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3.2.2.4 Romania's Monetary Sector


Update Note: The data on this page covers the time until 2008 and is still useful. For more recent data please visit the page about inflation in Romania

Not only real sectors in Romania were shaken during transition. The decline in output was accompanied by hyperinflation, which reached its first peak (256.1 %, cf. Figure 3.12) only in 1993. Afterwards it remained below 50 % for two years. The extent of inflation in Romania exceeded effects from price corrections (which ought to be an once-off adjustment anyhow; cf. Wyplosz 2000: 4) and the monetary overhang due to the decline in output by far. It was rather closely related to the exchange rate controls of the first years. Official exchange rates in Romania were primarily allocated to subsidized industries (cf. OECD 1998: 5) and only after 1997 market driven (ibid: 21ff.).

Inflation in Romania and the Exchange Rate

The former central banker Dăianu has two explanations for the turmoil of the monetary sector during the nineties, a straightforward one and then a technical, again very insightful one.[1] First, Dăianu & Kallai (cf. 2004: 2) clarify that without a working tax system (cf. chapter 3.2.2.5) seignorage was the only way to finance government expenditures. Second, Dăianu & Vranceanu (2001) explain the connection between high inflation in Romania and exchange rate controls as a form of indirect subsidizing.

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First, transition economies were not just “standard economies hit by a large adverse supply shock, which had to solve simultaneously a problem of monetary overhang and declining output” (ibid: 3). They inherited a centralized landscape of vertical interdependent enterprises, which risked to collapse entirely, even if only few of the firms had fallen out. On the other hand, not all intermediate products were home-made; especially energy had to be bought via world-markets. A rising exchange rate would have undermined the attempt to back these firms via subsidies and blocked energy prices in domestic currency. The budget deficits were financed by the central bank, what led to the vicious circle of increasing prices due to the increasing money supply and additional pressure on the exchange rate. “Even if the central bank had striven to keep the parity constant, the loss of competitiveness entailed reserve depletion and, in the end, the currency had to be devalued. A new inflation cycle is at work” (ibid: 4).

Later on, second, after the abolishment of many direct subsidies, the creation of massive arrears had a similar effect, as “the resulting deficit is in general monetized” (ibid.). But then, it was the private sector, which had a dominant incentive for pretending to be weak and to create the arrears as a form of tax exemption (ibid.). However, with the existence of a private sector the foundations for elimination of loss-making firms at lower social costs were laid (the following resume in restructuration, respectively lay-offs, can be observed well in Figure 3.5). After the liberalization of the exchange rate by 1997, when inflation reached another peak of about 155 % annually, inflation finally started dropping. Until the end of the nineties the BNR still tended to intervene quite often on the markets but the rise in prices decelerated subsequently at an average pace “by international and regional standards” (IMF 2004: 28).

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In short, the inflation dynamics of the nineties were driven by the Government’s intention to reduce the social costs of transition and to increase its revenues via seignorage.  The situation improved further after strengthening the independence of the Central Bank in 1998 when a new law (No. 101/1998) stipulated price stability as a main goal and reduced the Government’s access to seignorage revenues (cf. Albu & Pelinescu 2000: 12). Another interesting observation is that the peaks of inflation (respectively the freeze in disinflation) coincided with the election years 1992 and 1996/1997, respectively 1999/2000, but not so in 2004 (cf. chapter 3.2.2.5 for further observations).

Image3.12: Inflation and Exchange Rate
The interconnection between the Romanian exchange rates and inflation rates in Romania

Source: INS 2008 & PWT 6.2; own calculations, own graphic[2]

Current Inflation Dynamics in Romania

Academic Research paper and Study of the Economy of Romania and Romanian Business
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The IMF (2004: 22ff.) identified three important sources for inflation in Romania after 2000. First, inflation persistence; this is the time inflation needs to disappear after it once appeared as a reaction on a shock.[3] Exchange rate and labor shocks were found to be the other important sources of inflation, while demand shocks turned out to have a neglectable impact. The disinflation strategy after 2001 was a prudent and gradual one, aiming at reducing inflation by some 30 % a year. This strategy seemed to work fine and was qualified as “appropriate” by the IMF (ibid: 29). In 2005 Romania officially joined the new club of “Inflation Targeters” (cf. Dăianu & Lungu 2006: 23) among the transition economies. So did most other CEECs in that time, following the example of several Western countries such as New Zealand or Canada. The outcome so far has nowhere been a big improvement, nor has it worsened the situation (cf. ibid: 29ff.).

Footnotes

[1] Dăianu himself was chief economist of the BNR from 1992 to 1997. From 1997 to 1998 he was finance minister of the Romanian Government under Prime-Minister Victor Ciorba [cf. Alexandrescu & Stoica (2006: 390f.)].

[2] Exchange rate data taken from PWT 6.2. Direct quotation, expressed as national currency against 1 Int.-$.

[3] Inflation persistence is different from inflation inertia; the time of delay inflation needs to appear after a shock. Inertia might be caused by sticky prices and wages, adaptive expectations or the low credibility of a policy (cf. IMF 2004: 22ff.).