CENTRAL BANK AND MONETARY POLICY

1. CENTRAL BANK AND MONETARY POLICY Mario A. García Lara Vice-President of the Banco de Guatemala

2. Origin of the Central Banks • Riksbank (Sweden, 1656) and Bank of England (1694) arise as state banks (debt management) • It is generalized as of the beginning of the XXc., before the need to have an only money issuer and reduce banking chaos during the era

3. Origin of the Central Banks • The Federal Reserve System in the United States arises in 1914. • The Bank of Canada began operations in 1934 after the “ Great Depression”. • In 1914 there were 18 central banks. In 1950 there were 59, and 161 in 1999. • Their role as only issuers allowed them to regulate the MONETARY POLICY

4. Monetary Policy: a component of the economic policy ECONOMIC POLICY EFFICIENCY POLICIES MONETARY POLICY FISCAL POLICy INSTITU- TIONAL POLICY = + + + DEREGULA- RIZATION AND OPENING PROMOTE EFFICIENCY (SUPPLY) MONETARY OFFER AND INTEREST RATE INFLUENCE W/O ADDED DEMAND EXPENSES AND TAXES INFLUENCE W/O ADDED SUPPLY AND DEMAND INSTITUTION IMPROVEMENTS “GAME RULE” (SUPPLY) INSTRUMENTS INCREASE THE PRODUCT- IVITY PRESERVE STABILITY SUPPORT STABILITY AND PRO- DUCTIVITY MAKE GROWTH VIABLE AND SUSTAINABLE OBJECTIVES GROWTH AND DEVELOPMENT

5. Simplified Economic Policy ¡help!

6. Simplified Economic Policy fiscal policy monetary policy The temporary tank only avoids a crisis temporarily, while the main problem is solved. If the temporary tank overflows, an economic crisis of great proportion will ocurr money Inflation deficit devaluation production

7. Simplified Economic Policy • Macroeconomic Crisis: in almost all countries. • In Guatemala: • Inflation: 32% (‘85), 61% (‘90) • Ext. Deficit: 6.7% (‘81), 7.1 (‘92) • Devaluation: 45% (’90), 14% (’99) • Central banks are entrusted the responsibility of preserving stability in the general level of prices

8. Recent Evolution of Central Banks • Technological Progress + economic integration + financial globalization  the traditional functions of central banks turn more complex and difficult. • Central banks can not pursue multiple objectives of economic policy (like they did two decades ago); now they are centered in a main objective: promote stability in the general level of prices.

9. The role of the Banco de Guatemala in the Economy • A. Fundamental Objective • Following international standards, the Organic Law (article 3) establishes the objective of • “…contributing to the creation and maintenance of the most favorable conditions for orderly development of the national economy, for which, it will propitiate the monetary, exchange rate and credit conditions, that promote the stability in the general level of prices”.

10. INCREASE EFFECTIVITY OF THE MONETARY POLICY Orientation of the Organic Law (2002) STRENGTHEN AUTONOMY PROPITIATE MACROECONMIC STABILITY STRENGTHENCREDIBILITY CREDIBILITY + AUTONOMY = EFFECTIVITY  STABILITY

11. EFFECTIVITY = CREDIBILITY + AUTONOMY • III. ECONOMIC FINANCIAL AUTONOMY • treatment of the net deficiencies or net excess of the central bank maintenance of capital of the central bank on behalf of the State • zero credit to the government • clear definition of central bank-government relations • II. OPERATIVE • AUTONOMY • independence in the use instruments • overlap in the period of duration of the Directors regarding the Executive Power • destitution of Directors only for an established cause • IV. TRANSPA-RENCY and ACCOUNTS RENDITION • the monetary policy and its foundations must be made known to the public • the central bank must render accounts periodically before Congress • I. • CLARITY OF THE FUN- DAMENTALOBJECTIVE • eases the consecution of the objective • establishes a correct scheme of account rendition before society

12. 1st. Pillar in the Organic Law CLARITY OF THE FUNDAMENTAL OBJECTIVE Article 4 establishes that the functions of the institution are exercised privileging the achievement of the mentioned objective Article 3 establishes that as its fundamental objective the Banco de Guatemala will promote the stability in the general level of prices Articles 26, 30, and 34 establish that the attributions of the Monetary Board, of the Presidency and the Management are exercised without undermining the achievement of the mentioned objective • Instruments are redefined in function of the objective: • Legal reserve (Arts. 43 to 45) • OMAs (Art. 46) • Exchange ops. (Art. 47) • PUI (Art. 48)

13. 2nd. Pillar in the Organic Law OPERATIVE AUTONOMY Article 13 reaffirms the integration of the Monetary Board, according to article 132 of the Constitution, and article 14 declares that the members must act in function of national interest and of the fulfillment of the fundamental objective of the central bank. Article 26 reaffirms the constitutional power of the Board to determine the monetary policy, and article 40 delegates the Banco de Guatemala, as an autonomous entity, the capacity to execute said policy through an Execution Committee Articles 28 and 84 establish overlap in the duration of the charge of President and Vice-president of the Banco de Guatemala, regarding the presidential period of the Executive Organism Article 20 establishes the causal for which the President, Vice-president and the elected members of the Monetary Board can be removed.

14. 3rd. Pillar in the Organic Law ECONOMIC AND FINANCIAL AUTONOMY • Patrimonial strengthening of the central bank. Article 83 foresees making the accumulated cost of monetary, exchange rate and credit policy • Credit to the government. Article 71 observes, among others, the prohibition to the central bank to grant credit to the government contained in article 133 of the Political Constitution of the Republic of Guatemala. • Maintenance of capital in the central bank. Articles 8 and 9 establish that the net deficiencies or excess derived of the execution of the monetary, exchange rate and credit policy will be absorbed by the State

15. 4th. Pillar in the Organic Law TRANSPARENCY and ACCOUNT RENDITION Articles 63 and 64 establish that it is obligatory to publish the Board debates and the resolutions that correspond to the determination of the monetary, exchange rate and credit policy Article 61 establishes the publication of the monetary policy report with an explanation of the operations made to reach the fundamental objective Article 62 establishes that it is obligatory to report information and general publication of important data associated to the business of the central bank Article 34 literal i) establishes the publication of the Income and Expense Budget of theBanco de Guatemala

16. 4th. Pillar in the Organic Law TRANSPARENCY and ACCOUNT RENDITION Article 11 establishes that the financial statements of the central bank must be made according to the generally accepted norms and principles with international standards adopted by the Monetary Board at the proposal of the Bank Superintendence. Article 60 establishes that the President of the Banco de Guatemala must appear before the Congress of the Republic in January and July to render accounts on the results of the execution of the monetary, exchange rate and credit policy of the country. Article 62 refers to the monthly report of the general balance of the Banco de Guatemala, as well as the annual report on its financial statements, and article 12 requires an external audit to the central bank

17. FAVORABLE EXTERNAL MONETARY POLICY ENVIRONMENT DISCIPLINED MACROECONOMIC STABILITY: SAVINGS MORE PRODUCTION FISCAL POLICY INTEREST RATE FACTORS: (LONG TERM) INVESTMENT SUSTAINABLE IN THE L.P. ADEQUATE ECONOMIC ADEQUATE • POLICY TO IMPROVE EFFICIENCY • Deregulation of prices • Commercial opening • Financial Liberalization • Privatization GROWTH INFRASTRUCTURE HUMAN CAPITAL (health and education) ADEQUATE BETTER USE OF FACTORS: PRODUCTIVITY • INSTITUTIONS • Property rights • Regulatory Agencies (superintendence) • Autonomy of the central bank; fiscal regulations • Social Security • IMPERIO OF THE LAW • POLICY TO IMPROVE INSTITUTIONS • To CREATE markets • To REGULATE markets • To STABILIZE markets • To LEGITIMIZE markets SOCIAL INTERNAL HARMONY Economic Policy and Growth:

18. The propitiate stability of prices: • savings, investment and productivity • Better life quality when preserving the value of salary, of savings and of pensions • Interest rate (long term) lows • Reduction of public debt service (which frees resources for social investment), of business and home debt STABILITY IS INDISPENSABLE FOR ECONOMIC GROWTH

19. Framework of the economic policy in Guatemala, 1970-2006 Central Bank Autonomy Monetary Policy Exchange Regimen Financial Policy Mobility of Capital Fiscal Policy Expenses Income Explicit Inflation Goals Flexible ER with an exchange rule Legal and Solidity Reform Full liberty forcapital (Free Negotiation Law) New Organic Law SAT Banking Crisis Exchange Dsorder Zero Credit to the government (constitu-tional reform) Moderate Management Liberalization without appropriate regulation Tributary Reform Monetary Aggregates Multiple ER Big devaluation Control exchange Gradual adjustment Absolute loss of discipline Regulation for exit and entry of capital Fiscal Dominance: credit to the government Convertibility Till Financial Repression Structural Weakness Moderate Management Fixed ER

20. Thank you very much! MAGL June, 2006