Neaime Lectures on Monetary Policy in the MENA Region

Neaime: Pegging the exchange rate has often resulted in large public debt

According to AUB Economics Professor Simon Neaime, a number of Middle East and North Africa countries (known as the MENA region) reaped benefits once they decided to shift their monetary policy from one that primarily pegs the exchange rate to one that pegs prices and inflation.

Neaime, who chairs the Department of Economics and is a fellow at the Institute of Financial Economics (IFE), delivered a lecture on the subject on March 18 in West Hall. Titled "Monetary Policy Transmission and Targeting Mechanisms in the MENA Region," the talk was part of a series of lectures and workshops organized by the IFE and the Department of Economics on developmental and financial issues facing the MENA region.

As Neaime explained, a number of industrialized nations chose to adopt a new monetary policy in the early 1990s, in which central banks pegged the inflation rate over a specific period of time, while allowing flexibility in the exchange rate, with the long-term monetary goal of maintaining stable inflation.

Neaime said the developed countries decided to adopt this framework after they encountered difficulties in policies that pegged the exchange rate or used some monetary aggregate as the main intermediate target. They realized that the new framework would allow them to better control inflation, while making their monetary policies more transparent and accountable.

MENA economies have been able to contain the inflationary pressures of the last two decades by pegging their currencies to a relatively low-inflation currency, such as the Euro or the US dollar, and relying on high interest rate policies to defend their exchange rates. But they also realized that this policy "had generated persistent real exchange rate appreciations, losses in international competitiveness, large trade and budget deficits, the accumulation of sizeable debts, and in some instances serious currency crises," Neaime said, pointing to the experience of Egypt, Jordan, Turkey, and Lebanon in the 1990s.

As a result, a few MENA counties have explicitly adopted inflation targeting as their main policy goal (e.g. Turkey), while others, such as Morocco and Tunisia, are implicitly targeting inflation and are slowly moving towards an inflation targeting regime. "They are already targeting the real exchange rate, rather than the nominal rate, in order to maintain competitiveness and avoid currency overvaluation while opening their markets to international capital flows," he said.

Professor Neaime noted that there are two requirements that should be met before a country adopts inflation targeting. The first is that the central bank should have a considerable degree of independence, without political interference. "While recent efforts in Turkey and Egypt have rendered their respective central banks more independent, the MENA governments of Lebanon, Jordan, Morocco, and Tunisia will have to devote further efforts towards independence of their central banks, if they wish to successfully shift their monetary policy to targeting inflation," he said.

The second requirement is that the authorities should refrain from targeting the level or path of any other nominal variable, such as the nominal exchange rate. A case in point is Jordan in the early 1990s, and more recently Lebanon. A country that chooses a fixed exchange rate system subordinates its monetary policy to the exchange rate objective, and is not effectively able to target directly any other nominal variable, such as the rate of inflation. If these restrictions are relaxed through such variants of a fixed-rate system as crawling pegs or target zones,