If It Ain’t Broke, Don’t Fix It* **

1^st of July is the date when we celebrate 10 years from the beginning of the most successful reform which have been undertaken in the field of economic policy after the transformation of the Bulgarian economy. The introduction of the currency board put an end of the uncontrollable increase in the money supply, which is a significant premise for the stabilization of the Bulgarian lev and the confidence in it.

The high and stable economic growth is determined by the existence of individual liberty and personal responsibility. The different elements are connected with voluntary exchange, the protection of property rights and the rule of the law, low taxes, free movement of capital and people, and last but not least – stable money. The reforms which have been conducted during the last 10 years and which have contributed for increase in the economic freedom, have improved the conditions for individual initiative and accelerated development. The biggest advancement has been realized exactly in the sphere of money due to the implementation of the currency board.

The currency board has been introduced in Bulgaria after a severe financial crisis, which started in the beginning of the 1990s and reached its peak in 1996 and first months of 1997. The results were disastrous- significantly lower real income, the pensions got as low as USD 2 per month, and some wages – USD 3 per month. People used the lev to a lesser and lesser degree. It was substituted with the US dollar and the German mark not only for savings, but also for everyday payments in the shops. In some cases even natural exchange was implemented meaning that the lev did not perform its functions as money. Other negative peculiarities of this period are the real decrease in investment, the pouring out of capital, the chronic budget deficit, and the enormous public debt. The overall expenses for the economy from the crisis are 40% of the GDP for that period, classifying the crisis as one of the most sizeable in Central and Eastern Europe.

During the period 1991-1997 the Bulgarian National Bank implemented discretionary monetary policy, meaning a policy without clear principles. The set-down quantitative goals were not publicly known, or if the goals had become known, they were not achieved. Besides BNB was strongly dependent on the government and took into consideration its policy toward the budget deficit and the financing of the unprofitable state enterprises. Additionally, at the time of the peak of the crisis, the creditor of the last resort was not only the BNB but the one of the state owned banks, DSK, which undertook a great deal of the refinancing of the commercial banks.

The existence of a currency board presumes the complete termination of such practices because it requires the maintenance of firm financial discipline in the private and public sectors. The ability for BNB to be a creditor of last resort is severely limited only to cases of liquidity risk for the whole bank system. The central bank is forbidden to lend money to the government (with the exception for credits from the International Monetary Fund, which have to go through BNB before becoming available for the government, but this does not pose a violation of the essence of the currency board).

The Bulgarian lev is pegged to the Euro and the BNB is required to maintain a minimum of 100% coverage to the monetary base (including the fiscal reserve account at Issue Department which functions as a currency board) with assets denominated in euro. The full coverage of the monetary base and the requirement for BNB to exchange levs for euros upon demand ensures the convertibility of the local currency and increases its stability. In this sense the monetary emission is entirely subject to the market demand and BNB cannot discretionary increase the money supply.

The governments, being deprived of the ability to issue money and thus finance their expenditures, are forced to keep their budgets balanced after 1997, and in the last 3 years significant budget surpluses have been realized. As a result the inflation pressure is going down, and its negative consequences are under control. The Bulgarian lev stands stable relative to the goods and services that can be bought with it, and relative to the other currencies as well. It functions as a measure of the prices and allows the comparison between them. Besides, the stable lev results in higher credibility in the economy, reducing the expenses for hedging against sharp changes in the price level. Thus the resources are allocated more efficiently, investment is increased, capital is accumulated, and the economic growth is enhanced.

Of course, the currency board has its opponents who claim that as a result of its functioning a current account deficit emerged. They argue in favor of depreciation of the lev or a complete removal of the board. The consequences of such a decision would be strongly negative for the economy as a whole and would mean a reduction of real income for the employees because the prices of raw materials and technology will not go down for the reason that they are imported and paid in foreign currency. In the long-run due to higher inflation the real return from investment will be lower which will result in outflow of foreign investment and lower real growth of productivity. Therefore, the applicability of such measure is not only undesirable but also detrimental.

The results from the introduction of the currency board and the rest of the reforms such as privatization, the liberalization of trade and the movement of capital during the period 1998-2006 are presented in the table below. The improvements are result from more prudent policy and give grounds to conclude that the expansion of individual freedom is the proper way. The policy of the ruling parties should be built on this way if the goal is higher economic growth and standard of living.

A very important element of this policy is the maintenance of the currency board and the exchange rate toward the euro until its introduction as a legal tender. This will guarantee the preservation of the already achieved stability in the economy and will continue to contribute for its positive development. Any change in the monetary regime is absolutely ungrounded, would result in destabilization and redistribution of income in favor of definite small groups in the society at the expense of everybody else. This is the reason why the reasonable and responsible politicians should firm support the currency board.

Table: Some economic indicators (average for the period)

 Source: BNB, NSI, Ministry of Finance and own calculations

*Citation by Burt Lance

**The article is first published in "Capital" newspaper