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Monetary Policy and Currency Alignment in Post War Iraq Kevin A. Vetelino ECO 6226 Summer 2004 OUTLINE Introduction - where are we now Historical Monetary Policy in Iraq Possible Options Central bank, currency board, dollarization Experts Recommendations Analysis post-war and petroleum-based economies Conclusion and Recommendations Introduction 2003 invasion of Iraq An oppressive dictatorial regime removed Lack of security and relative lawlessness Suggests Future success lies with economic growth + stability, currency Price efforts required was underestimated system and monetary policy control is of utmost importance discourage investment in DIs +stunt financial system growth Iraqi Monetary History Iraq - created by the British in in 1916 Used Iraqi independence in 1932 Iraqi Iraqi the Indian rupee currency board established 1 Iraqi Dinar = 1 British pound sterling Central Bank established in1947 support 2003, government debt + drove inflation official exchange was 3.22 dinars/dollar money bazaars rates were 4000 dinars/dollar At the Time of the Invasion Two currencies in Iraq Saddam dinar: nationwide Swiss dinar: Kurdish region Six private commercial banks limited independence from from the government completely insolvent Current international debt in excess of $300B Central Banks Established regulate to provide a money + credit system monetary forces to promote economic growth. Functions regulation of the money supply, issuing currency, being a lender of last resort, fiscal advisor, bank regulator Conducts open monetary policy market operations, setting the prime lending rate, setting reserve requirement, printing money moral suasion Currency Boards Issues domestic currency at fixed rate to anchor currency pound sterling, EURO, US dollar (maintains 100% reserve) Do not lend to public or government (not a lender of last resort ) Advantages: Force strict fiscal discipline low inflation develops responsible banking practices. Disadvantages: Can’t implement monetary policy “lack of sovereignty” Arguments for Currency Board Hanke and Sekerke, Johns Hopkins University need to strictly control of inflation historical lack of fiscal discipline w/high debt Central bank cannot function in currently in Iraq Not financial markets Insolvent banks Lack of data and experience “flying blind without instruments” Mark Spiegel Fed in San Francisco establish currency credibility Steven Hanke Arguments for Central Bank Coalition Provincial Authority Established the Central Bank of Iraq Issued new dinar, floating exchange rate Paul Bremmer Roubini + Setser (NYU, Council on Foreign Relations) Superior for commodity based economy Currency boards adopt MP of anchor Oil supply shock (outside of Iraq) drive prices and demand for Iraq’s oil: tight money importing nations: loose money recipe for deflation Nouriel Roubini Analysis: Petroleum Exporters Norwa y Saudi Arabia Ve nezuela Iraq Petrole um Production 3.4M bl/day 6.0M bl/day 3.0M bl/day 3.0M bl/day (6M exp ) Petrole um GDP 35% 90% 85% 80-90% DEBT in 2002 Currenc y Exchange $0 (creditor) $25B $38B $300B Float Peg “managed peg” Float? Analysis: Petroleum Exporters INFLATION Analysis: Petroleum Exporters GDP per capita annual growth Analysis: currency board nations Bosnia and He rzego vina Establish ed currency boar d De bt/GD P (2002) Est on ia Lithuan ia Bul garia 1998 1992 1994 1997 51% 10% 9.4% 21% Iraqi debt/GDP is expected to be 300% in 2005 Dependent on debt restructuring Analysis: currency board nations INFLATION Analysis: currency board nations GDP per capita Conclusions Initiate a currency board arrangement To the dollar (or possibly to the Euro) Temporary measure for period of 5-7 years Establish a central bank gradual replacement of reserve w/domestic gov’t bonds conduct open market operations critical for a petroleum-based economy such as Iraq Temporary nature is critical for cultural and political reasons. allow the financial system to grow and mature Questions?