dec-09
May-10

CZ
Oct-10

HU
Mar-11
Aug-11

PL
Jan-12
Jun-12
RO Nov-12
Apr-13
and NBR`s computations

Sep-13
Feb-14
Jul-14
Sursa: ECB, National Central Banks,
Interest rates on newly-extended loans decrease

Dec-14
May-15
VIII. Is a new monetary policy rate
dilemma emerging?
 The hypothesis of secondarity and implications for monetary
policy in Romania

• Secondarity: the global surplus of savings is generated in an

increasing number of countries, whereas the overwhelming
part of the global deficit of savings is located in the US
(Croitoru, 2015b and 2015d)

• The US are far better equipped to accommodate swift capital

outflows, currency depreciation, an abrupt decline in
domestic asset prices, banking system weakening, and the
flagging domestic demand
 Illustrated secondarity: the history of savings-
investment imbalances across major countries and
regions (USD mill., current prices)
1700000 UK
West Africa (WA)
1200000 North Africa (NA)
Africa (excl. NA and WA)
Former Soviet Union
700000 Eastern European Countries
other developed countries
Germany
200000
Euro area (excl. Germany)
Latin America and the Caribbean
-300000 West Asia (WAS)
China
Emerging Asia (excl. China and WAS)
-800000 Japan
Source: author’s calculations US
based on UNCTAD data
-1300000 Asia (total)
Global excess savings
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
 The Romanian conundrum (I)

• The current account deficit plunged from 4.5 percent of

GDP in 2012 to 0.4 percent of GDP in 2014
• GDP growth accelerated over that period
• How was it possible?

– One of the implications of shifting to excess savings is

the reduction in the natural rate of interest. Mutatis
mutandis, the plunge in the current account deficit in
Romania to almost zero was reflected in the lower
natural rate of interest

– The swift narrowing of the savings deficit suggests

that the natural rate has declined at a quick pace as
well
 The Romanian conundrum (II)

Inflation: a downward path, largely reflecting the fall in

inflation expectations. Hence, the NBR cut the monetary
policy rate from 5.25 percent in December 2012 to 1.75
percent in May 2015

Thus, it is possible that, during 2013, 2014 and 2015, the

nosedive of the current account deficit, the monetary policy
rate cuts and liquidity management may have resulted in the
money market rate running below the natural rate
 A new policy dilemma?
 Actual growth rates above potential will, probably, close the GDP gap
in 2016

 GDP growth rates above potential and low global interest rates will
pose again a dilemma to monetary policy in Romania (Croitoru,
2015c):

 A higher policy rate would be needed to tame inflationary

pressure from the positive GDP gap

 A lower policy rate would be needed to avoid the leu

appreciation

 If a current account surplus emerged, as the secondarity suggests, the

policy rate dilemma would not appear

 However, the new Fiscal Code based on tax cuts together with wage
increases up to 70 percent would lead to fiscal deficits of 4-5 percent
in 2016 and 2017, eliminating the issue of the interest rate dilemma,
but creating other serious problems to the macroeconomic stability of
Romania
Thank you!
 Bibliography
Bernanke, Ben; Gertler, Mark; Gilchrist, Simon (1999), „The Financial Accelerator in a Quantitative Business
Cycle Framework”

Blanchard, Olivier; Jordi, Gali (2007), “Real Wage Rigidities and the New Keynesian Model”, (2007), Journal of
Money, Credit and Banking, Supplement to Vol. 39, No. 1 (February).

Blanchard, Olivier; Jordi, Gali (2008), “Labor Market and Monetary Policy: A new Keynesian Model with
Unemployment”, Working Paper 13897, Nationla Bureau of Economic Research (March).

Erceg, J. Christopher; Henderson, W. Dale; Levin, T. Andrew (2000) “Optimal monetary policy with staggered
wage and price contracts”, Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.

Christiano, J. Lawrence; Trabandt, Mathias; Walentin, Karl (2011),” Introducing financial frictions and
unemployment into a small open economy model”, Journal of Economic Dynamics and Control, Elsevier, vol. 35
(12), pp. 1999-2041.

Clarida, H., Richard; Jordi Galí;Mark, Gertler (1999), “The Science of Monetary Policy:A New Keynesian
Perspective” Journal of Economic Literature,Vol. XXXVII (December), pp. 1661–1707.

Clarida, H., Richard; Jordi Galí;Mark, Gertler (2001), “Optimal Monetary Policy in Closed Versus Open
Economies: An Integrated Approach”, NBER Working Paper 8604, pp. 5-6.

Croitoru, Lucian (2014), „Teoria și critica politicii monetare în România”, în Despre economie: cu și fără formule,
forthcomoing, Curtea Veche Publishing.

Croitoru, Lucian (2015b), „Tendința spre secundaritate în administrarea dezechilibrelor globale”, www.bnro.ro.

Croitoru, Lucian (2015c), „The Romanian Conundrum”, www.bnro.ro, NBR’s blog.

Croitoru, Lucian (2015d), „Monetary policy and the global imbalances”, www.bnro.ro, NBR’s blog.
 Fig.1: Labor productivity and the general index of economic freedom in
1996
180
Source: author’s computations; AMECO;
GDP at current prices per hour worked (PPS,

Heritage Foundatoin
160 Luxemburg

140
Belgia

120 Danemarca
Germania
Suedia Franța Olanda
EU15=100)

100 Italia Austria

Spania Finlanda Marea Britanie
Irlanda
80
Grecia Cipru
60 Slovacia Portugalia
Cehia
40 Slovenia Ungaria
Polonia
Lituania
20 Bulgaria
România
Repressed eeconomies Mostly unfree Moderately free Mostly free economies
(ER) economies (EPNL) economies(EML) (EPL)
0
40 45 50 55 60 65 70 75 80
General index of economic freedom
 Fig. 2: Labor productivity and the general index of economic freedom in
2014
180

Luxemburg
GDP at current prices per hour worked (PPS,

160

140

120 Belgia Olanda

Irlanda
Franța Germania Danemarca
EU15=100)

Suedia
100 Austria
Finlanda
Italia Spania
Marea Britanie
80 Slovacia
Cipru
Slovenia Cehia
Grecia Malta
60 Portugalia Ungaria
Polonia Lituania Estonia
RomaniaLetonia
40 Bulgaria

20
Repressed economies Mostly unfree Moderately free Mostly free economies
(ER) economies (EPNL) economies(EML) (EPL)
0
40 45 50 55 60 65 70 75 80
General index of economic freedom
 Fig. 3: Labor productivity and property freedom in 1996

180 Source: author’s computations; AMECO;

Heritage Foundatoin
GDP at current prices per hour worked (PPS,

160
Luxemburg

140
Belgia
120 Danemarca
Germania
Franța Olanda
EU15=100)

100 Italia Austria

Suedia Marea Britanie
Spania Finlanda
80 Irlanda

Cipru Grecia
60 Slovacia Portugalia
Slovenia Cehia
40 Ungaria
Lituania Polonia
România
20 Bulgaria

ER EPNL EML Economii libere

0
20 30 40 50 60 70 80 90 100
Property freedom
 Fig.4: Labor productivity and property freedom in 2014

180 Source: author’s computations;

AMECO; Heritage Foundatoin
GDP at current prices per hour worked (PPS,

160 Luxemburg

140
Olanda
120 Belgia Danemarca
Germania
Franța Irlanda
EU15=100)

Suedia
100 Austria
Italia Spania Finlanda
Marea Britanie
80 Slovacia Cipru
Grecia Slovenia Malta
60 Lituania Cehia
Polonia Portugalia Estonia
Letonia Ungaria
România
40
Bulgaria

20
ER EPNL EML EPL Economii libere
0
20 30 40 50 60 70 80 90 100
Property freedom
 Fig. 5: Labor productivity and freedom from corruption in 1996

180 Source: author’s computations; AMECO;

GDP at current prices per hour worked (PPS,

Heritage Foundatoin
160 Luxemburg

140
Belgia
120 Olanda
Danemarca
EU15=100)

Germania
100 Franța
Italia
Spania Suedia
Irlanda Austria
80 Marea Britanie
Cipru Finlanda
Grecia
60 Slovacia
Cehia Portugalia
40 Slovenia Ungaria
Lituania Polonia
20 Bulgaria
România
ER EPNL EML Economii libere
0
20 30 40 50 60 70 80 90 100
Freedom from corruption
 Fig. 6: Labor productivity and freedom from corruption in 2014

180 Source: author’s computations; AMECO;

GDP at current prices per hour worked (PPS,

Heritage Foundatoin
160 Luxemburg

140
Belgia
120 Irlanda Olanda
Franța Germania Danemarca
EU15=100)

100 Suedia
Austria Finlanda
Italia Spania
Marea Britanie
80
Slovacia Cipru
Cehia Slovenia
Malta Portugalia
Grecia
60 Lituania Estonia
Polonia
LetoniaUngaria
România
40 Bulgaria

20
ER EPNL EML EPL Economii libere
0
20 30 40 50 60 70 80 90 100
Freedom from corruption
 Financing of the current account: mostly from the
financial account (bn. EUR)
20.0

15.0

10.0

5.0

0.0

-5.0
Source: author’s computations based on NBR data

-10.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
CAPITAL ACCOUNT FINANCIAL ACCOUNT
NET ERRORS AND OMISSIONS CURRENT ACCOUNT DEFICIT