Monetary Policy and Currency Monetary Policy and Currency Alignment in Post War IraqAlignment in Post War Iraq

Kevin A. VetelinoKevin A. Vetelino

ECO 6226 ECO 6226 SummerSummer 2004 2004

OUTLINEOUTLINE Introduction - where are we nowIntroduction - where are we now Historical Monetary Policy in IraqHistorical Monetary Policy in Iraq Possible OptionsPossible Options

Central bank, currency board, dollarizationCentral bank, currency board, dollarization Experts RecommendationsExperts Recommendations AnalysisAnalysis

post-war and petroleum-based economiespost-war and petroleum-based economies Conclusion and RecommendationsConclusion and Recommendations

IntroductionIntroduction 2003 invasion of Iraq

An oppressive dictatorial regime removed

Lack of security and relative lawlessness Suggests efforts required was underestimated

Future success lies with economic growth + stability, currency system and monetary policy

Price control is of utmost importance discourage investment in DIs +stunt financial system growth

Iraqi Monetary HistoryIraqi Monetary History Iraq - created by the British in in 1916

Used the Indian rupee

Iraqi independence in 1932 Iraqi currency board established

1 Iraqi Dinar = 1 British pound sterling

Iraqi Central Bank established in1947 support government debt + drove inflation

2003, official exchange was 3.22 dinars/dollar money bazaars rates were 4000 dinars/dollar

At the Time of the InvasionAt 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 BanksCentral Banks Established to provide a money + credit system

regulate 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 monetary policy open market operations, setting the prime lending rate, setting reserve requirement, printing money moral suasion

Currency BoardsCurrency 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 BoardArguments 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 BankArguments for Central Bank

Coalition Provincial Authority Established the Central Bank of Iraq Issued new dinar, floating exchange rate

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

Paul Bremmer

Analysis: Analysis: Petroleum ExportersPetroleum Exporters

Norway SaudiArabia

Venezuela Iraq

PetroleumProduction 3.4M bl/day 6.0M bl/day 3.0M bl/day 3.0M bl/day

(6M exp)PetroleumGDP 35% 90% 85% 80-90%

DEBT in2002 $0

(creditor)$25B $38B $300B

CurrencyExchange

Float Peg “managedpeg” Float?

Analysis: Analysis: Petroleum ExportersPetroleum ExportersINFLATIONINFLATION

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

1994 1996 1998 2000 2002

YEAR

NorwaySaudi ArabiaVenezuala

Analysis: Analysis: Petroleum ExportersPetroleum Exporters GDP per capita annual growth GDP per capita annual growth

-30%

-20%

-10%

0%

10%

20%

30%

40%

1994 1996 1998 2000 2002

YEAR

NorwaySaudi ArabiaVenezuala

Analysis: Analysis: currency board nationscurrency board nations

Bosniaand

HerzegovinaEstonia Lithuania Bulgaria

Establishedcurrencyboard

1998 1992 1994 1997

Debt/GDP(2002)

51% 10% 9.4% 21%

Iraqi debt/GDP is expected to be 300% in 2005 Dependent on debt restructuring

Analysis: currency board nationsAnalysis: currency board nationsINFLATIONINFLATION

-10-505

10152025303540

1995 1996 1997 1998 1999 2000 2001 2002 2003

YEAR

B&HBulgariaEstoniaLithuania

Analysis: currency board nationsAnalysis: currency board nations GDP per capita GDP per capita

500

1000

1500

2000

2500

3000

3500

4000

4500

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

YEAR

B&HBulgariaEstoniaLithuania

ConclusionsConclusions 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?Questions?