To reach its potential Romania needs to “relax”

I am not a fan of “output gaps”, this measure of how much are resources in the economy employed. But central banks all over the world use it and thus we have to at least mention it.
In theory an output gap shows how far is the economy from its potential. A positive gap means that current GDP is above its long term potential while a negative one shows that the opposite.

Here  is how central banks use this measure. If for example we are looking at a positive output gap (potential GDP minus current GDP) then the central bank will use this to say that it needs to increase interest rates. If the central bank forecasts a positive output gap for the period ahead than we should expect more interest rate rises until the forecast of the output gap is zero or slightly negative.

Let’s take now the case for the Romanian economy. In February 2009, the NBR was estimating that output gap will reach its worst at -2% sometime that year but then it will be back to potential by middle of 2010. If they were talking about the potential before the crisis than it would have meant full recovery of nominal GDP to the pre-crisis level in just one year. Furthermore, such an estimate of the output gap would have not required a series of interest rate cuts as all resources in the economy would have been fully employed again quite soon.

As we know today it did not happen that way. In fact the output gap estimates in February 2010 show that the minimum was much lower, at -7.5%, and now the return to potential should have been expected sometime during 2012. With this estimate of the output gap one would should have expected a long period of relaxed monetary policy. That was not the case, but on this one on a later post.
A year later on February 2011 the output gap estimates show that recovery to full potential is now pushed to 2013. Thus, fiscal and monetary policies did not have a positive effect on recovery to potential GDP which meant that capital and labor will still be under-employed until at least 2013.

It is now one more year later, February 2012, and the story repeats itself and now the NBR expects return to potential GDP in the later part of 2016 or later.

Here is a graph showing all these estimates.

As you can see there is an evolution also. While the output gap remains negative the level gets smaller. The difference relative to potential GDP has lowered from -7.5% to -4%. Isn’t that a good thing you might ask? Isn’t that showing that fiscal and monetary policies have worked and it just takes a little more time but we are on the right track?

No and this is why. If the output gap would have been calculated against the potential GDP from 2008 then yes the smaller output gap, albeit negative, would have shown progress. Unfortunately both my estimates and official estimates show that potential GDP is much lower than in 2008. In my view close to zero but by official estimates around 2.5%. Therefore, the output gap was not closed by the lower bound, good economic performance, but by the upper bound which shows loss of potential GDP. In other words Romania will catch up to the average EU country in much longer period if we keep the current mix of economic policies.

It is clear, at least to me,  that the current mix of fiscal and monetary policy are not helping the economy move to full employment. Even worse, it seems that the long term potential GDP has been at best halved relative to its 2008 level. To restore potential GDP and speed-up the closing of the output gap Romanian economic policies need to “relax”. So far, as the output gap shows both fiscal and monetary policy have been too tight. To be more specific, fiscal policy needs to lower taxes and monetary policy needs to create a liquid long term money market (not necessarily lower interest rates).


21 thoughts on “To reach its potential Romania needs to “relax”

  1. @Florin, I agree with a leaner fiscal policy, however I do not see the benefits of increased liquidity as I feel that nothing is free and any benefits brought on will be negated by inflation which will erode end user’s purchasing power and impair local antreprenorial capital formation. As monetary base has increased 8 fold in the last 10 years I feel we have a reserve of inflation not yet materialized (without taking in to consideration any further “liquidity” injections which will hinder enough future development).

    1. @i-conomics
      Well, first the M1 measure of money is still below the 2008 level. However, we do not necessary need to increase the monetary base we just need to redistribute it differently. Right now most of it is concentrated it in very short term maturities and thus perceived as temporary by the banks. Spreading it over one year maturity will help bans extend cheaper credit to the real economy. Also, the NBR could just lower the reserve requirements for RON which will lead to cheaper borrowing rates for the real economy.

  2. As far as I am concerned the current mix of fiscal and monetary policy is oriented towards helping the Government meet certain quantitative requirements imposed by the IMF and EC. Why would the NBR increase maturity on market liquidity? By doing so it would create lending incentives to the private sector/households increasing the cost of lending to the Gov. There is market demand from both the MoF and the private sector and the NBR is basically shifting the balance in one specific direction.

  3. Romania is already one of the most relaxed economies – and I mean it! Look at the composition of the new govt and their relation with real economy or with the economy knowledge. Look at the market failures instances in each and every market in romania, or at the conflict of interest coupled with assimetric information. It is much easier to make money in romania than in most of the countries worldwide! Forget about eonomic policies, have a look at the rough reality around.

    1. @Ion
      If by relaxed you mean poorly governed than I agree. It is easier to make money for the chosen few not for the rest. Medium term this model will only ensure massive migration and poverty.

      1. Wrong! Medium and longterm this model will ensure a very good living for a few, and a big change in the behaviour of the rest. As it is already happeing, to be a state emplyee, to be able to steal & to cheat are the new wishes of 99% of the population.
        Probably is poorly governed for the 99% of the population, but the rest. the chosen ones, are building up their war chest and living very well.
        Seriously – who cares about the population?

        On a different note – what is the level of accountability for isarescu for all the decisions he is taking at central bank? NONE! He couldn’t be sued, couldn’t be judged, couldn’t be made responsible for his actions in any way whatsoever! Sorry, I forgot, there is one way – the gun!

      2. @Ion
        I am not trying to point fingers at individuals, although behind polices we have people. My aim is to show that we are adopting the wrong policies for the situation. Not only in Romania but also in EU and to some extent in the US. Politicians are too involved in the current process and their solution will be biased towards preserving an important role for the state in the future. This is simply wrong in my view.

  4. m-am uitat la tvr info si cu scuzele de rigoare am sa pun aici cateva concluzii.ce am priceput eu su cu ce nu m-ati lamurit.
    – am intels ca problema cresterii salariilor cu 5% e o discutie falsa ,500 de milioane nu reprezinta mare lucru nici pentru stat ,dar nici pentru cei ce primesc.adica in economie nu va creste consumul sau economisirea semnificativ
    – am intels ca imprumut pe 10 ani din sua e pagubos , de imagine , pierdem 250 de milioane, euro sau dolari, asta nu am pricept
    – am intels ca BNR cu curifeii ei foarte apreciati de moise guran pentru profesionalism, au dus o politica monera proasta, au impiedicat creditarea cu regulamente restrictive si dobanzi mari , 20% in 2009
    dar ce nu am inteles e de ce au facut-o.sunt prea precauti,nu sunt cu adevarat profesionisti, sau din interes politic dar nu l-am inteles care ar fi.daca baga un guvern incompetent in rahat,baga si tara in acelasi melange,.cui foloseste?
    nu am priceput nici de ce avem nevoie de acordul stand-by cu fmi , inca o data repet tanasescu a spus ca miliardul si jumatate nu poate fi folosit decat pentru echilibrarea balantei de plati sau pentru rezerva bnr.
    nu am priceput ce s-au facut cu cele 2o de liarde de la fond,am inteles ca doar doua au intrat in consum,chestiunea cu diminuarea rezervelor si plecarea lor tot la finante prin bancile preferate sau la bancile mama a fost cam neclara.m-am uitat la moderatori ,nici ei nu au inteles chiar tot , in diferite momente pareau cam resemnati ca nu pot reformula pe inteles lor.
    uite ce scrie aici:

    În trezoreria statului au intrat 8,15 mld. euro în urma Acordului cu FMI, Comisia Europeană şi Banca Mondială

    Valoarea totală a sumelor trase de către BNR şi MFP până în prezent: 17,94 miliarde euro, din care 11,94 miliarde euro de la FMI.

    Plus 1 miliard euro de la BERD şi BEI pentru proiecte de investiţii în sectorul privat (fără nicio implicare a sectorului public).

    Emitent: Guvernul Romaniei – Biroul de presa

    Data: 31.01.2012in concluzie nu pricep aici nimic.
    mai departe.

    cu privatizarile,in programul de guvernare al noului premier probabil scrie ca vor sa scoata la vanzare pe bursa 10% din hidroelectrica si nu inteleg ce e rau in pricep insa ce vor face menegerii privati asa repede daca ei vor sa scoata pe bursa pana la finele anului pachete minoritare sau mojoritare iar acesti manageri vor fi selectati in minimum 6 luni.
    in concluzie,nu inteleg de ce a procedat asa gresit BNR pana acum ?poate mai veniti la tv si explicati
    in al doilea rand mi-ar place sa va mai vad la tv analizand programul de guvernare dar pe rand ,prea multa informatie economica deodata ne cam zapaceste de cap si pana la urma ar trebui sa explicati sa priceapa toata lumea.asa ar vota in cunostinta de cauza si nu manipulata de neaveniti si habarnamisti economic.
    moise guram zicea azi eva inteleigent,el face emisiuni mai didactice .zicea ca merkel a criticat spania ca a facut drumuri si nu investiti reproductive, ca somajul e mare ca s-au terminat drumurile.greci au intrat in asa deficit si datorita faptului ca au absobit foarte multe fonduri europene,au cheltuit bani pe cofinantare si s=au imprumutat apoi pentru ce era absolut mai facut si olimpiada si programul de guvernare e o lista de investitii pe domeni, sunt convinsa ca multe pot fi taiate si cu banii stimulat sectorul privat
    mi-ar place sa vorbiti si despre modalitatea cea mai adecvata de impozitare acum , pe criza si despre raportul dintre impozitarea muncii si a proprietatii.
    in fine la final va multumesc pentru efortul care il faceti,in momentul in care lumea intelege un pic de economie va vota in cunostinta de cauza.
    cu tratul … pactul asta de stabilitate zisei ca holande a spus ca isi va retrage semantura daca ramane asa, noi ce o sa facem atunci, mai ales ca noi am putea folosi regula lui 4 pana intram in euro,daca o sa mai avem unde intra si semna si tratatul ca doar de atunci ni s-ar aplica


  5. Florin: But M1 is volatile and influenced by the banks propencity to give out loans. Why not look at M3 and its 25% increase despite deflationary effects of a major recesion?
    Decreasing ths RON reserve will not lead to cheaper borowing rates but will put pressure on RON exchange rate as the Banks will transform the RON in EUR and repatriate the cash…. Despite the fact that NBR is stating that foreign banks have not decreased their exposure to romania it seems that since the begining of the recesion the repatriated funds converge towards the quantum of the IMF loan….

    1. @i-conomics
      M1 is the least volatile and the only one that the central bank controls directly . That is why is always my focus. Interventions in the FX or MM impact M1 and not M3. M3 is a broader measure of money and it depends on the money multiplier. It is true that over long periods of time a relaxed monetary policy will increase M3 but over short term monetary policy decisions can be seen in the M1.
      The 25% increase in M3 is mostly due to the EUR part of M3 and has very little to do with Romanian Monetary policy.

      My view is that lower MRR will give a signal to banks that liquidity is permanently injected in the system and they can reduce interest rate volatility and level. Some of the reserves could be repatriated but that only shows that the economy does not offer viable investment opportunities and it does not mean that M1 will not increase. Unless NBR intervenes to support the RON and does not sterilize those interventions the M1 will increase which should help the economy on the short term.

  6. am citit dar nu prea inteleg,dl Citu a spus ca acum masa monetara e mai mica ca cea din 2008.Dvs in afara de argummente care par logice, aveti si cifre cu masa asta monetara?
    in plus ce face acum fedul nu poate fi o politica a agenturilor straine, care am presupune ca il constrang si pe isarescu la asemenea politici monetare?

    1. @Gabriela,
      Am tot scris despre asta pe blog, mai ales cand arat ca in Romania politica monetara este de fapt un consiliul monetar. Dar ca sa te ajut
      in Septembrie 2008 masa monetara in sens restrans era 92,571,072.3 mii de lei. A scazut pana la 76,617,021.5 mii de lei in 2010. Iar in Decembrie 2011 se afla la 85,834,977.9 mii de lei.
      Romania este foarte departe de riscul unei politici monetare prea relaxate.

  7. @dl Citu
    eu am venit recent pe acest blog,, va ascult de citeva luni bune cand veniti la televizir, in rest scuze ca nu stiu ce ati scris inainte,abia apuc sa citesc ce scrieti acum . am auzit cand ati spus ca nu avem piata monetara, ca daca tintesti inflatia care e treaba ta ,nu ar trebui sa tintesti si cursul, dar intr-o zi ati spus ca pana la urma e treaba inca o data va intreb, de ce atatia economisti din tara asta si politicieni care stiu economie nu sesizeaza aceasta politica proasta si descurajatoare a BNR> mai mult e asa manipulare ca isarescu are cea mai mare incredere.ce se intempla de ce nimeni nu tipa????????????????

    1. @Gabriela
      Intr-o economie care depinde de stat este contraproductiv pentru cariera unui individ sa critice statul. Decat daca acel individ nu are nimic de pierdut. Cei la care va referiti au prea mult de pierdut.

    1. @Daniel
      There are some answers to your question in my post Destroying the liquidity crisis myth..
      But basically the major difference is that while in Romania M1 is still below the 2008 level in the US the monetary base has been increased quite nicely.
      To be clear I do think that money helps growth in the short term. But too much money for too long will be trouble.

    1. @Daniel
      It is too late for US and EU. Unless NGDP targeters convince some country that is dealing with recession to adopt this policy I am afraid it will just remain a theoretical model.

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