‘Currency instability’ should NOT be a concern for Canada

The commodity currencies of the world continues to take a beating on the back of the sharp drop in oil prices. This is now causing some to fear “currency instability”. Just these this story from Canada’s Financial Post:

The Canadian dollar is falling too far and too fast, damaging public and business confidence in Canada, say economists.

National Bank Financial Markets warned in a new report Monday that the loonie is now out of line with fundamentals and the Bank of Canada cannot risk driving it even lower with a rate cut.

“Currency instability has become a concern, and we think the Bank of Canada must take note,” said Stéfane Marion, chief economist at National Bank. “For Canadian businesses, currency depreciation has already sent the price of machinery and equipment (73% of which is imported) to a new record high. This is bound to complicate Canada’s transition to a less energy-intensive economy.”

Marion said that by his team’s calculations, the loonie should have shed about 10 cents against the U.S. dollar in the past few months. But it has fallen by 25 cents.

…“Rarely has it tumbled so far so fast, and against so many currencies,” Marion said. “The steepness of the CAD’s depreciation against the USD is without precedent — 33%, or 3.5 standard deviations, in 24 months.”He warned that in order to help create some stability for the loonie, the Bank of Canada should not cut interest rates at its Wednesday meeting. Doing so would risk sending the currency as low as 66 cents this week.

“In our view, the Bank of Canada would be better to keep its powder dry this month and act, if need be, after the next federal budget when it will be better able to assess fiscal support to the economy,” Marion said.

Economists aren’t the only ones warning about the damage of a lower loonie. Jayson Myers, chief executive of Canadian Manufacturers & Exporters, told Bloomberg Monday that exchange rate volatility has hurt business confidence and put a chill on spending decisions.

“My advice right now would be to even take a look at increasing interest rates by a quarter of a point,” he told Bloomberg. “Interest rates are low already. A little bit of dollar stability would be better.”

Sorry guys, but this is all nonsense. There are absolutely no sign of “currency instability” (whatever that is) and there are no signs at all that the drop in the Canadian dollar is causing any financial distress.

In fact if we look at the development in the Canadian dollar in recent weeks it has developed completely as we would have been expected given the drop in oil prices and given the developments in global currency markets in general.

I have earlier argued that we could think of the Canadian free floating currency regime basically as a regime that shadows an Export Price Norm. Hence, the Loonie is developing as if it is pegged to a basket of oil prices (15%), the US dollar 65% and Asian currencies (yen and won, 20%).

The graph below shows the actual development in USD/CAD and a “predicted” USD/CAD had Bank of Canada pegged the Loonie to 65-20-15 basket.


The graph is pretty clear – there is nothing unusual about the development in the Loonie. Yes, the Loonie has weakened significantly, but this can fully be explained by the drop in oil prices and by the weakening of the Asian currencies (in the basket primarily the drop in the won) and of course by the general continued strengthening of the US dollar.

If anything this is a sign that the Bank of Canada remains credible and that the markets are confident that the BoC will be able to ease monetary conditions further to offset any demand shock to the Canadian economy due to lower export prices (oil prices).

Therefore, it is also obvious that the BoC should not undertake any action to curb the weakening of the Loonie. In fact if the BoC tried to curb the Loonie sell-off then the result would be a dramatic tightening of monetary conditions, which would surely push the Canadian economy into recession and likely also create public finance troubles and increase the risk of a financial crisis. Luckily the Bank of Canada for now seems to full well-understand that there is absolutely no point of intervening in the FX market to curb the Loonie sell-off. Well-done!

HT Dr. Brien.

PBoC should stop the silliness and float the RMB

This is morning we got this news (from Bloomberg):

China’s central bank conducted the biggest reverse-repurchase operations since September, adding funds to the financial system after money-market rates surged and equities slumped.

The People’s Bank of China offered 130 billion yuan ($19.9 billion) of seven-day reverse repos on Tuesday at an interest rate of 2.25 percent. The monetary authority suspended the operations in the last auction window on Dec. 31, ending a six-month run of cash injections that helped drive borrowing costs lower in an economy estimated to grow at the slowest pace in more than two decades.

The People’s Bank of China (PBoC) continues to behave as if there is not Tinbergen constraint, but the PBoC soon has to realize it cannot continue to try to ease monetary conditions through liquidity injects into the money markets, lowering of reserve requirements and cutting interest rates, while at the same time trying to maintain an artificially strong Renminbi.

What the PBoC effectively is doing it trying to ease monetary policy with the one hand, while at the same time tightening monetary policy with the other hand by intervening in the currency market to prop up the Renminbi.

Instead it is about time that PBoC either let the Renminbi float completely freely (which effectively would cause a significant depreciation of RMB) or implement a large devaluation – for example 30% – so to avoid any speculation of further devaluations and then introduce a peg to a basket of currency as hinted in December.

The problem with the present policy is that everybody in the market realizes that this is what we will get eventually and that has caused an escalation of the currency outflow from China and this outflow is likely to continue until the PBoC bites the bullet and introduce a completely new monetary regime. This halfway house will not stand for long and if the PBoC keeps fighting it the central bank will just do even more harm to the Chinese economy and potentially also cause an major banking crisis.

PBoC is not alone in making this mistake and the Tyranny of the Status Que is strong within central banks around the world. Two good example are Kazakhstan and Azerbaijan. Both countries have in recent months given up the tighten link to the US Dollar and devalued their currencies significantly. This in my view has been the right decision as both of these oil exporting countries have been suffering significantly from the continued decline in oil prices.

But neither the Kazakhstani nor the Azerbaijani central banks (and governments) have introduce new rule based monetary policy regimes. So one can say they have left the Dollar peg, but forgot to finish the job. Therefore policy makers in both countries should now focus on what regime should replace the Dollar peg. I would recommend an Export Price Norm for both countries, where their currencies are pegged to a basket of the oil prices and the currencies of the countries’ main trading partners.

And China need to do the same thing – not introducing an Export Price Norm, but rather let the Renminbi float and then introduce an NGDP target or a nominal wage growth target and it need to do it very soon to avoid an escalation of the financial distress.

The PBoC has the power to end this crisis right now by floating the Renminbi, but the longer this decision is postponed the bigger the risk of something blowing up becomes.

PS notice that despite the sharp rise in tensions between Saudi Arabia and Iran oil prices are now lower than on at the close of trading last week. That to me is a pretty strong indication just how worried that markets are about China.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Oil exporters do not devalue to boost exports, but to stabilize public finances

Yesterday Azerbaijan’s central bank gave up its pegged exchange rate regime and floated the Manat. The Manat plummeted immediately and was essentially halved in value in yesterday’s trading.

Azerbaijan is not the first oil exporter this year to have given up its fixed exchange rate policy. Kazakhstan did the same thing a couple of months ago and last week South Sudan was forced to devalue by 85%. Angola also earlier this year devalued and Russia has now also given up its attempt to manage the float of the rouble.

And Azerbaijan is likely not the last oil exporter to give up maintaining a pegged exchange rate. Given the continued drop in oil prices and the strengthening of the dollar oil exporters with pegged exchange rate (to the dollar) will continue to suffer from currency outflows.

I have said it before – devaluation is not about competitiveness 

Critics of floating exchange rates and of devaluation of the kind the Azerbaijan i central bank undertook yesterday often say that devaluation just will cause higher inflation and any effects on competitiveness will be short-lived and that “internal devaluation” therefore is preferable.

Furthermore, these critics argue that for a country like Azerbaijan a devaluation will not help as oil is priced in US dollars anyway and that the countries have little else than oil to export.

However, this in my view misses the point completely. Giving up a fixed exchange rate and floating the currency (or introducing an Export Price Norm) is not about exports and competitiveness. Rather it is about avoiding a collapse in domestic demand and more practically it is about stabilizing government revenues.

Hence, for a country like Azerbaijan the majority of government revenues come directly from oil exports – typically directly from a government owned oil company and/or through taxes on oil and gas companies.

This means that if oil prices collapse the government revenues will collapse as well. However, a crucial part of this story that is often missed is that the important thing is what happens not to the oil price in US dollar, but the oil price denominated in local currency as the government’s expenditures primarily are in local currency.

Hence, a government can keep it’s oil revenue completely stable if the government allows the currency to weaken as much as the drop in oil prices (in US dollars).

Therefore, the choice for the government and central bank in Azerbaijan was really not a question about boosting exports. No, it was a question about avoiding public sector insolvency. Of course the Azerbaijani government could also have introduced massive austerity measures to avoid a sovereign default.

However, with a pegged exchange rate regime massive fiscal austerity measures would likely be extremely recessionary – and remember here that under a fixed exchange rate the budget multiplier typically will be positive and maybe even larger than one.

Hence, under a fixed exchange rate regime fiscal policy is at least in the short-term “keynesian” as there is no monetary offset. Said in a more technical the so-called Sumner Critique do not hold in a fixed exchange rate regime.

In that sense we should think of the devaluation in Azerbaijan as a one-off improvement in oil revenues – as oil revenues increases exactly as much as the currency was weakened yesterday.

The alternative to a 50% devaluation was a 20% drop in GDP

Let me try to illustrate this with an example. Let us first assume a oil-elasticity of 1 for Azerbaijani government revenues – meaning a 1% increase in oil prices increases the nominal revenue by 1% as well.

Yesterday USD/AZN jumped from 105 to 155 – so nearly 50%. This of course means that the oil prices denominated in Manat overnight also increases by around 50%.

Given government revenues presently are around 27% of GDP this means that a 50% devaluation “automatically” increases government revenues to around 40% of GDP (27 + 50%).

Said in another way overnight the budget situation was “improved” by 13% of GDP. If the government alternatively should have found this revenue through tax hikes (or spending cuts) without a devaluation then that would have caused a deep recession in the Azerbaijani economy.

In fact if we assume a fiscal multiplier of 1.5 (which I don’t think is unreasonable for a fixed exchange rate economy) then such fiscal tightening could have caused real GDP to drop by as much as 20% relative to what otherwise (now!) would have been the case.

Obviously there is no free lunch here and over time inflation will be higher due to the devaluation and to the extent that is allowed to be translated into higher expenditure some of the impact of the devaluation will be eroded. The extreme example of this is Venezuela or Argentina.

However, there is one very important difference between the two scenarios – devaluation or fiscal austerity – and that is under a fiscal austerity scenario it would be not only real GDP that would drop, but nominal GDP would likely drop even more.

This will not happen in the devaluation scenario where monetary easing exactly means that nominal GDP is kept stable or increases. This means that the debt dynamics will be much more positive than under an “internal devaluation” (fiscal austerity) scenario.

What I am arguing here is not discretionary monetary policy changes, but I am trying to explain why so many oil exporters have chosen to float their currencies this year and to illustrate why this is not about exports and competitiveness, but rather about ensuring government revenue stability and therefore avoiding ad hoc fiscal adjustments that potentially could cause a massive economic contraction.

So once again – I am not advocating “continues devaluations”, but rather I am advocating automatic currency adjustments to reflect shocks to the oil price within a clearly defined rule-based framework and I therefore also continue to advocate that commodity exporters should not peg their exchange rates against the dollar, but rather either float their currencies and implement a nominal GDP target or implement an Export Price Norm, where the currency is pegged to a basket of currencies and the oil price so the currency “automatically” will adjust to shocks to the oil price. This would stabilize not only government revenues, but also stabilize nominal spending growth and over time also inflation.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.





The ‘Dollar Bloc’ continues to fall apart – Azerbaijan floats the Manat

I have for sometime argued that the quasi-currency union ‘Dollar Bloc’ is not an Optimal Currency Area and that it therefore is doomed to fall apart.

The latest ‘member’ of the ‘Dollar Bloc’ left today. This is from Bloomberg:

Azerbaijan’s manat plunged to the weakest on record after the central bank relinquished control of its exchange rate, the latest crude producer to abandon a currency peg as oil prices slumped to the lowest in 11 years.

The third-biggest oil producer in the former Soviet Union moved to a free float on Monday to buttress the country’s foreign-exchange reserves and improve competitiveness amid “intensifying external economic shocks,” the central bank said in a statement. The manat, which has fallen in only one of the past 12 years, nosedived 32 percent to 1.5375 to the dollar as of 2:30 p.m. in the capital, Baku, according to data compiled by Bloomberg.

The Caspian Sea country joins a host of developing nations from Vietnam to Nigeria that have weakened their currencies this year after China devalued the yuan, commodities prices sank and the Federal Reserve prepared to raise interest rates. Azerbaijan burned through more than half of its central bank reserves to defend the manat after it was allowed to weaken about 25 percent in February as the aftershocks of the economic crisis in Russia rippled through former Kremlin satellites.

The list of de-peggers from the dollar grows longer by the day – Kazakhstan, Armenia, Angola and South Sudan (the list is longer…) have all devalued in recent months as have of course most importantly China.

It is the tribble-whammy of a stronger dollar (tighter US monetary conditions), lower oil prices and the Chinese de-coupling from the dollar, which is putting pressure on the oil exporting dollar peggers. Add to that many (most?) are struggling with serious structural problems and weak institutions.

This process will likely continue in the coming year and I find it harder and harder to believe that there will be any oil exporting countries that are pegged to the dollar in 12 months – at least not on the same strong level as today.

De-pegging from the dollar obviously is the right policy for commodity exporters given the structural slowdown in China, a strong dollar and the fact that most commodity exporters are out of sync with the US economy.

Therefore, commodity exporters should either float their currencies and implement some form of nominal GDP or nominal wage targeting or alternatively peg their currencies at a (much) weaker level against a basket of oil prices and other currencies reflecting these countries trading partners. This of course is what I have termed an Export Price Norm.

Unfortunately, most oil exporting countries seem completely unprepared for the collapse of the dollar bloc, but they could start reading here or drop me a mail (lacsen@gmail.com):

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down



If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.





Bank of Canada at the Zero Lower Bound: The Export Price Norm to the rescue

The continued drop in the oil prices have caused the Bank of Canada to reconsider whether it should cut it key policy rate – the Overnight rate – and in a speech earlier this week BoC governor Stephen Poloz said that he would not rule out negative interest rates in Canada even though he did not expect it and he also voiced some worries about negative rates in general.

I overall think it is prudent for the BoC governor to remind the markets that the BoC is not “out of ammunition” (I hate that expression when it comes monetary policy). The reason for this is that if Poloz instead had said “we are approaching the Zero Lower Bound and below zero there is nothing more we can do to ease monetary policy” then surely we would have seen a strong market reaction – the lonnie would have strengthened, (market) inflation expectations would have dropped, Canadian stocks would have dropped and that all on its own would have been monetary tightening.

Instead he rightly reminded the markets that the BoC certainly can cut rates below zero, but there certainly is also other options. The most obvious is quantitative easing – the BoC could purchase assets – e.g Canadian Treasury bonds.

I therefore also very much welcome that the BoC a couple of days ago published a paper on how to conduct monetary policy at “low interest rates” (Poloz’s speech was based on this paper). I do not agree on everything in the paper, but I clearly think that it is right that the BoC already now makes it completely clear to the markets that it has lots of options to ease monetary policy if needed – also with interest rates close to the Zero Lower Bound (the Overnight Rate is presently at 0.5%).

Hence, this means that if oil prices continue to drop – this by way is a negative demand shock for the oil-exporting Canadian economy – the markets would not have any reason to doubt that the BoC will move to ease monetary conditions to ensure nominal stability.

Consequently if oil prices drop then rational investors should expect monetary easing and that in itself would cause the Canadian dollar to weaken, which on its own should do a lot to offset the negative demand shock from lower oil prices.

The Export Price Norm to the rescue

The question is, however, how the BoC could (and would) ease monetary conditions at the Zero Lower Bound. Obvious one possibility would be to cut rates below zero, but there are numerous reasons why the BoC would be reluctant to do this and there probably also at least a mental limit (among central bankers) for just how negative rates could become.

Another obvious option would be to do quantitative easing. However, central bankers aren’t to happy about this option either.

There is, however, an alternative to QE and negative interest rates, which I think the BoC should consider and that is the exchange rate channel.

My concrete proposal is that the BoC could combine two related ideas – Bennet McCallum’s MC rule (not to be confused with the McCallum money base rule) and my own Export Price Norm (inspired heavily by Jeff Frankel’s Peg-the-Export-Price).

In McCallum’s 2005 paper “A Monetary Policy Rule for Automatic Prevention of a Liquidity Trap? he discusses a new policy rule that could be highly relevant for the BoC today. What McCallum suggests is basically that central banks should continue to use interest rates as the key policy instrument, but also that the central bank should announce that if interest rates needs to be lowered below zero then it will automatically switch to a Singaporean style regime, where the central bank will communicate monetary easing and tightening by announcing appreciating/depreciating paths for the country’s exchange rate. This is the MC rule.

My suggestion would be to take McCallum’s MC rule one step further and would be for the BoC to announce that it would peg the Canadian dollar to a basket of currencies and the oil price and maintain that rule as long as core inflation is below the BoC’s 2% (operational) core inflation target (which is presently not the case).

A Canadian Export Price Norm: 65% US dollar, 20% Asian currencies and 15% oil prices 

Since the BoC started targeting inflation in the early 1990s the central bank has done a very good job of hitting the inflation target and furthermore, nominal spending growth has also be quite stable. As a result we have also – as a positive side-effect had a fairly high level of real stability in the economy.

This means that if monetary policy in general has been “good” then the outcome on different financial variables that reflect this policy could be seen as good monetary policy indicators. So if we for example look at the Canadian dollar then the development in the dollar should reflect “good” monetary policy.

So if we can construct a basket of currencies and the oil prices that would “track” the historical development in the Canadian dollar then that could serve as BoC’s operational exchange rate target to be “switched” on if conditions demanded it (a negative demand shock, disinflation, ZLB etc.).

I have constructed such basket. It is 65% US dollars, 20% Asian currencies (10% Korean won and 10% Japanese yen) and 15% oil prices (this by the way more or less reflects Canada’s trading patterns). By pegging to this basket we get an implied rate for the Canadian dollar against the US dollar that would keep the basket fixed (the Export Price Norm).

CAD Export Price Norm

As the graph shows the implied USD/CAD rate (the Export Price Norm) has tracked the actual USD/CAD rate quite closely in the past 20 years and as monetary policy overall in this period has been “good” I would argue that this basket would be a useful basket to implement for Canada.

But I should also stress that I am not arguing that BoC should give up it’s present monetary policy regime – just that the BoC should announced that it can use an Export Price Norm as a policy instrument to ensure nominal stability if needed (inflation drops below then inflation target and interest rates are stuck at the Zero Lower Bound).

That said, I don’t think the Export Price Norm should be implement right now – even though it could be a good idea to pre-announce it – as core inflation seems to be pretty well-anchored and the Canadian economy is doing fairly well. Furthermore, with the overnight rate at 0.5% we are still not at the Zero Lower Bound so the first step could be to cut the overnight rate to zero (maybe already now).

And finally, if it is notable that since USD/CAD more or less has tracked the Export Price Norm during the recent massive drop in oil prices there is really no indication that the markets in general are loosing trust in BoC’s ability and willingness to ease monetary conditions to offset the demand shock from lower oil prices. This is very encouraging and Governor Poloz luckily seems to understand the need to communicate to market participants that the BoC will continue to ensure nominal stability also if interest rates hit the Zero Lower Bound.

PS Read Bob Hetzel new paper What is a Monetary Standard. More on that in the coming days.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Kwanza devaluation is the right decision, but fundamental regime change is needed

This is from Reuters:

Angola’s central bank devalued the kwanza currency by about 6 percent against the dollar, a statement showed, a move analysts said was aimed at stimulating foreign currency inflows eroded by falling global oil prices.

 According to the bank’s latest update on the official exchange rate, issued late on Thursday, one U.S. dollar will now cost 116-117 kwanza, compared with 109-111 before.

The exchange rate is however much higher at 185-195 on a thriving informal market.

Plunging oil prices have hit Africa’s second largest crude exporter, forcing the central bank to restrict dollar sales as foreign exchange supplies dried up.

Analysts said the official devaluation would not be sufficient to shore up Angola’s foreign reserves.

I have long argued that Angola’s central bank would be forced to devalue it’s currency in response to the combination of falling oil prices and slowing Chinese growth – oil is Angola’s main export and China is both the biggest investor into Angola and the biggest importer of Angolan goods (oil).

This is what I wrote two years ago:

Hence Angola de facto operates a pegged exchange rate regime and it is pretty clear in my view that this regime is likely to exacerbate the negative impact from the ‘China shock’.

The China shock is likely to lead to depreciation pressures on the Angolan kwanza in two ways. First the drop in global oil prices is likely to push down Angolan export prices – more or less by a one-to-one ratio. Second, the expected drop in Chinese investment activity is likely to also reduce Chinese direct investments into Angola. The depreciation pressures could potentially become very significant. However, if the Angolan central bank tries to maintain a quasi-pegged exchange rate then these depreciation pressures will automatically translate into a significant monetary tightening. The right thing to do is therefore obvious to allow (if needed) the kwanza to depreciate to adjust to the shock.

What we have been seeing is effectively the petro-monetary transmission mechanism at work. Hence, given Angola’s dollar peg a drop in oil prices – and hence in Angolan export prices – has caused downward pressure kwanza and the Angolan central bank has tried to curb these depreciation pressures by tightening monetary conditions. However, the central bank has now rightly allowed the necessary devaluation of the kwanza.

However, the latest policy decision from the Angolan central bank – while warranted – is not enough. The decision is essentially a completely discretionary adjustment within the present regime. However, what Angola really needs is not discretionary adjustments of the exchange rate peg, but a rule-based monetary policy regime, which automatically adjusts monetary conditions to external shocks – such as a decline in global oil prices.

This is what I suggested back in 2013:

There are two ways of ensuring such depreciation. The first one is to simply to allow the kwanza to float freely. That however, would necessitate serious reforms to deepen the Angolan capital markets and the introduction of an nominal target – such as either an inflation target or an NGDP target. Even though financial markets reforms undoubtedly are warranted I have a hard time seeing that happening fast. Therefore, an alternative option – the introduction of a Export Price Norm (EPN) is – is clearly something the Angolan authorities should consider. What I call EPN Jeff Frankel originally termed Peg-the-Export-Price (PEP).

I have long been a proponent of the Export Price Norm for commodity exporting economies such as Russia, Australia or Angola (or Malaysia for that matter). The idea with EPN is that the commodity exporting economy pegs the currency to the price of the commodity it exports such as oil in the case of Angola. Alternatively the currency should be pegged to a basket of a foreign currency (for example the dollar) and the oil price. The advantage of EPN is that it will combine the advantages of both a floating exchange (an “automatic” adjustment to external shocks) and of a pegged exchange rate (a rule based monetary policy). Furthermore, for a country like Angola where nearly everything that is being produced in the country is exported the EPN will effectively be an quasi-NGDP target as export growth and aggregate demand growth (NGDP growth) will be extremely highly correlated. So by stabilizing the export price in local currency the central bank will effectively be stabilizing aggregate demand and NGDP.

Operationally it would be extremely simple for the Angolan central bank to implement an EPN regime as al it would take would be to target a basket of for example oil and US dollars, which would not be very different operationally than what it is already doing. Without having done the ‘math’ I would imagine that a 20% oil and 80% US dollar basket would be fitting. That would provide a lot of projection against the China shock.

So yes, the devaluation of the kwanza is the right policy decision right now and within the present (outdated) regime, but the Angolan authorities should as fast as policy move towards a entirely new monetary policy regime and my recommendation would certainly be to implement some variation of an Export Price Norm.


See some of my older posts on EPN here:

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Talking to my phone: The Gulf States should peg their FX rates to oil prices

Oops I did it again – this time I talk to my phone about monetary policy in the Gulf States and my suggestion that these countries should peg their currencies to the oil price or a basket of the oil price and the US dollar. This is of course what I have suggested should be termed the Export Price Norm (EPN). Have a look here.

See some of my older posts on EPN here:

Oil-exporters need to rethink their monetary policy regimes

The Colombian central bank should have a look at the Export Price Norm

Ukraine should adopt an ‘Export Price Norm’

The RBA just reminded us about the “Export Price Norm”

The “Export Price Norm” saved Australia from the Great Recession

Should small open economies peg the currency to export prices?

Angola should adopt an ‘Export-Price-Norm’ to escape the ‘China shock’

Commodity prices, currencies and monetary policy

Malaysia should peg the renggit to the price of rubber and natural gas

The Cedi Panic: When prayers don’t work you go for currency controls

A modest proposal for post-Chavez monetary reform in Venezuela

“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression

PEP, NGDPLT and (how to avoid) Russian monetary policy failure

Turning the Russian petro-monetary transmission mechanism upside-down


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

Oil-exporters need to rethink their monetary policy regimes

I started writing this post on Monday, but I have had an insanely busy week – mostly because of the continued sharp drop in oil prices and the impact of that on particularly the Russian rouble. But now I will try to finalize the post – it is after on a directly related topic to what I have focused on all week – in fact for most of 2014.

Oil prices have continued the sharp drop and this is leading to serious challenges for monetary policy in oil-exporting countries. Just the latest examples – The Russian central bank has been forced to abandon the managed float of the rouble and effectively the rouble is now (mostly) floating freely and in Nigeria the central bank the central bank has been forced to allow a major devaluation of the country’s currency the naira. In Brazil the central bank is – foolishly – fighting the sell-off in the real by hiking interest rates.

While lower oil prices is a positive supply shock for oil importing countries and as such should be ignored by monetary policy makers the story is very different for oil-exporters such as Norway, Russia, Angola or the Golf States. Here the drop in oil prices is a negative demand shock.

In a country like Norway, which has a floating exchange rate the shock is mostly visible in the exchange rate – at least to the extent Norges Bank allows the Norwegian krone to weaken. This of course is the right policy to pursue for oil-exporters.

However, many oil-exporting countries today have pegged or quasi-pegged exchange rates. This means that a drop in oil prices automatically becomes a monetary tightening. This is for example the case for the Golf States, Venezuela and Angola. In this countries what I have called the petro-monetary transmission mechanism comes into play.

An illustration of the petro-monetary transmission mechanism

When oil prices drop the currency inflows into oil-exporting countries drop – at the moment a lot – and this puts downward pressure on the commodity-currencies. In a country like Norway with a floating exchange rate this does not have a direct monetary consequence (that is not entirely correct if the central bank follows has a inflation target rather than a NGDP target – see here)

However, in a country like Saudi Arabia or Angola – countries with pegged exchange rates – the central bank will effectively will have tighten monetary policy to curb the depreciation pressures on the currency. Hence, lower oil prices will automatically lead to a contraction in the money base in Angola or Saudi Arabia. This in turn will cause a drop in the broad money supply and therefore in nominal spending in the economy, which likely will cause a recession and deflationary pressures.

The authorities can offset this monetary shock with fiscal easing – remember the Sumner critique does not hold in a fixed exchange rate regime – but many oil-exporters do not have proper fiscal buffers to use such policy effectively.

The Export-Price-Norm – good alternative to fiscal policy

Instead I have often – inspired by Jeffrey Frankel – suggested that the commodity exporters should peg their currencies to the price of the commodity the export or to a basket of a foreign currency and the export price. This is what I have termed the Export-Price-Norm (EPN).

For commodity exporters commodity exports is a sizable part of aggregate demand (nominal spending) and therefore one can think of a policy to stabilize export prices via an Export-Price-Norm as a policy to stabilize nominal spending growth in the economy. The graph – which I have often used – below illustrates that.

The graph shows the nominal GDP growth in Russia and the yearly growth rate of oil prices measured in roubles.

There is clearly a fairly high correlation between the two and oil prices measured in roubles leads NGDP growth. Hence, it is therefore reasonable in my view to argue that the Russian central bank could have stabilized NGDP growth by conducting monetary policy in such a way as to stabilize the growth oil prices in roubles.

That would effectively mean that the rouble should weaken when oil prices drop and appreciate when oil prices increase. This is of course exactly what would happen in proper floating exchange rate regime (with NGDP targeting), but it is also what would happen under an Export-Price-Norm.

Hence, obviously the combination of NGDP target and a floating exchange rate regime would do it for commodity exporters. However, an Export-Price-Norm could do the same thing AND it would likely be simpler to implement for a typical Emerging Markets commodity exporter where macroeconomic data often is of a low quality and institutions a weak.

So yes, I certainly think a country like Saudi Arabia could – and should – float its currency and introduce NGDP targeting and thereby significantly increase macroeconomic stability. However, for countries like Angola, Nigeria or Venezueala I believe an EPN regime would be more likely to ensure a good macroeconomic outcome than a free float (with messy monetary policies).

A key reason is that it is not necessarily given that the central bank would respect the rules-of-the-game under a float and it might find it tempting to fool around with FX intervention from time to time. Contrary to this an Export-Price-Norm would remove nearly all discretion in monetary policy. In fact one could imagine a currency board set-up combined with EPN. Under such a regime there would be no monetary discretion at all.

The monetary regime reduces risks, but will not remove all costs of lower commodity prices

Concluding, I strongly believe that an Export-Price-Norm can do a lot to stabilise nominal spending growth – and therefore also to a large extent real GDP growth – but that does not mean that there is no cost to the commodity exporting country when commodity prices drop.

Hence, a EPN set-up would do a lot to stabilize aggregate demand and the economy in general, but it would not change the fact that a drop in oil prices makes oil producers such as Saudi Arabia, Russia and Angola less wealthy. That is the supply side effect of lower oil prices for oil producing countries. Obviously we should expect that to lower consumption – both public and private – as a drop in oil prices effectively is a drop in the what Milton Friedman termed the permanent income. Under a EPN set-up this will happen through an increase inflation due to higher import prices and hence lower real income and lower real consumption.

There is no way to get around this for oil exporters, but at least they can avoid excessive monetary tightening by either allowing currency to float (depreciate) free or by pegging the currency to the export price.

Who will try it out first? Kuwait? Angola or Venezuela? I don’t know, but as oil prices continue to plummet the pressure on governments and central banks in oil exporting countries is rising and for many countries this will necessitate a rethinking of the monetary policy regime to avoid unwarranted monetary tightening.

PS I should really mention a major weakness with EPN. Under an EPN regime monetary conditions will react “correctly” to shocks to the export prices and for countries like Russia or Anglo “normally” this is 90% of all shocks. However, imagine that we see a currency outflow for other reasons – for as in the case of Russia this year (political uncertainty/geopolitics) – then monetary conditions would be tightened automatically in an EPN set-up. This would be unfortunate. That, however, I think would be a fairly small cost compared to the stability EPN otherwise would be expected to oil exporters like Angola or Russia.

PPS I overall think that 80-90% of the drop in the rouble this year is driven by oil prices, while geopolitics only explains 10-20% of the drop in the rouble. See here.

Recession time for Russia – the ultra wonkish version

I have long been a proponent of what I have called the Export Price Norm (EPN). The idea with EPN is that commodity exporting countries can ensure stable nominal spending growth by pegging their currency to either the price of the country’s main export good or to a basket of the export product and a foreign currency.

The case of Russia is illustrative. Hence, one could imagine that the Russian central bank (CBR) implemented a variation of EPN by including oil prices in the basket of euros and dollars, which the CBR has been “shadowing” in recent years. I believe that this in general would lead to a stabilisation of nominal GDP growth in Russia.

The graph below, I believe, illustrates this well.

EPN Russia

We see that over the past 10 years there has been a very high and stable correlation between Russian NGDP growth and (the growth of) the price of oil measured in roubles. As the oil price in roubles seems to lead NGDP growth by 1-2 quarters it is clear that the CBR would have been able to stabilize NGDP growth by managing the rouble in such a way to ‘offset’ positive and negative shocks to the oil price. That of course would have happened “automatically” if the CBR had included the oil price in it’s EUR-USD basket – or alternatively allowed the rouble to float freely and communicated that it would allow the rouble to appreciate or depreciate to offset shocks to the oil price to ensure stable nominal spending growth in the Russian economy.

Nothing surprising about the slowdown in Russian growth

In the last couple of the years the Russian economy has slowed considerably. This I believe is due to the fact that the CBR effectively has been tightening the monetary conditions by keeping the rouble too strong relative to the development in oil prices.

Since early 2011 the oil price (in US dollars) has been declining moderately. This effectively has meant that the currency inflow into Russia has been slowing and not surprisingly this has put downward pressure on the rouble. This should be welcomed news, but the CBR has nonetheless kept monetary conditions too tight by not allowing a large enough depreciation of the rouble to fully offset the oil price shock.

As a result nominal GDP growth has slowed quite significantly and as prices and wages are sticky in Russia (as everywhere else) this has also led to a slowdown in Russian real GDP growth.

Why the EPN ‘prediction’ might be wrong this time around

However, things have been changing over the past year. So while the oil price has continued to “stagnate” the rouble has weakened significantly over the past year – as has been the case for most other Emerging Markets currencies in the world.

Hence, as the drop in the value of the rouble has been significantly larger than the change in the oil price (in USD) the oil price measured in roubles has increased somewhat.

As the graph above shows this de facto monetary easing has already started lifting NGDP growth and given the historical relationship between the oil price measured in rouble and NGDP growth then one should expect NGDP growth to pick up from well-below 10% to 13-14% y/y.

However, this “prediction” strictly based on the Export Price Norm is likely to be far too optimistic. The reason is that the Export Price Norm only ensures nominal stability if all shocks come from the export price – in the case of Russia from oil price shocks.

Historically it has been a reasonable assumption that nearly all shocks to Russian aggregate demand are shocks to the oil price (remember in the case of Russia an oil price shock is a demand shock and not a supply shock). This is why we have such a good fit in the graph above.

But over the past year the Russian economy has been hit by another external shock and a lot of the outflows from Russia has been driven by other factors than oil prices. Hence, the general negative Emerging Markets sentiment over the past year has undoubtedly own its own contributed to the currency outflow.

Furthermore, and more importantly the sharply increased geo-political tensions in relationship to Putin’s military intervention on the peninsula of Crimea has clearly shocked foreign investors who are now dumping Russian assets on large scale. Just Monday this week the Russian stock market fell in excess of 10% and some of the major bank stocks lost 20% of their value on a single day.

In response to this massive outflow the Russian central bank – foolishly in my view – hiked its key policy rate by 150bp and intervened heavily in the currency market to prop up the rouble on Monday. Some commentators have suggested that the CBR might have spent more than USD 10bn of the foreign currency reserve just on Monday. Thereby inflicting greater harm to the Russian economy than any of the planned sanctions by EU and the US against Russia.

By definition a drop in foreign currency reserve translates directly into a contraction in the money base combined with the CBR’s rate hike we this week has seen a very significant tightening of monetary conditions in Russia – something which is likely to send the Russian economy into recession (understood as one or two quarters of negative real GDP growth).

This in my view illustrates a weakness in the very strict form of an Export Price Norm. If the central bank pegs the currency directly to the export price – for example oil prices in the case of Russia – then other negative external shocks – would effectively be monetary tightening.

CBR should implement a 40-40-20 basket with an adjustable +/-15% fluctuation band

Given this weakness in the strict form of the EPN I believe it would be better for the Russian central bank to implement a less strict variation of EPN.

The most obvious solution would be to include oil prices in the CBR’s present operational basket. Overall I think a basket of 40% euros, 40% dollars and 20% oil prices would be a suitable policy basket for the central bank. Furthermore, the CBR should allow for a +/-15% fluctuation band around this policy basket.

The reason I stress that it should be a policy basket is that the ultimate target of the CBR should not be that basket but rather to achieve a stable growth rate of nominal spending in the Russian economy – for example 8-10% NGDP growth.

I believe that under most circumstances the CBR could maintain composition of the policy basket and maintain the fluctuation band unchanged and that would to a large degree ensure nominal stability without changing the basket or the “parity” for this basket and long as the CBR communicates clearly that the purpose of this policy is to ensure nominal growth stability. Then the market would take care of the rest.

Unfortunately Putin’s Russia has much bigger (self-inflicted) problems than monetary policy these days…


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The Cedi Panic: When prayers don’t work you go for currency controls

The Ghanaian cedi has lost more than 30% against the US dollar over the past year and the sell-off in the currency has escalated since the beginning of the year as the Ghanaian markets have been hit by the same turmoil we have seen in other Emerging Markets.

The sharp cedi sell-off has sparked widespread concerns in Ghanaian society. One of the more bizarre examples of this came on Sunday when Archbishop Nicholas Duncan-Williams  actually prayed for the cedi to recover! Just listen here.

The prayers didn’t work – so now the Bank of Ghana has introduced draconian currency controls

However, Duncan-Williams prayers did not work and the sell-off in the cedi has continued this week and that has caused the Ghanaian authorities to introduces draconian measures to prop up the currency.

First we got the introduction of currency controls on Tuesday. This is the statement Bank of Ghana issued on Tuesday:

Further to Bank of Ghana Notices Nos. BG/GOV/SEC/2007/3 and BG/GOV/SEC/2007/4, it is announced for the information of all authorized dealer banks and the general public that with effect from February 5, 2014, the rules governing the operations of FEA and FCA have been revised.

These rules are intended to streamline the operations of these accounts and bring about clarity and transparency in their operations as well as ensure compliance with Bank of Ghana Notice No. BG/GOV/SEC/2012/12 dated October 10, 2012 on the pricing, advertising receipts and payments for goods and services in foreign currency in Ghana. The Notice states that all transactions in the country are required to be conducted in Ghana cedis, which is the sole legal tender.


The Bank of Ghana has revised the mode of operation for the FEA and FCA as follows:

a. No cheques or cheque books shall be issued on the FEA and FCA.

b. Cash withdrawals over the counter from FEA and FCA shall only be permitted for travel purposes outside Ghana and shall not exceed US$10,000.00 or its equivalent in convertible foreign currency, per person, per travel.

c. Authorised dealers shall not sell foreign exchange for the credit of FEA or FCA of their customers.

d. Transfers from one foreign currency denominated account to another are not permitted.

e. All transfers outside Ghana from FEA and FCA shall be supported by relevant documentation.

Margin Account for Import Bills

f. Foreign exchange purchased for the settlement of import bills shall be credited to a margin account which shall be operated and managed by the bank on behalf of the importer for a period not exceeding 30 days.

Foreign Currency Denominated Loans

g. No bank shall grant a foreign currency denominated loan or foreign currency linked facility to a customer who is not a foreign exchange earner.

h. All undrawn foreign currency denominated facilities shall be converted into local currency with the coming into effect of this Notice. However, existing fully drawn foreign currency denominated facilities and loans to non-foreign exchange earners shall run until expiry.

Banks and the general public are hereby advised to note the above and be guided accordingly.

Frankly speaking I don’t know what is most stupid – praying for the currency to recover or introducing currency controls of this kind, but as if that was not enough the Bank of Ghana today announced that it had hiked its key policy rate by 200bp to 18% from 16%. So not only is this likely to lead to a completely stop to any foreign direct investments into the economy – the Bank of Ghana will also send domestic demand into a free fall.

The first of many? Lets pray it is not

Luckily not many countries have done what Ghana just did over the past five years. There is only two other countries – Iceland and Cyprus – which have introduced major capital controls since 2008. I have followed the Icelandic economy closely for years and in my mind there is no doubt that the capital controls are having a very negative effect. Most notable has been the extremely negative impact on foreign direct investment into Iceland. It has completely disappeared and I don’t that this is a result of the capital controls. Furthermore, even the Icelandic government said that the controls would only temporary there are no signs that we will see any major liberalization of the controls anytime soon.

One could certainly fear that the same thing will happen in Ghana. The currency controls will become permanent. As Milton Friedman  once said “There is nothing as permanent as a temporary government program”.

The question many investors now are asking is whether other Emerging Markets will copy Iceland and Ghana and introduce capital controls. I pray that that will not happen and investors are certainly nervous that it could happen. If that fear gets more widspread then we are likely to see a lot more Emerging Markets turmoil.

PS If you ask me what the Bank of Ghana should have done I would tell you that the Bank should have introduced an Export Price Norm and pegged the cedi to a basket of the USD dollar and the prices of the main commodities Ghana is exporting such as cocoa, petroleum and liquefied natural gas to ensure a stable development in nominal spending growth. And obvious all capital and currency controls should be abolished.


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