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 (

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: or






Mario, stay on track and avoid the mistakes of 1937 and 2011

The global stock markets have been facing some headwinds recently, and there may be numerous reasons for this. One obvious one is the recent rebound in oil prices, which I believe is essentially driven by markets’ expectation that the Saudi-led global oil price war is now ending.

If that is indeed the case then we are seeing a (minor) negative supply shock, particularly to the European and U.S. economies. Such supply shocks often get central banks into trouble. Just think of the ECB’s massive policy blunder(s) in 2011, when it reacted to a negative shock (higher oil prices on the back of the Arab spring) by hiking interest rates twice, or the Federal Reserve’s (or rather the Roosevelt Administration’s) premature monetary tightening in 1937 – also on the back of high global commodity prices.

It may be that the ECB will not repeat the mistakes of 2011, but you can’t blame investors for thinking that there is a risk that this could happen – particularly because the ECB continues to communicate primarily in terms of headline inflation.

Therefore, even if the ECB isn’t contemplating a tightening of monetary conditions in response to a negative supply, the markets will effectively tighten monetary conditions if there is uncertainty about the ECB’s policy rule. I believe that is part of the reason for the market action we have seen lately.

The ECB needs to spell out the policy rule clearly

What the ECB therefore needs to do right now is to remind market participants that it is not reacting to a negative supply shock, and that it will ignore any rise in inflation caused by higher oil prices. There are numerous ways of doing this.

1) Spell out an NGDP target

In my view the best thing would essentially be for the ECB to make it clear that it is focusing on the development of expected nominal GDP growth. This does not necessarily have to be in conflict with the overall target of hitting 2% over the medium term. All the ECB needs to do is to say that it is targeting, for example, 4% NGDP growth on average over the coming 5 years, reflecting a 2% inflation target and 2% growth in potential real GDP in the euro zone. That would ensure that markets also ignore short-term fluctuations in headline inflation.

2) Target 2y/2y and 5y/5y inflation

Alternatively, the ECB should only communicate about inflation developments in terms of what is happening to market inflation expectations – for example 2y/2y and 5y/5y inflation expectations. Again, this would seriously reduce the risk of sending the signal that the bank is about to react to negative supply shocks.

3) Re-introduce the focus on M3

There are numerous reasons not to rely on money supply data as the only indicator of monetary conditions. However, I strongly believe that it is useful to still keep an eye on monetary aggregates such as M1 and M3. Both M1 and M3 show that monetary conditions have indeed gotten easier since the ECB introduced its QE programme. That said, the money supply data is also telling us that monetary conditions overall can hardly be described as excessively easy. Yes, money supply growth is still picking up, but M3 growth is still below the 6.5% y/y that it reached in 2000-2008, and significantly below the 10% “target” I earlier suggested would be needed to bring us back to 2% inflation over the medium term.

If the ECB re-introduces more focus on the money supply numbers – and monetary analysis in general – then it would also send a pretty clear signal that the bank is not about to change course on QE just because oil prices are rising.

4) Change the price index to the GDP deflator or core inflation

Another pretty straightforward way of trying to convince the markets that the ECB will not react to negative supply shocks is by changing the focus in terms of the inflation target. Today, the ECB is officially targeting HICP (headline) inflation. This measure is highly sensitive to swings in oil and food prices as well as changes in indirect taxes. These factors obviously are completely outside the direct control of the ECB, and it therefore makes very little sense that the ECB is focusing on this measure.

Recently, ECB chief Mario Draghi hinted that the ECB could start focusing on a core measure of inflation that excludes energy, food and taxes, and I certainly think that would be a step in the right direction if the bank does not want to introduce NGDP targeting. This would effectively mean that the ECB had a target similar to the Fed’s core PCE inflation measure. It would not be perfect, but certainly a lot better than the present headline inflation measure.

An alternative to a core inflation measure, which I believe is even better, would be to focus on the GDP deflator. The good thing about the GDP deflator (other than being the P in MV=PY) is that it measures the price of what is produced in the euro zone, and hence excludes imported inflation and indirect taxes.

Conclusion: It is still all about credibility – so more needs to be done

One can always discuss what is in fact going on in the markets at the moment – and I will deliberately avoid trying to explain why German government bond yields have spiked recently (it tells us very little about monetary conditions) – but I would focus instead on the markets’ serious nervousness about whether the ECB will prematurely end its QE programme.

There would be no reason for such nervousness if the ECB clearly spelled out that it does not intend to let a negative supply shock change its plans for quantitative easing, and that it is intent on ensuring nominal stability. I have given some suggestions on how the ECB could do that, and I fundamentally think that Mario Draghi understands that the ECB needs to move in this direction. Now he just needs to make it completely clear to the markets (and the Bundesbank?)


If you want to hear me speak about this topic or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or

Me, myself and my phone #1 (Chuck Norris, Saudis and beer)

It has been very hectic for me recently with a lot of personal and professional changes. So while we are at it here is another change – I will in the future from time to time try to post commentary in a bit of a different format – I will be talking to my phone. Have a look at my first attempt of phone-blogging here (I recorded it Friday night.)

I would love to hear your comments on this and don’t worry – I will continue to do regular blogging. In fact I expect to blog at a higher frequency in the future.

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.

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