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Here’s Why Costa Rica Should Be Dollarized

Article Summary:

Let’s cut to the chase: Costa Rica should be dollarized. In his blog “Por la libre” published in Elfinancierocr.com, Juan Carlos Hidalgo reviews the alternatives for monetary policy in Costa Rica, coming to the conclusion in the headline: the only healthy and permanent solution is to dollarize the economy.

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Original Article Text From el Financiero CR via Google Translate:

The solution remains dollarize

Returns the debate on monetary policy to the fore with the strong dollar inflows into the country, something that is increasingly hampering the work of the Central Bank to defend the floor of the exchange rate band (¢ 500) while you want to keep inflation under control. It is a discussion idle if only we were to conclude that the best monetary policy for a small open country like ours is not to have monetary policy.

Consider: What seemed a strong inflow of foreign currency to own all year, when transnational corporations bring dollars to pay the bonuses, has continued in January and promises not diminish in the coming weeks or months. The reason seems to lie in the difference in interest rates between Costa Rica and the United States, a situation that will not change in the near future as Ben Bernanke, Federal Reserve chairman, said it will continue its policy interest rates near to zero (0.25%) until unemployment in the country down to 6.5% (it is now at 7.7%). Since income people in the U.S. can expect on your money are actually negative (inflation is higher than interest rates), it makes sense to get the money and bring it to nations where interest rates are higher, like ours. In Costa Rica the monetary policy rate BCCR-good theory is that it should serve as a reference for the national economy is at 5%. However, the base rate which actually is the reference of the banking system, and that is 9.05%

The logical solution would be to lower the interest rate in the country. But it is hard not to put pressure on inflation: if artificially cut the interest rate, there will be more money in the street and this will push the prices of goods and services up. Some are willing to pay the price. After all, they say, the country last year had the lowest inflation rate in decades, to 4.5%, below the Latin American average. However, the regional average is inflated by Argentina and Venezuela. Actually 10 countries in Latin America had lower inflation rates to Costa Rica in 2012.

Worse, even the rate of inflation which is contentera some alegronazo could end up being a donkey . Given the strong dollar inflows, the BCCR has had to work hard to defend the floor of the exchange rate band at ¢ 500. Central Reservations and reached a record $ 7.000 million in just over a year, all accumulated BCCR $ 1.500 billion planned purchase for 2012 and 2013 together. If Central is buying dollars at this rate, for which it must issue stirs colones-or inflation or puts even more pressure on interest rates, if you decide to pick up the call liquidity through sterilization (selling securities to banks on which you pay good interest).

Not much output. That’s why two ideas have surfaced in recent days: leave the band system and move to a floating “managed” or adopt capital controls to prevent capital coming into the country “swallow”, as it calls speculative flows coming into the country attracted by the higher interest rate. Both have serious problems.

Let’s start with the floating “managed” or “dirty”. The idea would be to float the colon against the dollar, but giving BCCR discretion to intervene under certain circumstances. The detail that is precisely the discretion. It is a still less transparent than the bands, as the Board may intervene BCCR the exchange rate at any time, creating winners and losers with just one stroke. You can set clear rules for intervention, but it is hard not to think of a scenario where BCCR Board receives heavy pressure from political and economic groups to manipulate the exchange rate.

For example: According to the dynamic that we have seen in recent weeks, it is expected that if adopted the managed float, the exchange rate would fall sharply, which certainly would have a strong impact on the most dynamic industries of the national economy: tourism and exports. Not to be a witch to see the representatives of these sectors pasting the cry to government asking to intervene sky and cheapen the colon. For those who doubt this, I send a small white box with a picture of Luis Liberman published out there in one of the many news of the last two years where the VP out saying what should be the policy of the BCCR (although in theory, is an independent body). And no doubt, by the prospect of a colon to appreciate in the short-term, with floating, hopefully that will encourage the entry of speculative capital even more, further more expensive and colon-hitting hardest at tourism and export sectors.

The other solution, proposed by the same Liberman, is adopting capital controls to prevent the entry of speculative capital calls . The problem is that such a measure goes against the model of open capital account has been Costa Rica for almost 20 years. Moreover, not only frighten swallows but eagles, condors, falcons, etc. (Ie, healthy capital fows that extent would a worrying sign). No investor wants to put their money in a country that could present obstacles in case you need to remove the silver, much less in times of global uncertainty. Therefore, this measure is not an option unless you want to pay a high price. Liberman says that you can design a control system of capital very specific to avoid these problems. But we have seen the chambonería government has done something as simple as determining a list of products that they would remove the sales tax exemption. I doubt that the government and the BCCR can conjure surgical capital controls that have no undesired effects on foreign investment.

What to do then? One way to reduce the interest rate on a non-artificial course would cut government spending. But we have seen that this administration is addicted to it, and it will be this election year. The BCCR could also contribute further reducing inflation to interest rates drop. But here the question is which comes first: the chicken or the egg? Can BCCR further reduce inflation at a time when industrial quantities must issue colones to defend the exchange rate band? Economic theory says that.

For me the simplest solution is still letting us get rid of sticks and colon. Adopt the dollar as official currency and stop worrying about the exchange rate, interest rates, swallows and others. Dollarization completely eliminate discretion in monetary policy, where the seven old BCCR Board decide what the value of our income. As always, these decisions tend to benefit those with more political muscle. Moreover, by getting rid of colon interest rates would fall naturally to converge with local interest rates in dollars. This would reduce the incentive for capital espectulativos. Also, to get rid of the colon not have to worry about the exchange rate and uncertainty-which is no small-causing swings in this. Finally, under normal conditions the country would lower inflation if we had the colon as official currency, which particularly benefits the poor.

Any action other than dollarization promises to be a patch that does not come to face the reality that our economy is small, open and exchange traded funds with U.S., Mexico, Central America and many other partners. Dollarization is not a canary ointment. But it is much better than the alternatives currently discussing the authorities.

Link to Original Article:

From El Financiero CR

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