Monetary Policy and Currency Alignment in Post War Iraq

1. Monetary Policy and Currency Alignment in Post War Iraq Kevin A. VetelinoECO 6226 Summer 2004

2. OUTLINE • Introduction - where are we now • Historical Monetary Policy in Iraq • Possible Options • Central bank, currency board, dollarization • Experts Recommendations • Analysis • post-war and petroleum-based economies • Conclusion and Recommendations

3. Introduction • 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

4. Iraqi 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

5. At 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

6. Central 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

7. Currency 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”

8. Arguments 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

9. Arguments for Central Bank • Coalition Provincial Authority • Established the Central Bank of Iraq • Issued new dinar, floating exchange rate Paul Bremmer • 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

10. Analysis: Petroleum Exporters

11. Analysis: Petroleum ExportersINFLATION

12. Analysis: Petroleum Exporters GDP per capita annual growth

13. Analysis: currency board nations • Iraqi debt/GDP is expected to be 300% in 2005 • Dependent on debt restructuring

14. Analysis: currency board nationsINFLATION

15. Analysis: currency board nations GDP per capita

16. Conclusions • 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

17. Questions?