Monetary Policy and Currency Alignment in Post War Iraq Kevin A. Vetelino ECO 6226 Summer 2004

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

Introduction u 2003 invasion of Iraq u An oppressive dictatorial regime removed u Lack of security and relative lawlessness u Suggests efforts required was underestimated u Future success lies with economic growth + stability, u currency system and monetary policy u Price control is of utmost importance u discourage investment in DIs +stunt financial system growth

Iraqi Monetary History u Iraq - created by the British in in 1916 u Used the Indian rupee u Iraqi independence in 1932 u Iraqi currency board established u 1 Iraqi Dinar = 1 British pound sterling u Iraqi Central Bank established in1947 u support government debt + drove inflation u 2003, official exchange was 3.22 dinars/dollar u money bazaars rates were 4000 dinars/dollar

At the Time of the Invasion u Two currencies in Iraq u Saddam dinar: nationwide u Swiss dinar: Kurdish region u Six private commercial banks u limited independence from from the government u completely insolvent u Current international debt in excess of $300B

Central Banks u Established to provide a money + credit system u regulate monetary forces to promote economic growth. u Functions u regulation of the money supply, issuing currency, being a lender of last resort, fiscal advisor, bank regulator u Conducts monetary policy u open market operations, setting the prime lending rate, setting reserve requirement, printing money moral suasion

Currency Boards u Issues domestic currency at fixed rate to anchor currency u pound sterling, EURO, US dollar (maintains 100% reserve) u Do not lend to public or government (not a lender of last resort ) u Advantages: u Force strict fiscal discipline u low inflation u develops responsible banking practices. u Disadvantages: u Can’t implement monetary policy u “lack of sovereignty”

Arguments for Currency Board u Hanke and Sekerke, Johns Hopkins University u need to strictly control of inflation u historical lack of fiscal discipline w/high debt u Central bank cannot function in currently in Iraq u Not financial markets u Insolvent banks u Lack of data and experience u “flying blind without instruments” u Mark Spiegel Fed in San Francisco u establish currency credibility Steven Hanke

Arguments for Central Bank u Coalition Provincial Authority u Established the Central Bank of Iraq u Issued new dinar, floating exchange rate u Roubini + Setser (NYU, Council on Foreign Relations) u Superior for commodity based economy u Currency boards adopt MP of anchor u Oil supply shock (outside of Iraq) u drive prices and demand for Iraq’s oil: tight money u importing nations: loose money u recipe for deflation Nouriel Roubini Paul Bremmer

Analysis: Petroleum Exporters

Analysis: Petroleum Exporters INFLATION

Analysis: Petroleum Exporters GDP per capita annual growth

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

Analysis: currency board nations INFLATION

Analysis: currency board nations GDP per capita

Conclusions u Initiate a currency board arrangement u To the dollar (or possibly to the Euro) u Temporary measure for period of 5-7 years u Establish a central bank u gradual replacement of reserve w/domestic gov’t bonds u conduct open market operations u critical for a petroleum-based economy such as Iraq u Temporary nature is critical u for cultural and political reasons. u allow the financial system to grow and mature

Questions?