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    Case Studies: Exchange Rate Regime Choice in A Postwar Country: Iraq

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    Boda Tanvi
    This document discusses exchange rate regime choices for postwar Iraq. It argues that adopting a currency board was the optimal choice over other options like managed floating. A currency board would impose needed discipline on Iraq's central bank after years of monetary abuse under Saddam Hussein. It would also curb any temptation to monetize deficits by requiring full foreign exchange reserves at a fixed exchange rate. While there are some arguments against a currency board, the document counters that given Iraq's situation and priorities at the time, a currency board was the best short-term solution to achieve monetary stability and restore confidence in Iraq's currency.

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    Case Studies: Exchange Rate Regime Choice in A Postwar Country: Iraq

    Uploaded by

    Boda Tanvi
    15 views2 pages
    This document discusses exchange rate regime choices for postwar Iraq. It argues that adopting a currency board was the optimal choice over other options like managed floating. A currency board would impose needed discipline on Iraq's central bank after years of monetary abuse under Saddam Hussein. It would also curb any temptation to monetize deficits by requiring full foreign exchange reserves at a fixed exchange rate. While there are some arguments against a currency board, the document counters that given Iraq's situation and priorities at the time, a currency board was the best short-term solution to achieve monetary stability and restore confidence in Iraq's currency.

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    This document discusses exchange rate regime choices for postwar Iraq. It argues that adopting a currency board was the optimal choice over other options like managed floating. A currency board would impose needed discipline on Iraq's central bank after years of monetary abuse under Saddam Hussein. It would also curb any temptation to monetize deficits by requiring full foreign exchange reserves at a fixed exchange rate. While there are some arguments against a currency board, the document counters that given Iraq's situation and priorities at the time, a currency board was the best short-term solution to achieve monetary stability and restore confidence in Iraq's currency.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    15 views2 pages

    Case Studies: Exchange Rate Regime Choice in A Postwar Country: Iraq

    Uploaded by

    Boda Tanvi
    This document discusses exchange rate regime choices for postwar Iraq. It argues that adopting a currency board was the optimal choice over other options like managed floating. A currency board would impose needed discipline on Iraq's central bank after years of monetary abuse under Saddam Hussein. It would also curb any temptation to monetize deficits by requiring full foreign exchange reserves at a fixed exchange rate. While there are some arguments against a currency board, the document counters that given Iraq's situation and priorities at the time, a currency board was the best short-term solution to achieve monetary stability and restore confidence in Iraq's currency.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    of 2

    9

    Case Studies

    Exchange rate regime choice in a postwar country: Iraq


    This case study draws heavily on Moosa (2004a, 2004b). Iraq is a case of
    a postwar country that experienced hyperinflation resulting from exces-
    sive currency printing. Between 1991 and 1995, the nominal value of
    the currency in circulation jumped from 22 billion to 584 billion, giving
    rise to an average annual inflation rate of 250 per cent. Monetary reform
    in post-Saddam Iraq is an issue that has been dealt with in the academic
    literature (for example, Hanke, 2003a; Roubini and Sester, 2003), in the
    media (for example, Hanke, 2003b) and in policy documents (for exam-
    ple, Sanford, 2003). King (2004) used the case of Iraq to demonstrate
    that expectations of future collective decisions can have a major impact
    on the value of a currency, irrespective of the policies pursed by the
    current government.
    One of the major tasks facing any civilian authority in a postwar
    situation is to get the economy up and running. Central to this effort
    is putting in place stable monetary conditions as a prerequisite for the
    success of economic reconstruction. This is particularly the case if the
    country in question has been enduring macroeconomic mismanage-
    ment and inflationary monetary policy, which were the conditions that
    Iraq endured for many years under the regime of Saddam Hussein. The
    question that had to crop up, therefore, was the choice of exchange rate
    regime, as this choice is a critical component of monetary reform in
    Iraq. As expected, the views on this issue diverge between the extremes
    of dollarization and free floating.
    I argue that the optimal exchange rate regime under the prevailing
    conditions is a currency board, while arguing against suggestions for

    225

    I. A. Moosa, Exchange Rate Regimes


    © Imad A. Moosa 2005
    226 Exchange Rate Regimes

    adopting managed floating and other regimes. The basis of the argu-
    ment for a currency board and against managed floating is that the
    former imposes the discipline that the Central Bank of Iraq (CBI) needs
    after years of monetary abuse. It is also argued that while a currency
    board is a rather stringent system, it is an extreme measure that is
    needed to deal with an extreme situation. There is no better way to curb
    the temptation to monetize the deficit than a currency board, whereby
    the central bank keeps a full foreign exchange cover at a fixed exchange
    rate.
    One argument against a currency board for Iraq is that the foreign
    currency reserves needed to run the exchange rate arrangement can and
    should be used more appropriately for the reconstruction of the coun-
    try. Some counter-arguments can be suggested. The first is that this is a
    price worth paying to achieve monetary stability and restore confidence
    in the currency. The other counter-argument is that the foreign
    exchange reserves required for a full cover are rather small relative to
    the total cost of reconstruction. Assuming that the monetary base/GDP
    ratio is 0.1 and that GDP in 2003 is $25 billion, the initial cover required
    is $2.5 billion. This is a small fraction of the $100 billion or so needed to
    finance reconstruction. The amount required for this purpose should be
    readily available from the frozen Iraqi assets. Moreover, keeping full
    reserves at the CBI gives it more credibility at a time when potential
    transaction partners associate it with bankruptcy. This is not to mention
    that the CBI needs to hold some reserves under other exchange rate
    arrangements, albeit smaller amounts.
    The arguments against a currency board for Iraq are the following:

    . Difficulties of managing external shocks.


    . The requirement of a strong fiscal policy in place.
    . The possibility of serious consequences if an inappropriate level of the
    fixed exchange rate is selected.

    While there are no problems with these arguments in a general sense,


    I find it unacceptable to put forward propositions that do not take into
    account the specifics of the situation in Iraq and its priorities. Hence,
    consider the following counter-arguments:

    . To start with, the argument about shocks is mostly applicable to a


    developed country with a diversified export base, not to a country that
    derives 95 per cent of its foreign exchange revenue from a commodity
    that is priced in US dollar terms. Iraq will be (for a long time to come)

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