Central Bank Head Explains Regime Change
The son of a Central Bank cashier, Francisco de Paula Gutiérrez has always found himself around money.
“I’ve been coming to the Central Bank my whole life,” said the San José native.
Originally appointed Central Bank president by former Costa Rican President Abel Pacheco (2002-2006), the U.S.-educated economist was reappointed by President Oscar Arias in May.
This time around, he is responsible for seeing Costa Rica through its first exchange rate regime change in 22 years (see separate article). The reform, which will give the Central Bank leverage to fight Costa Rica’s double-digit inflation, comes as the government and the Central Bank are both steeped in debt.
Gutiérrez, 57, who has a Ph.D. from the University of Pennsylvania, has worked as a professor at the Central American Institute of Business Administration (INCAE) in Alajuela, northwest of San José, and served as Finance Minister under the administration of former President José María Figueres (1996-1998).
Sincere, down-to-earth, Gutiérrez slings around weighty macroeconomic issues like monetary reform effortlessly.
“The Central Bank is an interesting place to be for an economist,” he said with a grin on his face, eyes smiling through thick glasses. Gutiérrez, who is married and has two children, believes there is no better time than now for Costa Rica to migrate to a new exchange rate system.
He recently sat down with The Tico Times in his spacious Central Bank office to explain why. Excerpts:
TT: Why does Costa Rica need a new exchange rate system?
FG: The Central Bank has been discussing this topic for a long time. The bank did a study as early as 1996, in which researchers began to ask what should be Costa Rica’s next step in monetary policy.
The Central Bank’s Board of Directors has been discussing (moving to a currency band system) with the presidency for more than a year. This plan is not necessarily coming from this administration. In January 2005, the Central Bank Board of Directors approved a strategic long-term project that aims to control the country’s inflation rate.
As part of that project, it is necessary to have more exchange rate flexibility.
The Board of Directors is acting with that strategic plan in mind, though obviously the changing of the exchange rate regime is something that affects everyone.
You have said inflation is one of Costa Rica’s biggest problems today.Why?
Inflation like ours – which was at 14 % (accumulated in 2005), and is expected to reach 11% by the end of this year – are high levels in this era, compared to the rest of the world economy. Inflation rates in developed countries are around 3-4%.
High inflation has many hidden costs. One of the costs is known as the “inflationary tax.” It acts as a tax on the Costa Rican currency, reducing its value.
The low-income groups are most affected by this. It hits the poor people the hardest. Many people don’t see it this way, but the middle and upper classes have a way to protect the value of their financial assets. Their assets aren’t all in one basket. They may have assets in bonds, in property, in bank accounts with interest rates, some assets in dollars, in real assets. However, for those with low incomes, their financial assets are basically what they receive with each paycheck, and the time that passes between when they receive that paycheck and when they spend it. Let’s say they are paid every 15 days or once a month. During that month their paychecks lose value. And they don’t have the ability to buy a 15-day bond. So they are basically receiving zero interest on their financial assets, and those financial assets are losing purchasing power each day because of inflation.
Also, interest rates in colones have to be higher to compensate people for inflation. Which is why people don’t want to go into debt to invest in a house in colones. Although they know the property will have a higher value in the future, the high interest rates cost them and make them not want to take out a loan for 15 years.
So, due to higher interest rates, people look for other options for credit. They look to dollars. That impacts the economy with a growing trend of dollarization.
The Central Bank wants lower interest rates for more stability.Why haven’t we been able to get lower interest rates? There are two reasons.
One is that the Central Bank is in debt. We have more liabilities than assets.We have a negative net worth of $2 billion.
We have to pay interest on those liabilities, which is money we’re printing and putting into the street each day to take care of our losses.
The other problem is that we’re also putting colones in the street in exchange for dollars as a means of maintaining monetary policy. So we increase reserves but we throw around a lot more colones. Because of that, there is an excess of colones in the economy – making them worth less.
Isn’t about half of Costa Rica’s liquid economy in dollars now? Will the new system reverse the trend of dollarization?
(The level of dollarization) is high. The problem is there is too much certainty. People know that the colón will devaluate in the current system and by how much.
The main goal of exchange rate regime change is to control inflation. But it can also have the effect of counteracting the dollarization of the economy.
What is your biggest fear with the implementation of the new exchange rate regime?
That the people will have to learn to live with the system. There will be a process of learning for some time.
But it is a good time to do this.We have a good amount of reserves – the Central Bank’s finances have been improving since the 1980s. We have a lot of income from direct foreign investment, and an economy that is growing, so we decided it is a good moment to move toward a more flexible system.
You’ve said that ultimately the goal is to liberalize the colón and have it float freely against the dollar with no or little Central Bank intervention.How long will it be until this transitional currency band system becomes a freely floating colón?
It’s hard to say. When the mini-devaluation system was put into effect 22 years ago, it was said then that that was a transitional system (laughs).
So what if fiscal reform isn’t approved?
We’ve also conversed with the Finance Ministry about how we need the ministry to capitalize the Central Bank, and shift the Central Bank’s debt to the ministry. That, of course, will depend on whether or not fiscal reform is approved. That way, the Finance Ministry would generate fresh resources to pay the debt we have. The problem right now is we have a Central Bank and a government in debt, which is why we need fiscal reform.
If we don’t have the fiscal reform to capitalize (the Central Bank’s debt), we’ll have less success controlling inflation in the long term. It won’t allow us to have much room to control inflation.
Isn’t inflation already decreasing?
Yes, partly because of the fall in world oil prices. But of course it’s still worth making the change.We hope we can reach the goal of bringing the rate down to 11% by the end of this year.
What the economy has been doing in the past few years is very positive.What’s important is that the country advance. That means fiscal reform, capitalization of the Central Bank’s debt, and CAFTA (the Central American Free-Trade Agreement with the United States).
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