Assessing NBR’s policy, some tough preliminary conclusions

As usual, before every NBR interest rate decision economists/analysts/journalists will take their shot at guessing what that decision will be. As Chief Economist for a commercial bank I was guilty of participating in this very narrow interpretation of monetary policy. Today “freed” from those shackles I can ask the really important question: Is monetary policy Romania loose or tight?

This is not a simple question to answer for few reasons. First, we need a reference point. Monetary policy has to be loose or tight relative to something. Luckily the NBR has a target, inflation, so we can see how it did against this indicator. Second, we need an indicator. Are falling interest rates a sign of easy money? Or should we look at growth of monetary aggregates? And third, we need to assess the importance of the economic times. Is monetary policy loose or tight for current economic conditions?

Let’s start with the performance against inflation. NBR introduced the inflation targeting regime in August 2005. The first graph below shows monthly data for annual inflation rates since January 2001. The decreasing trend is clear until January 2007.

Let’s focus on the period starting 2007 to get a better look. The second graph clearly shows the divergence of actual inflation from target starting 2007. What is interesting is that while the target was getting more ambitious with every year actual inflation was not following.

Here is a table showing average inflation performance versus target.  It is clear that average inflation did not fall below 6% since 2005 while the average target has been reduced by 1.6%.

2005-2011 2007-20011 2009-2011


Average Inflation










What to make of all this? I see two conflicting conclusions. If we look at the inflation performance versus target it seems monetary policy has been too loose since 2005. But if we judge it by the target alone it seems that NBR was trying to convey the message of conducting a tightening monetary policy.

Let’s move on to interest rates. Below is a graph showing the key policy rate versus interbank rates. Again, NBR does not make it easy for us. Looking at the key policy rate alone does not tell you much as until 2008 the NBR was a net debtor to the financial sector. Assessing the key policy rate against money market rates (i.e. price of short term liquidity) offers few interesting conclusions: very expensive liquidity from October 2008 to January 2010 and much cheaper after that. However, conclusions about monetary policy from the Romanian money market should be treated with caution as since October 2008 there is a cap on the upside price for money market liquidity imposed by NBR.

Still interesting here is to look at average interest rates versus average inflation.

2005-2011 2007-20011 2009-2011


Average Inflation





Average Key Rate





Average MM rates





Just by looking at this data it shows that real rates in the money market have been fairly low and even negative in 2011. This would once again lead to the conclusion that NBR ran a loose monetary policy and even a too loose one during 2011.

Somehow this conclusion does not seem right. Most of the shocks to the inflation came from the supply side and the fall that followed was just the statistical base effect, nothing really to do with monetary policy.  Furthermore the price for retail deposits or the interest margin on lending has not decreased in line with expectations from a loose monetary policy.

My biggest concern is that looking at inflation or interest rates does not capture the negative shock Romania received in 2008 from the global economy and the response of monetary policy to that shock. One way to identify that shock, in a market where interest rates are controlled by regulation, is to look at monetary aggregates, especially M1 as it is easily controlled by the monetary policy of NBR.

And here it is. I think it should be clear from the picture below that immediately after the fall of Lehman Brothers there was a massive negative shock to the economy through the money supply. This was happening in the same time as Romania was receiving another negative shock from the global economy thorough fall in demand and capital outflow.

Of course, one could say that money supply fell because there was a big contraction in domestic demand. This is not likely. My preliminary econometric analysis and the graph below show the contrary. In the graph below M1 growth is fared against NGDP growth. As you can see, is the M1 who leads not the drop in GDP.  Also interesting, if we look at the most recent data the gap between the two can be closed either by increasing money supply or by a drop in NGDP.  As the money supply has already been contracted  in 2011 I expect NGDP to contract also in the quarters ahead.

Is not an easy job to identify the NBR’s policy and its impact. Against a nominal target NBR policy seems too lose, but as I explained this is not true as most of the shocks to inflation came from the supply side. Most importantly the NBR policy seems too tight when it comes to the real economy. Although not ready with the research yet, preliminary conclusions show that monetary policy in Romania chose the wrong response to the October crisis and might have pushed the economy further into recession. That is why I hope that tomorrow central banks will consider all monetary conditions and their impact on the economy.

Sneak preview

There are three applied projects I am currently pursuing. First, I am looking at the impact of adding exchange rate as a target in a flexible inflation targeting regime for Romania. Second, I am looking to show that even thought the NBR claims that in October 2008 it based its decisions on a third generation model currency crisis the actual response was that of a second generation crisis model. This paper will also deal with the negative shock to the economy from the NBR’s response to that event. Third, I am fairly advanced in writing a book about the financial sector in Romania over the last 6 years. It will also include my detailed experience working for a commercial bank during these difficult times.  A local version of Liar’s Poker if you will.

Sources: NBR, IMF, Eurostat

13 thoughts on “Assessing NBR’s policy, some tough preliminary conclusions

  1. “Most importantly the NBR policy seems too tight when it comes to the real economy.”

    Unfortunately, this is the only thing that matters in a country: the real economy.

    It’s like some are living on Terra and others are living on Mars. Why not try to live everybody, including NBR, on the same place?!

    But I’m waiting for your book with interest. >:D<. Lair's Poker and The Big Short are part of my favorites.

    Together with a research a litte bit more outside the box and the books regarding the impact of monetary policy in Romania on the real economy, where does most part of the infation come from (for instance, the industrial output … why not?), what did the guyz in NBR to decrease the natural rate of inflation in Romania, as a result of understanding where the inflation tends to come from, what exactly is this inflation, and so on. A little bit more like the big picture and the impact on our lives. This way finally we and the NBR could end up living on the same planet.

    I can't understand why should I applaud a decrease in foods prices in 2009 (is the only inflation it decreased that year, the non-food and services were higher than the boom years, as far as I can remember!), if it happened because more and more people were starving, thnx to their rate+other credit contraction decisions, which amplified bankruptcies and unemployment. Because at the end of the road, NBR decided to make a little bit of reform inside the romanian business environment. LOL.

  2. And, btw, we should also take the loans into account in deciding if they are tight or loose, because in the end this is how they hope to affect our inflation. And also to compare the evolution of ron denominated with the evolution of euro denominated. Mostly for companies in the recession times, because intuitively you expect the companies to be more interested in getting finance, mostly long term, like >5y in Romania, during such times, and not the people, which are more affected by risk aversion and will tend to make more deposits then ask for loans.

    1. @lav Credit channel does not work anyway during crisis. I looked and the story holds. But there one can say is the bank’s fault not the monetary policy. In the study is included.

      Sent from my iPhone

      1. I do agree with you that because of the risk aversion there’s less to be done.

        But make a graph with the loans for companies, >5y, for instance, and plot both the level for lei denominated and the level for euro denominated. And also make some calculation. You will see that there has been some demand for loans, but euro denominated, while lei was decreasing. It’s not like the bank wouldn’t wanna give loans to just anybody. It’s like people didn’t want the lei denominated loans.

        Plus, there is another problem. Most of the companies have a variable rate. If you increase the rate, and keep it high, during hard economic times, of course their variable rate goes much higher, while they sell less. The debt service starts to be a problem for these companies. And this is how you enter a death spiral. Some companies had a DAE of 10%, generally speaking, and then in the winter of 2009 had a DAE of 20% or more, for their loans, while selling less. Of course they started to fire people, which in turn made things just worse.

        Then, something funny. In 2010 or 2009 I read in the media opinions like: oh, but we have more bad loans for ron denominated than euro denominated, so the euro loans are not that bad.

        Of course we witnessed this phenomenon in that partiular period, and not also now, because some of those people had a variable rate, which took more and more from their disposable income, as the rate was increased and then was kept to not proper levels by the NBR, taking into account the state of the real economy.

        It’s not only about the new demand for loans, but also about the old loans with a variable rate. Is the reason for which the FED is desperate for keeping the rates down, for instance :). But NBR didn’t thought that far away.

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