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The Academy of Economic Studies Bucharest Doctoral School of Banking and Finance

DISSERTATION PAPER The Analysis of the Monetary Policy Stance In Romania Using Monetary Conditions Index (MCI). The Case of Managed Floating Under MCI Targeting MSc. Student:

Cristian Sabou

Supervisor: Prof.

Moisa Altar Bucharest, July 10, 2001

Contents •

Objectives

•

Concepts rewiew

•

Models of the MCI in a small open economy

•

A model of MCI in a managed floating fx regime

•

Econometrical estimation and parameter determination

•

Conclusions

The characteristics of monetary policy stance in Romania The variables used by the NBR in conducting its monetary policy The influence of the FX managed float regime of Romania over the real monetary policy stance in the economy

The monetary policy of the NBR: rules vs. discretionarity The operational targets of the NBR: the interest rate, the exchange rate of ROL and the monetary base Can the Monetary Conditions Index be calculated for Romania?

The information provided by the MCI for the monetary policy in Romania

Derivation of the MCI in an Open Economy A simple model of an open economy 

 1  

 

y t

  (

e t



e t

 1 )  

 1

y t

 1   

r t

 

e t

 

y t

 

 1

e t

 1   

r t

 1  

 1 From this model it is derived (Ball,1997) the MCI:

MCI

 ( 1 

)

e t



wr t



ay t



( 

 

e t

 1 )

L t

  1 (

 

t S

) 2   2 ( 

 

) 2 Through minimization of the loss function, Gerlach and Smetz obtain:

MCI t opt

 1 /  1 ( 

t D

 

t S

)  (  ) /  1 ( 



E t

 1 

)

r t opt



( 

, ~

) 

ˆ 

( 

 

) 

b y t MCI t opt



( 

, ~

) 



( 

 

) 

b y t

The case of managed floating in determiningthe MCI

y t

  0   1

r t

  2

e t

 

t d y t

  0   1

r t

  2

E t



e t

 1   3

e t

 

t d E t



e t

 1  

e t y t

  0   1

t r

  2 

e t

  3

e t

 

t d

   1 (

r t



ˆ )   2 

e t

  3 (

e t



ˆ )  

t d MCI

  1 (

r t



0 )   2 

e t

  3 (

e t



0 ) A monetary policy framework for small open economies using MCI

i t

 1 1   (

ICM opt

   

r t

* )  



s t

 1 1   (

ICM opt

  

r t

* )  

 

The empiric testing of the Monetary Conditions Index (MCI) for a managed floating currency regime

MCI

  1 (

r t



0 )   2 

e t

  3 (

e t



0 ) We will estimate the structural parameters taking into account the IS curve in the same model

y t

  0   1

r t

  2 

e t

  3

e t

 

t d

We use the industrial production as a proxy variable for the output

Variables Name L_CS L_CS_REAL DOB_REALA L_PROD_FX L_USD_FX L_BSK_FX Description Fx nominal rate for USD/ROL in log Fx real rate for USD/ROL in log The real interest rate for corporates Industrial production index with fixed base ianuarie 1997 in logaritm Real fx rate of USD/ROL with fixed base as of 1/97 in log Real fx rate of BASKET /ROL with fixed base as of 1/97 in log

ADF test Lag t statistic L_CS constant ă şi trend L_CS_REAL DOB_REALA L_PROD_FX L_USD_FX L_BSK_FX Constant ă Constant ă constant ă şi trend constant ă constant ă 1 1 1 1 1 1 -3,1072 -5,4095 -4,4941 -2,9820 -4,6777 -6,4846 1% -4,1458 -3,5778 -3,5778 -4,1678 -3,5778 -3,5778 5% -3,4987 -2,9256 -2,9256 -3,5088 -2,9256 -2,9256 The only nonstationary series are L_CS and L_PROD_FX

For the order of integration, we determine the first difference: Lag ΔL_CS ΔL_PROD_FX Constant ă Constant ă 1 1 t statistic -11,7830 1% -3,5653 5% -2,9202 -6,6410 -3,5814 -2,9271 We find that the L_CS and L_PROD_F are first order integrated, so the OLS or VAR are not appropiate. I will use a partial adjustment model.

Structural parameter estimation taking into account the USD/ROL fx rate L_PROD_FX = –0.0167 + 0.7880·L_PROD_FX(-1) + 0.1030·L_USD_FX(-3) + (-0.572) (8.670) (1,205) 0.4477·ΔL_USD_FX –0.621·DOB_REALA+ -0.106·DM9803 (1,194) (-1,081) (1,837) 0.123·SEAS(12) (-4,131)

The residual graph: 0.15

0.10

0.05

0.00

- 0.05

- 0.10

- 0.15

97:07 98:01 98:07 99:01 99:07 00:01 00:07

According to the Jarque - Bera test, the errors are normally distributed 14 12 10 2 0 8 6 4 -0.10

-0.05

0.00

0.05

0.10

Series: Residuals Sample 1997:03 2000:12 Observations 46 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability -1.61E-17 0.004532

0.122594

-0.110723

0.051092

-0.112420

3.285504

0.253126

0.881119

Other tests: R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat 0.778199 Mean dependent var 0.744076 S.D. dependent var 0.054882 Akaike info criterion 0.117469 Schwarz criterion 72.04399 F-statistic 2.244708 Prob(F-statistic) -0.235604

0.108486

-2.828000

-2.549728

22.80559

0.000000

So, in this case we have obtained:  1  0 .

621 ,  2   0 .

4477

 3   0 .

1030

The structural parameter estimation taking into account the Basket / ROL real FX rate L_PROD_FX = –0.003 + 0.8045·L_PROD_FX(-1) + 0.1060·L_BSK_FX(-3) + (-0.101) (8.920) (1,189) 0.617·ΔL_BSK_FX –0.6740·DOB_REALA+ -0.112·DM9803 (1,579) (-1,178) (1,941) 0.1259·SEAS(12) (-4,237)

The residual graph looks like: 0.15

0.10

0.05

0.00

- 0.05

- 0.10

- 0.15

97:07 98:01 98:07 99:01 99:07 00:01 00:07 Jarque - Bera test shows that the errors are normally distributed

16 12 8 4 0 -0.10

-0.05

0.00

0.05

0.10

Series: Residuals Sample 1997:04 2000:12 Observations 45 Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis Jarque-Bera Probability -2.37E-17 0.001646

0.121494

-0.116521

0.050540

-0.144529

3.432204

0.506915

0.776113

Other tests are: R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat 0.755546 Mean dependent var 0.716948 S.D. dependent var 0.054384 Akaike info criterion 0.112389 Schwarz criterion 70.97795 F-statistic 2.254033 Prob(F-statistic) -0.241414

0.102220

-2.843464

-2.562428

19.57472

0.000000

So, in this case we have obtained:  1  0 .

6740 ,  2   0 .

6170

 3   0 .

1060

EVOLUTION OF THE MCI, WITH BASIS PERIOD AS OF JANUARY 1997

0.4

0.3

0.2

0.1

0 Ja n-9 7 M ar-9 7 M ay -9 7 Ju l-9 7 Se p-9 7 No v-9 7 Ja n-9 8 M ar-9 8 M ay -9 8 Ju l-9 8 Se p-9 8 No v-9 8 Ja n-9 9 M ar-9 9 M ay -9 9 Ju l-9 9 Se p-9 9 No v-9 9 Ja n-0 0 M ar-0 0 M ay -0 0 Ju l-0 0 Se p-0 0 No v-0 0 -0.1

-0.2

-0.3

MCI_USD

TIMP

MCI_BASKET

Other factors that influence the choice of the foreign exchange rate regime in Romania •the manner in which inflationary expectations are formed •the currency structure of the external andd internal debt •the stage of the process of the integration in U.E.

Conclusions • the stance of the monetary policy was much more restrictive in the period of 1997 - 2000, than NBR aimed at • if a managed floating regime is not taking into consideration the currency of the main trading partners, this would cause high output variability •in the near future, Romania will have to redirect its fx regime towards the euro (starting with the targeting the EUR/ROL fx rate within still a managed floating currency regime)

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