Download Effectiveness of currency board

Eesti Pank
Bank of Estonia
15 years of currency
board in Estonia
Ülo Kaasik
Eesti Pank
Bank of Estonia
Outline
Currency Board Arrangement in Estonia
• History
• Framework and results
• Recent developments and challenges
Ülo Kaasik CBA in Estonia
2
Eesti Pank
Bank of Estonia
Why choosing CBA?
• Need for stabilising anchor in the beginning of
1990s
• Creating a simple and reliable monetary system,
effective since 1992
• Small open economy with free capital mobility
Ülo Kaasik CBA in Estonia
3
Eesti Pank
Bank of Estonia
Monetary system
• Fixed exchange rate against euro (since 1999,
formerly since 1992 equivalently against the
DEM)
• Full convertibility of Estonian kroon
• Base money is fully backed by high quality
foreign assets
Ülo Kaasik CBA in Estonia
4
Eesti Pank
Bank of Estonia
Operational framework
• Smooth liquidity management through unlimited
EUR-EEK exchange with the central bank (forex
window)
• High liquidity buffers in the form of required reserves
(reserve ratio currently 15%)
• No domestic monetary policy interest rate: monetary
stance is determined by European Central Bank
monetary policy decisions
Ülo Kaasik CBA in Estonia
5
Eesti Pank
Bank of Estonia
Other policies supporting CBA
• Fiscal policy based on a balanced budget
principle
• Tax system – motivating, transparent, simple
• Liberal trade and investment regime since
1991
• Flexible labour market
• Strong banking system
• Preparations for EU membership
Ülo Kaasik CBA in Estonia
6
Eesti Pank
Bank of Estonia
What are the results?
Ülo Kaasik CBA in Estonia
7
Eesti Pank
Bank of Estonia
Relatively quick stabilisation of the economy
1992 -- 1077%
The introduction of
the currency board
was crucial in
achieving disinflation
20
00
100%
During the last 8
years the average
CPI has been 3.7 %
CPI (1991-2007)
80%
1991 -- 257%
60%
40%
20%
20
06
20
07
(4
)
20
05
20
04
20
03
20
02
20
01
19
99
19
98
19
97
19
96
19
95
19
94
19
93
0%
Ülo Kaasik CBA in Estonia
8
Eesti Pank
Bank of Estonia
The interest rates have converged to the
interest rate level in euro-area countries
20%
18%
A
16%
14%
A-
12%
10%
8%
BBB+
6%
4%
2%
0%
1996
1997
1998
1999
2000
3M EURIBOR (3M DEM LIBOR)
2001
2002
3M TALIBOR
2003
2004
2005
2006
2007
Sovereign Rating (Standard & Poor's)
Ülo Kaasik CBA in Estonia
9
Eesti Pank
Bank of Estonia
Fast capital inflow,
through FDI and banking system
90%
140%
domestic banks, total assets % of GDP
FDI stock, % of GDP
80%
120%
FDI inflow, % of GDP
70%
banks with foreign ownership, total assets % of GDP
100%
net foreign assets of banks, % of GDP
80%
60%
60%
50%
40%
40%
20%
30%
0%
20%
-20%
10%
-40%
Ülo Kaasik CBA in Estonia
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
-60%
1994
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
0%
10
Eesti Pank
Bank of Estonia
Very rapid income convergence
70
10000
60
8000
50
6000
40
4000
30
2000
20
0
10
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
12000
GDP per capita (EUR, nominal), left scale
Source: Eurostat
GDP vs EU-25 (%, PPP), right scale
Ülo Kaasik CBA in Estonia
11
Eesti Pank
Bank of Estonia
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
goods balance
income balance
total current account
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
-30%
1993
% of GDP
… and current account deficit
services balance
current transfers balance
Ülo Kaasik CBA in Estonia
12
Eesti Pank
Bank of Estonia
Pace have accelerated during last years
•
•
•
•
Double digit GDP growth
Rapid credit growth
Deepening CAD
Inflation well above Maastricht criterion
Ülo Kaasik CBA in Estonia
13
Eesti Pank
Bank of Estonia
How to avoid overheating of the economy
under CBA? Case of Estonia
• Flexibility: in economic policies and markets
• Reducing cost and price pressures of the
government
• Reminding conservative financial decisions
• More reserves in the financial system
• Close cooperation with supervisors and central
banks of the host countries
Ülo Kaasik CBA in Estonia
14
Eesti Pank
Bank of Estonia
45,000
reserve requirement
40,000
deposits in Bank of Estonia
market value of foreign assets liquidity portfolio
35,000
30,000
25,000
20,000
15,000
10,000
5,000
Ülo Kaasik CBA in Estonia
02/08/2007
02/02/2007
02/08/2006
02/02/2006
02/08/2005
02/02/2005
02/08/2004
02/02/2004
02/08/2003
02/02/2003
02/08/2002
02/02/2002
02/08/2001
02/02/2001
02/08/2000
02/02/2000
02/08/1999
02/02/1999
02/08/1998
0
02/02/1998
mln EEK
CBA ensures high liquidity buffers
15
Eesti Pank
Bank of Estonia
Flexible labour markets is crucial for
economic adjustment
40%
nominal wage growth
35%
real productivity growth
30%
25%
20%
15%
10%
5%
Ülo Kaasik CBA in Estonia
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
0%
16
Eesti Pank
Bank of Estonia
CBA cannot operate without
conservative fiscal policy
5%
4%
General government deficit/surplus,
% of GDP
3%
2%
1%
0%
-1%
-2%
-3%
-4%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Ülo Kaasik CBA in Estonia
17
Eesti Pank
Bank of Estonia
Is inflation too high?
Ülo Kaasik CBA in Estonia
18
Eesti Pank
Bank of Estonia
Average annual real GDP growth (2001-2005),
%
Lower level of convergence implies faster
growth rate
9
8
7
6
5
4
3
2
1
0
LV
LT
20
EE
40
60
80
100
GDP per capita in PPS (2000), EU25=100
Ülo Kaasik CBA in Estonia
120
19
Eesti Pank
Bank of Estonia
Income and price levels tend to
correlate i.e. converge together
R2 = 0,9101
140
120
price level
100
80
60
40
20
0
0
20
40
60
80
100
120
140
160
gdp per capita
Price level and GDP per capita in PPS in European Union (except Luxembourg)
Source: Eurostat
Ülo Kaasik CBA in Estonia
20
Eesti Pank
Bank of Estonia
Apart from conjunctural price increases
current inflation rate also reflects price
convergence
CPI
Services
Manufactured goods excl fuel
12%
10%
8%
6%
4%
2%
0%
-2%
2000
2001
2002
2003
2004
2005
Ülo Kaasik CBA in Estonia
2006
2007
21
Eesti Pank
Bank of Estonia
Economy has started to cool down, 2007 Q2 growth was
7.6%
difference
GDP growth Estonia
GDP growth euroarea
14%
12%
10%
8%
6%
4%
2%
0%
-2%
-4%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Ülo Kaasik CBA in Estonia
2005
2006
2007
22
Eesti Pank
Bank of Estonia
Credit cycle has turned
Credit growth in the non-financial sector
60%
50%
40%
30%
20%
10%
0%
I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV
2001
2002
2003
2004
Credit growth y-o-y
2005
2006
2007
2008
• Monthly credit
growth has not
declined to a too
low level – it
remained around
2% during the
whole summer
2009
Spring forecast 2007
Ülo Kaasik CBA in Estonia
23
Eesti Pank
Bank of Estonia
The external balance has not widened any further
Current account (% of GDP)
0%
-2%
-4%
-6%
-8%
-10%
-12%
-14%
-16%
-18%
-20%
I II III IV I II III IV I II III IV I II IIIIV I II III IV I II III IV I II III IV I II* III IV I II IIIIV I II III IV
2000
2001
2002
2003
Current account
2004
2005
2006
2007
2008
2009
Spring forecast 2007
* Flash estimate
Ülo Kaasik CBA in Estonia
24
Eesti Pank
Bank of Estonia
No big impact of financial turbulences
3M Talibor-Euribor (l.s)
3M Rigibor-Euribor (r.s)
04.09.07
21.08.07
07.08.07
24.07.07
10.07.07
26.06.07
-1
12.06.07
0,0
29.05.07
0
15.05.07
0,1
01.05.07
1
17.04.07
0,2
03.04.07
2
20.03.07
0,3
06.03.07
3
20.02.07
0,4
06.02.07
4
23.01.07
0,5
09.01.07
5
26.12.06
0,6
12.12.06
6
28.11.06
0,7
14.11.06
7
31.10.06
0,8
6M Talibor-Euribor (l.s)
6M Rigibor-Euribor (r.s)
Ülo Kaasik CBA in Estonia
25
Eesti Pank
Bank of Estonia
Euro adoption as the ultimate exit clause
• Adoption of the euro as soon as possible,
targeting 2011
• Central role of the government in reducing
inflation:
– Avoiding additional cost and price pressures
– Managing regulated prices
• No changes expected in the monetary
environment due to euro adoption
Ülo Kaasik CBA in Estonia
26
Eesti Pank
Bank of Estonia
Conclusions
• CBA can be an effective corner stone for the
economy
• However, CBA cannot be successful without
supportive economic policies
• CBA offers the closest monetary environment to
the euro area, preparing the economy for the
euro adoption
Ülo Kaasik CBA in Estonia
27