The Influence of the Currency Board on the Goals of Economic Policy and Macroeconomic Stability

Abstract

Currency board as a monetary regime is a demonstration of a related monetary policy according to which the main objective of the central bank is the stability of the exchange rate in relation to the anchor currency. However, there is still a debate in academic circles about the objectives of the central bank, whether it should take care of price stability or support other objectives such as employment, economic growth, and balance of payments. The subject of the research is the currency board in Bosnia and Herzegovina. The results presented in this chapter examine the movement of macroeconomic aggregates as a function of economic policy goals, risks, and asymmetries of the currency board, credibility of central banks operating in the currency board regime, and macroeconomic stability in the currency board. The scientific research methodology applied in the work is based on qualitative and quantitative methods, comparative analysis, deduction and induction methods, linear regression model, and hierarchical multiple linear regression. The results of the research are presented by proving the main hypothesis of the research, according to which the currency board of Bosnia and Herzegovina does not fully contribute to the achievement of the goals of economic policy and macroeconomic stability.

1. Introduction

If we briefly go back in time, after the dollar crisis and the collapse of the Bretton Woods system in the 1970s, several industrialized countries abandoned fixed exchange rates and switched to flexible exchange rates. From then until today, the choice of exchange rate regime is a subject of debate in academic circles. Since then, no consensus has been reached regarding the choice of the optimal exchange rate regime, the determinants that determine the optimal exchange rate, and the answer to whether the regimes are sustainable or not. The choice of exchange rate regime has renewed the debate among policy makers and researchers making this topic topical. In this work, the starting point is represented by numerous sources of information that have been reached on the basis of exploratory research, achievements in monetary theory and macroeconomics, and the experiences of countries whose financial system operates in the currency board regime or similar monetary regimes. As the sources are numerous, we will mention only a few that determine the advocates and opponents of this model of monetary policy. Opponents attribute numerous shortcomings to the currency board, such as the fact that it is an unsovereign monetary system, an underdeveloped money and capital market, and a strict macroeconomic policy. Foreign trade deficit, current account deficit and low level of foreign and direct investments are a trap of the currency board as in Ref. [1]. In Ref. [2] talks about the benefits of introducing a currency board, stabilization of the monetary and macroeconomic system, restoring confidence in the monetary system. At the same time, he warns against the excessive rigidity of the currency board because it is difficult to respond to macroeconomic and microeconomic shocks, because it does not provide answers to short-term liquidity on the money market. Proponents of the currency board welcome the currency board through independence of monetary authorities, aversion to inflation and trust in monetary authorities as in Ref. [3]. Then they argue that the currency board leads to monetary and financial stability as in Refs. [3, 4, 5].

The influence of the currency board on the goals of economic policy and macroeconomic stability represents a challenge and a direction that needs to emphasize and the concept of independence of monetary authorities should be consistently pursue. The basis for this position derived from the analysis of the macroeconomic situation the application of different monetary regimes in the countries of Southeast Europe. Special reference to Bosnia and Herzegovina, Bulgaria, Estonia and Lithuania (until their entry into the European Monetary System)—as countries that represent an experimental group, and Serbia, Croatia, Montenegro and Macedonia, which represent the control group of countries.

In accordance with the mentioned sources, the experiences of individual countries, theoretical achievements and empirical analyzes in response to the question: Does the currency board, as a monetary regime, contribute to the realization of the goals of the economic policy and macroeconomic stability of the country? a research hypothesis was put forward which reads:

H: The currency board does not contribute to the realization of economic policy goals: it does not contribute to full employment, price stability, balance of payments and sustainable economic growth.

In accordance with the set hypothesis, in the continuation of the paper, the topics that develop in the direction of proving the main hypothesis using statistical models of multiple correlation, analysis of variances, ANOVA and multiple regression discussed.

2. Movement of macroeconomic aggregate as a function of economic policy objectives in the currency board

The aim of the chapter is to prove the hypothesis about the influence of the currency board on economic policy goals and macroeconomic stability, through comparative and statistical analyzes of dependent and independent variables derived from the definition of common zones: economic policy, macroeconomics and monetary policy.

The great global economic crises of the 1930s of the twentieth century, as well as the crisis of 2008, clearly indicate that there are certain imperfections in the market, which is why economic systems cannot left exclusively to the operation of the market mechanism. In order to preserve the stability of the economic system and create conditions for its further development, it is necessary actively engage the state in economic life. There is a continuous debate on the extent to which the state should regulate economic movements. It is clear that privately owned companies are more efficient than public ones, it is also clear that not all companies in the economy can be left to the private sector and that only the state can prevent the negative consequences that certain economic behaviors of market subjects can have on the system. Nevertheless, there is a sharp debate in academic circles about whether the involvement of the state in economic life has more positive or negative consequences. Whatever the answer to that question is, the fact is that modern economies are so-called mixed economies and that in addition to the market mechanism and competition, the state has an influence on economic trends. The participation of the state manifested through the economic policy it leads and which is mutually conditioned and connected to the concrete economic system. Economic policy represents a form of state intervention in the economy through state institutions, established rules and measures through which influence on the economic system achieved. The subject, that is, the bearer of economic policy, is the state and its various institutions: the assembly, the government, various ministries, the central bank, local self-government bodies and administrations of smaller territorial units, etc. Economic policy has many goals in front of it. These goals are often complementary, but there are not rare cases in which the holders of economic policy have completely opposite goals in front of them, such as, for example, in the case when they need to reduce budget spending and at the same time provide a satisfactory level of income for workers in education and health. Due to the existence of mutually opposing goals, it is necessary to weigh priorities very carefully when formulating the goals of economic policy. In order for the goals of the economic policy to be achieved satisfactorily, it is necessary that the goals, as well as the entities that will implement the activities, be as precisely determined as possible, that they be realistic and, if possible, quantitatively expressed. The goals of economic policy divided into long-term and short-term. The long-term (strategic) goals of economic policy: expansion of production, increase in productivity, improvement in resource allocation, improvement in the distribution of gross domestic product, satisfaction of common needs, more efficient inclusion in the international economy, increase in the competitiveness of the economy. The short-term goals of economic policy: full employment, price stability, balance of payments and sustainable economic growth and development. The short-term goals of the economic policy are simultaneously the goals of the monetary policy, and therefore also the goals of the central banks as representatives of the monetary authorities.

Monetary policy represents that part of economic policy that the state conducts through its central bank. In Ref. [6] states that the ultimate goals of monetary policy and the central bank are inflation control, full employment, permanent economic growth, balance of payments and protection of the domestic currency. As in Ref. [7] talks about the six basic goals of monetary policy, of the Federal Reserve and other central banks in the world: high employment rate, economic growth, price stability, interest rate stability, financial market stability and foreign exchange market stability. As in Ref. [8] states that central banks around the world have the goal of ensuring economic development, low unemployment, keeping inflation under control. According to the European System of Central Banks, the primary goal is to maintain price stability and support the general economic policy of the Community, in order to contribute to the achievement of the Community’s goals as in Ref. [9].

In order to achieve the objectives of the monetary policy, the central bank as the subject of that policy uses monetary policy instruments: discount rates, the policy of banks’ required reserves, the policy of open market operations and the issue of money.

In the 1980s of the twentieth century, there was a trend of increasing independence of central banks and the sole objective of monetary policy was price stability. However, the debate about the objectives of the central bank is still present and it is to the greatest extent a consequence of the disagreement about what monetary policy can and should provide? Should it take into account price stability or support other objectives such as employment, economic growth and balance of payments balance?

In practice, the objectives of central banks defined differently, but most cases they reduced to maintaining price stability and implementing economic policy objectives. The Figure 1 shows the goals defined by law of the central banks of the countries belonging to the experimental group and the control group, which essentially have different monetary policy statuses. Differences in objectives can explained by differences in the environment in which central banks implement monetary policy.

Figure 1.

Law defined goals of selected central banks. Source: Editing by the author.

The global financial crisis also opened a new chapter on observing the goals of central banks. The last crisis showed that inflation is less dangerous for the functioning of the economy and the financial system than financial instability. In inflationary conditions, the real and financial systems can function with more or less difficult, however, in conditions of financial instability there is a complete paralysis of real and financial flows. As an example, we can cite the disruptions in the world financial market and the commodity market during COVID-19, as well as the disruptions caused by the war in Ukraine. The result of the disruption reflected in the shortage of goods and the uncontrolled expansion of the prices of consumer goods. Moreover, fixing financial instability requires much more money and time than fighting inflation. However, financial stability and instability do not currently have a generally accepted definition in terms of goal setting. Instability cannot expressed numerically, then financial stability is not exclusively the responsibility of the central bank, it also includes the Ministry of Finance and supervisory agencies. Bearing in mind that the central bank cannot be the only institution responsible for financial stability, the question arises why financial stability is set as the goal of central banks. The answer lies in the fact that there is a lot of evidence in support of the hypothesis that the future financial crisis foreshadowed by the uncontrolled expansion of money and bank loans.

Macroeconomic aggregates are all relevant economic dimensions of a country’s economy in which its resources and results collectively expressed. Resources are all factors that used to achieve economic activity, and results are products and services that arise from economic activity and the use of resources.

Macroeconomic aggregates as a collective expression of economic resources are: employment-unemployment, production capacities at the disposal of an economy, available natural resources, the number of companies that carry out economic activities, the number of households that provide labor resources to companies and form monetary income from them, the use of which forms the demand for products and services. The results of the economic activity of an economy are the products and services offered on the market. In summary, they represent the gross domestic product.

$$\text{Y=C+I+G+}\left(\text{X-Z}\right)$$E1

Thanks to the circular flow of income, from the point of view of the expenditure approach, the basic structure of the gross domestic product (Y) consists of private consumption (C), investments (I), public consumption (G) and the net difference between exports and imports (X−Z). In order to analyze the economic situation in a certain country, it is necessary to look at the circular flow of income in the structure of the gross domestic product. That is, (1) whether the budget deficit was caused by positive private net savings (S−I); (2) whether the growth of exports generated income that is directed to savings (X−Z); and (3) whether the fall in investment caused a recession that reduced imports and tax revenues, thus creating a current account surplus or a budget deficit (T−G). If we incorporate the above into the mathematical expression of gross domestic product, we get the following situations:

$$\text{Y=C+I+G+}\left(\text{X-Z}\right)$$E2

$$\text{C}+\text{S}+\text{T}=\text{C}+\text{I}+\text{G}+\left(\text{X}-\text{Z}\right)$$E3

$$\left(\text{S-I}\right)\text{+}\left(\text{T-G}\right)\text{=}\left(\text{X-Z}\right)$$E4

The purpose of the parentheses in the equations is to emphasize the fact that the corresponding expressions in the parentheses shown as net inflows or outflows to the private sector, the government and the rest of the world respectively. Each of these three net incomes viewed as a specific form of savings, as an outflow or inflow. For example, if S > I, the private sector saves more, the reverse is the debtor. If T > G, taxes are higher, public spending is lower, the government saves more, and conversely, the government lends money by issuing debt securities to domestic or foreign residents. If X > Z, the country exports more than it imports, and achieves a positive result on the foreign trade account. Through these expressions, it is necessary to measure the impact of monetary policy on resources and results, that is, on the goals of economic policy and on macroeconomic results and their stability.

Based on the content interpreted so far, it is not difficult to notice that in all three areas there are common elements such as employment, economic growth, economic balance, inflation price stability and other variables that represent goals, resources and results.

3. Analysis of the influence of monetary aggregates on the balance of payments

The deductively posed hypothesis about the influence of the currency board on economic policy goals and macroeconomic stability is not sufficient explained only through comparative analyses. In order to achieve more precise results in the research, in this part, certain analyzes will be performed using the statistical model of multiple linear regression on panel countries, using SPSS software. More precisely, the possibility of a linear relationship between the balance of payments, gross domestic product and unemployment as control variables on the one hand and money supply, monetary reserves and real interest rate as predictor or changeable variables in the period 1997–2015, will be examined.

The balance of payments is a report of all payments and monetary transactions between a country and the rest of the world observed over a certain period. The basic structure of the balance of payments consists of the current account (goods and services), capital account (loans), financial account (direct and portfolio investments and reserve assets) and net errors and omissions. The main benefit of the balance of payments is that it allows a country to identify long-term trends that may be difficult for the economy. The most important item of the balance of payments is the balance of the current account. It obtained by adding the balance of exchange of goods and services with the balance of transfers that do not belong to commercial or financial transactions (public transfers, foreign aid, payments and disbursements from the EU budget, remittances sent by associates to their country). The remaining items of the balance of payments belong to financial transactions. If a deficit recorded in the balance of payments, residents sent more money abroad than they received through commercial and financial transactions. In this case, the monetary authorities absorb the difference, returning the domestic currency to the country, which means that the monetary authorities spent part of their foreign exchange reserves to buy the domestic currency and balance the balance. If the capital balance of the private sector is in balance, the inflow of domestic money into the country will exceed its outflow, which reflected as excess demand for domestic currency on all foreign exchange markets of the world. Such a situation will lead to appreciation on the foreign exchange market, that is, to an increase in the value of the domestic currency. If the monetary authorities want to prevent appreciation, they will sell the missing amount of domestic money in relation to foreign money and thus the sign in the balance of interventions on the foreign exchange market will become negative. In this case, the surplus on the current account takes the form of buying foreign currency, that is, it seen as a loan to foreign monetary authorities. If the monetary authorities do not intervene, the appreciation will reduce the surplus, because then domestic goods become more expensive and foreign goods become cheaper, which accelerates the outflow of capital.

Therefore, the monetary authorities can control the exchange rate and the balance of payments through foreign exchange reserves and the foreign trade balance, that is, the balance of payments.

Below is the state of balance of payments of the panel countries, the experimental group consisting of countries whose monetary systems function in the currency board, namely: Bosnia and Herzegovina, Bulgaria, Estonia and Lithuania, and the control group of countries consisting of Serbia, Croatia, Macedonia and Montenegro whose monetary systems have monetary sovereignty for the period 1997–2015, Figure 2.

Figure 2.

Balance of payments analytic presentation by country 1997–2015. Source: Editing by the author.

The calculation methodology and balance of payments data, with its structure, taken from the website of the International Monetary Fund. In addition to the balance of payments, the second graphic shows the current account and trade balance. By comparing balance sheets, current balances and foreign trade balances, it concluded that during the period 1997–2015 all countries had a balance of payments deficit except Estonia, Lithuania and Bulgaria in the period 2009–2015, Figure 3.

Figure 3.

Balance goods and services by country 1997–2015. Source: Editing by the author.

For Serbia and Montenegro, data shown since 2007, because since that year Serbia and Montenegro have been acting as independent states. Without going into a detailed analysis for each year separately, at first glance one can notice a big breakdown or deficit in the period of the emergence of a major economic crisis. More precisely, we can say with certainty that the economic crisis, looking at the balances of payments of the experimental countries and the control group of countries, was more difficult to bear by the experimental countries despite strict monetary control and macroeconomic discipline.

Bearing in mind the objectives of economic and monetary policy, the question arises: How much can the monetary system really influence the state of the balance of payments? Can the balance of payments balance influenced by the monetary aggregates money supply M1, monetary reserves and the real interest rate?

In addition, the money supply M1 Figure 4, the real interest rate also comes into focus. Within the financial system, operations of saving, taking and granting loans and investing continuously performed. The links between these operations particularly affected by the interest rate. The interest rate represents the price that the credit user pays for the use of rare credit resources that he has taken from the creditor for use for an agreed period.

Figure 4.

Monetary aggregate M1 by country 1997–2015. Source: Editing by the author.

Without going into details about each monetary aggregate individually, it noted from the attached graphs the growth of the money supply and monetary reserves Figure 5 in all countries, and the stabilization of real interest rates Figure 6. However, it is an extremely interesting question: with these indicators, why is there a chronic deficit of the balance of payments and its key structures? Can we say that the absence of monetary sovereignty in the case of the experimental countries contributes to such a result or is the currency board unable in the long term, due to its rigidity, to stick to the common goal with economic policy, which is the balance of payments?

Figure 5.

Monetary reserves (includes gold) by country 1997–2015. Source: Editing by the author.

Figure 6.

Real interest rate (%) by country 1997–2015. Source: Editing by the author.

In response to these questions, two hypotheses put forward using the statistical hierarchical model of multiple linear regression:

H₀: In the sample of currency board countries (experiment), there is no linear relationship between balance of payments and money supply, monetary reserves and real interest rate.

H₀: In the sample of currency board countries (experiment), the money supply, monetary reserves and real interest rate cannot influence changes in the balance of payments.

By applying the mentioned statistical model, the aim is to examine:

• whether the predictor variables money supply, monetary reserves and real interest rate can explain a significant part of the variability of the control variable balance of payments;

• which part of the variability of the balance of payments can be explained by the money supply, monetary reserves and the real interest rate, what is the strength of the connection between these variables;

• what is the structure of the connection, i.e. linearity, and

• forecast the value of the balance of payments.

The estimation of the regression model derived from the relation:

$$Y_i^{\ast }=b_0+b_1{x}_{i1}+b_2{x}_{i2}+\dots +b_m{x}_{im}$$E5

Y_i^*—predicted value of the criterion variable based on the sample;

b₀, b₁, b₂…b_m—regression parameters calculated according to the principle of least squares.

The statistical model includes variables shown in the annual time interval from 1997 to 2015 for the experimental and control group of countries. The values of the variables taken from the website of the World Bank for Reconstruction and Development (IBRD) and from the website of the International Monetary Fund (IMF). The criterion (dependent) variable is the balance of payments, while the money supply (M₁), real interest rate (RIR) and monetary reserves are predictor (independent) variables. The hierarchical multiple linear regression model based on examining the linear relationship between control and predictor variables by creating different models. The input variables, in the Variables Entered/Removed table, represent the predictor variables presented in the models according to which the linearity test, the strength of the relationship, the structure of the relationship and the prediction of the value of the control variable performed. Models that meet the condition of statistical significance analyzed from the tables.

Empirical findings have shown that in the case of experimental and control countries there is a strong correlation and linear relationship between monetary aggregates of money supply and monetary reserves and balance of payments. In both cases, monetary reserves showed a stronger impact on the balance of payments.

4. Analysis of the impact of monetary aggregates on employment

The key objective of the economic policy, in addition to the balance of payments, is the achievement of full employment, because unemployment and total employment are one of the main indicators of economic activity that reflect the labor market. Unemployment is a phenomenon that occurs when a person does not have a job in the observed period, but is actively looking for one and is ready to work. The most common measure of unemployment is the unemployment rate as in Ref. [9]. The unemployment rate defined as the percentage of the total workforce that is unemployed, obtained by dividing the total number of unemployed by the registered number of people on the labor market. Unemployment occurs in several variants: as frictional, structural and seasonal unemployment. The generally accepted natural rate of unemployment gravitates between 5 and 6%, therefore this rate represents the goal of economic policy. This the goal that is defined by the monetary policy. The trend of unemployment in the countries of the panel given in the graphic. The source of the information taken from the website of the International Bank for Reconstruction and Development according to the estimates of the International Labor Organization as in Ref. [10].

Looking at the Figure 7 for the countries was included in the panel, it is not difficult to conclude that in all countries during the entire period from 1997 to 2015 was extremely high unemployment is present. It is interesting that Estonia, Lithuania and Bulgaria had an unemployment rate of approximately 6% during the period of the greatest economic crisis. The question arises as to what is the cause of such high unemployment. Are unemployment affected by monetary aggregates M₁, monetary reserves and real interest rate?

Figure 7.

Unemployment, total (% of total labor force) by country 1997–2015. Source: Editing by the author.

As in the previous case, two hypotheses tested using the statistical hierarchical model of multiple linear regression as in Eq. (5).

H₀: in the sample of currency board countries (experiment), there is no linear relationship between unemployment and money supply, monetary reserves and real interest rate.

H₀: in the sample of currency board countries (experiment), money supply, monetary reserves and real interest rate cannot affect changes in unemployment.

By applying the mentioned statistical model, the aim is to examine:

• whether the predictor variables money supply, monetary reserves and real interest rate can explain a significant part of the variability of the unemployment control variable,

• which part of employment variability can be explained by money supply, monetary reserves and real interest rate, i.e. what is the strength of the relationship between these variables,

• what is the structure of the connection, i.e. linearity,

• forecast the value of the balance of payments.

The statistical model includes variables shown in the annual time interval from 1997 to 2015 for the experimental and control group of countries. The values of the variables taken from the website of the World Bank for Reconstruction and Development (IBRD) and from the website of the International Monetary Fund (IMF). Criterion (dependent) variable is unemployment (Unemployment, total % of total labor force; modeled ILO estimate), while money supply (M₁), real interest rate (RIR—Real interest rate) and monetary reserves represent predictor (independent) variables. The hierarchical multiple linear regression model based on examining the linear relationship between control and predictor variables by creating different models. The input variables, in the Variables Entered/Remove table, represent the predictor variables presented in the models according to which the linearity test, the strength of the relationship, the structure of the relationship and the prediction of the value of the control variable performed. Models that meet the condition of statistical significance analyzed from the tables.

Therefore, according to the same model, the impact of monetary aggregates on employment in the control and experimental countries examined. In the control countries, a strong, while in the experimental countries, a moderate multiple correlation between monetary aggregates and unemployment is present. The F test showed statistical significance in both groups of countries in the linear association between the defined models and unemployment as soon as the alternative hypothesis H₁ was accepted. In the control group of countries, only the money supply had an impact on unemployment, while in the experimental countries all defined monetary aggregates had an impact on unemployment as soon as the alternative hypothesis H₁ was accepted.

5. Analysis of the influence of monetary aggregates on gross domestic product

The gross domestic product previously decisively defined, as was its structure. The attachment shows of the movement of the gross domestic product at the annual level from 1997 to 2015 for all countries of the panel, Figure 8. The aggregate based on constant 2010 prices and expressed in billions of US dollars for all panel countries. The source of the data is the World Bank for Reconstruction and Development.

Figure 8.

GDP at market prices by country 1997–2015. Source: Editing by the author.

As in the previous case, two hypotheses tested in this case using the statistical hierarchical model of multiple linear regression:

H₀: in the sample of currency board countries (experiment), there is no linear relationship between gross domestic product and money supply, monetary reserves and real interest rate.

H₀: in the sample of currency board countries (experiment), money supply, monetary reserves and real interest rate cannot affect changes in gross domestic product.

By applying the mentioned statistical model, the aim is to examine:

• whether the predictor variables money supply, monetary reserves and real interest rate can explain a significant part of the variability of the control variable gross domestic product,

• what part of the variability of the gross domestic product can be explained by the money supply, monetary reserves and the real interest rate, what is the strength of the connection between these variables,

• what is the structure of the connection, i.e. linearity,

• forecast the value of the balance of payments.

The statistical model includes variables shown in the annual time interval from 1997 to 2015 for the experimental and control group of countries. The values of the variables taken from the website of the World Bank for Reconstruction and Development (IBRD) and from the website of the International Monetary Fund (IMF). The criterion (dependent) variable is gross domestic product, while the money supply (M₁), real interest rate (RIR) and monetary reserves represent predictor (independent) variables. The hierarchical multiple linear regression model based on examining the linear relationship between control and predictor variables by creating different models.

In the analysis of the influence of monetary aggregates on the gross domestic product, a strong multiple correlation confirmed in both groups and the F test showed a linear connection in both groups. In the case of the control countries, the money supply has statistical significance in influencing the gross domestic product, while in the case of the experimental countries, all three variables, which represent monetary aggregates in a certain strength, affect the gross domestic product, thus accepting the alternative hypothesis H₁.

6. Asymmetry of public debt in currency board systems

In the case of Bosnia and Herzegovina, due to the regime of the currency board, monetization of public debt and printing money is not an exit option in the event of a budget deficit. How did governments cover this deficit? Governments covered the budget deficit in the mentioned period by increasing the public debt, both internal and external, because the monetary authorities in Bosnia and Herzegovina are not able to cover the budget deficit by monetization or issuing money due to the currency board.

Therefore, with the creation of a budget deficit, due to the great fiscal pressure and restrictions imposed by the currency board in Bosnia and Herzegovina, there was an increase in the total public debt, Figure 9. The external debt of Bosnia and Herzegovina led to an appreciation of the nominal exchange rate, which reflected in the negative indicators in the current account of the balance of payments of Bosnia and Herzegovina. A situation in which the monetary policy is completely passive, in which the budget deficit leads to an increase in public indebtedness, an appreciation of the nominal exchange rate and a deficit of the current account of the balance of payments does not correspond to the state of macroeconomic balance. This statement corresponds to the research hypothesis, which states that the currency board does not contribute to achieving balance of payments balance.

Figure 9.

Public debt by country 1997–2015. Source: Editing by the author.

By applying the statistical hierarchical model of multiple linear regression, two hypotheses examined:

H₀: in the sample of currency board countries (experiment), there is no linear relationship between public debt and money supply, budget balance, current account and nominal effective exchange rate.

H₀: in the sample of currency board countries (experiment), the money supply, the state of the budget balance, the current account and the nominal effective exchange rate cannot affect the public debt.

By applying the aforementioned statistical model, the goal is to examine:

• whether the predictor variables money supply, budget balance, current account and nominal effective exchange rate can explain a significant part of the variability of the public debt control variable,

• which part of the variability of the public debt can be explained by the money supply, the state of the budget balance, the current account and the nominal effective exchange rate, i.e. what is the strength of the relationship between these variables,

• what is the structure of the connection, i.e. linearity,

• forecasting the value of the balance of payments.

The statistical model includes variables shown in the annual time interval from 1997 to 2015, for the experimental and control group of countries. The values of the variables taken from the website of the World Bank for Reconstruction and Development (IBRD) and from the website of the International Monetary Fund (IMF). The criterion (dependent) variable is the public debt, while the money supply (M₁), the state of the budget balance, the current account and the nominal effective exchange rate represent the predictor (independent) variables. The hierarchical multiple linear regression model based on examining the linear relationship between control and predictor variables by creating different models. The input variables, in the Variables Entered/Removed table, represent the predictor variables presented in the models according to which the linearity test, the strength of the relationship, the structure of the relationship and the prediction of the value of the control variable performed. Models that meet the condition of statistical significance analyzed from the tables.

A strong correlation was found in the control group, and a moderate correlation in the experimental group. The F test in both groups showed a linear relationship between the variables, thus accepting the alternative hypothesis H₁.

In the case of the control countries, the budget balance and the current account have a significant impact on the state of the public debt, while in the experimental countries only the money supply has statistical significance in terms of the impact on changes in the public debt. Seen from the point of view of currency board countries, the alternative hypothesis H₁ is accepted. It follows from this that the asymmetry of the currency board reflected in the insufficient amount of money supply, which affects the increase in public debt.

7. The fifth instrument of monetary policy: transparency and public relations

In the final part, the central theme of the content related to the role of monetary authorities in financial intermediation. Using the induction method, a conclusion reached about the achieved credibility of the central banks of both experimental and control countries. The basis for the research of this topic are works and literature written on this topic and real events in the observed period 1997–2015 years.

Until the 1990s, central banks were traditionally closed institutions from the public, which resulted in a very small amount of strictly selected information related to conducting monetary policy. As the government’s banker, they avoided disclosing information about public financing when acting as a lender of last resort. In this way, they tried to avoid damaging trust in financial institutions and the financial system. This attitude of the monetary authorities partly resulted from the dependence of the central bank on the executive authorities. The struggle to achieve greater independence of the central bank accompanied by the problem of responsibility imposed on the central bank. More precisely, the monetary authorities had to demonstrate sensitivity in defining the monetary policy that the public should understand, which directly required the achievement of high transparency of the central bank’s work. Independence and responsibility meant reaching a compromise between transparency and conducting quality monetary policy.

Many authors define transparency as the absence of asymmetric information between financial markets and monetary policy makers. As in Ref. [11] point out transparency includes publicity, openness, honesty and mutual understanding. The IMF [12] defines transparency as an environment in which goals and policies—legal, institutional framework of monetary policy, decisions and reasons for their adoption, data and information related to monetary and financial policy presented to the public in an understandable manner and in a timely manner. In Ref. [13] define transparency in theory and practice by applying the transparency index, that is, it is about political, economic, procedural, operational transparency and transparency of policy decisions.

The rise of transparency is the result of the connection of several different attitudes. First, it is part of a wider trend that responds to pressure for governments to respond more quickly to the public. Second, transparency seen as a key element of accountability in the area of central bank independence. Third, central bank transparency seen as a direction in which certain government decisions seen through the market. When the work of the central bank is transparent, then it is less possible to be surprised by the conduct of monetary policy, more precisely, investors can be less surprised during investment decisions that manifest themselves through price changes and financial distress. Fourth, transparency is a means of strengthening the credibility that results from a low and stable inflation rate, with the central bank’s policy detailed in explaining this step. In turn, greater credibility gives the central bank more freedom to deviate from policy in atypical conditions. The transparency of the central bank through the aforementioned positions contributes to financial information being available to all actors in the financial system, and enables the central bank to establish its position as an institution that works in the interest of maintaining monetary stability through the achievement of defined goals.

Communication with the public has a great influence on the formation of expectations and reactions of financial markets. The statements of representatives of the central bank can provide good guidelines and assessments related to the perspectives of the economy, inflation, risks, explanations of the movement of certain variables, and the like. The speech of the central bank can influence the formation of expectations only if the target groups follow the statements of the central bank. A large number of studies unequivocally indicate that the markets react to the statements of the central banks, but the key question is whether the market reacts in the desired direction. The main goal of communication strategies is to ensure public understanding and support for the actions implemented by the central bank and to increase the effectiveness of monetary policy instruments by reducing uncertainty about the goals, intentions and thinking of the central bank. In crisis conditions, relations with the public gain great importance, because an adequate communication strategy used to reduce panic and guide the public in the desired direction.

Today, a large number of central banks publish standard publications such as price movement reports, annual work reports, financial stability reports, monetary and statistical bulletins, etc. In the case of this paper, all the banks that make up the countries of the panel perform their function of transparency through their websites. Through which they realize a part of the communication strategy, i.e. they inform the public about economic, world and environmental trends, as well as information about the measures taken during the observed period by monetary authorities.

One of the main tools for strengthening the banking sector in Bosnia and Herzegovina is an aggressive marketing approach and client orientation through the development of public relations. In this field, commercial banks have really achieved great success, however, the question arises as to what happened in the case of the central bank. The Central Bank, unlike commercial banks, relies almost entirely on public relations as the bearer of the information process. The function of public relations in the Central Bank of Bosnia and Herzegovina has existed since the establishment of the bank and throughout the years has been the main channel for informing the public because it highlights the transparency of the Bank’s work in various situations.

At the time of the outbreak of the crisis, the Central Bank of Bosnia and Herzegovina undertook several activities. Due to the crisis in Bosnia and Herzegovina, the bad history of the financial system, as well as the still obvious lack of trust in Bosnia and Herzegovina, citizens first started withdrawing deposits as soon as the great need for euros appeared. Although the Central Bank is solely responsible for convertible marks at that time, the Central Bank responded to the demands of its citizens in the desire to help commercial banks and strengthen confidence in the financial system, the Central Bank and the banking sector. This approach quickly yielded results as the citizens returned the withdrawn deposits back to financial channels, somewhere around 818 million convertible marks.

Another important segment of crisis management related to the reserve requirement as the only instrument of monetary policy that the Central Bank of Bosnia and Herzegovina can use due to the monetary policy model established by the currency board arrangement. In order to help preserve the liquidity of the Bosnian banking sector, the Governing Council of the Central Bank of Bosnia and Herzegovina made a decision three times to reduce the rate of required reserves held by commercial banks at the Central Bank, thus providing banks with additional liquidity. Then, the Central Bank made a decision according to which all new credit lines drawn by commercial banks from abroad are not included in the basis for calculating the required reserve. Such a decision made in order to stimulate the inflow of capital into the domestic banking sector and to give additional impetus to the lending activities of commercial banks. The last measure referred to the introduction of a differential rate of mandatory reserve on deposits of commercial banks. Finally, through their activities in the boards of other financial sector bodies, such as the Deposit Insurance Agency of Bosnia and Herzegovina, the representatives of the Central Bank of Bosnia and Herzegovina contributed to the adoption of measures such as increasing the amount of insured deposits, which provided additional security to clients. Therefore, the crisis in Bosnia and Herzegovina met with a dual strategy of the Central Bank, such as crisis management and crisis communication.

8. Conclusion

In the currency board, the money supply defined by monetary reserves. Bearing in mind the goals of economic and monetary policy, the question arose: How much can monetary policy really affect the balance of payments, employment and gross domestic product through the aforementioned aggregates? In Bosnia and Herzegovina, during the entire period, the current account of the balance of payments is in a constant deficit despite a stable exchange rate, inflation and other indicators. From there, a research hypothesis put forward in the paper, according to which the position taken that the currency board has a negative effect on the balance of payments.

The results of the statistical processing showed that in the case of the control countries there is a strong, while in the experimental countries there is a moderate multiple correlation between monetary aggregates and the balance of payments. The F test confirmed the linear relationship between monetary aggregates and balance of payments balance in the control countries. The t test showed that the money supply and monetary reserves affect the balance of payments, with monetary reserves having a stronger effect. In the case of the experimental countries, the F test confirmed the linear relationship between monetary reserves and the balance of payments, thus accepting the alternative hypothesis H₁. The t test showed that only monetary reserves affect the state of the balance of payments, thus accepting the alternative hypothesis H₁. This practically means that monetary reserves are the only instrument with which the central bank in the currency board can influence the balance of payments.

According to the same model, the impact of monetary aggregates on employment in control and experimental countries examined. In the control countries, a strong, while in the experimental countries, a moderate multiple correlation between monetary aggregates and unemployment is present. The F test showed statistical significance in both groups of countries in the linear association between the defined models and unemployment as soon as the alternative hypothesis H₁ was accepted. In the control group of countries, only the money supply had an impact on unemployment, while in the experimental countries all defined monetary aggregates had an impact on unemployment as soon as the alternative hypothesis H₁ was accepted.

The asymmetry of the public debt in the work refers to the questions: Do and how much, in the regime of the currency board? Do the monetary authorities contribute to the creation of the budget deficit and public indebtedness, which as such do not contribute to the achievement of the goals of economic policy and macroeconomic stability? The state apparatus in most countries is extremely large, because some governments tax and spend almost half of their GDP, which means that a large part of budget expenditures intended for income redistribution. Budget deficits are not a rare phenomenon in the world, most governments in such cases look for salvation by borrowing from the private sector or abroad, so internal or external debt formed. In order to stay within the intertemporal budget limit, the state must cover the deficit or borrow money from another party, that is, increase its public debt.

In the case of Bosnia and Herzegovina, due to the currency board regime, entity governments covered the budget deficit in the mentioned period by increasing the public debt, both internal and external, because the monetary authorities are not able to cover the budget deficit by monetizing or issuing money due to the currency board. A situation in which the monetary policy is completely passive, in which the budget deficit leads to an increase in public indebtedness, an appreciation of the nominal exchange rate and a deficit of the current account of the balance of payments does not correspond to the state of macroeconomic balance. This statement corresponds to the research hypothesis, which states that the currency board does not contribute to achieving balance of payments balance. In order to provide an answer to this question, the paper examined the statistical significance of the linear connection and interdependence of the public debt on the one hand, the state of the budget balance, money supply, current account and nominal effective exchange rate on the other hand, using a hierarchical multiple linear regression model.

Taking risks and asymmetries into account, the question arises of the credibility of central banks in different monetary systems. There is no general agreement on the question of the credibility of countries because it stems from the fact that credibility is difficult to measure, and therefore it is difficult to obtain empirical evidence. In the paper, the credibility of central banks in the currency board regime discussed: transparency, price stability, interest rate stability, exchange rate stability and public relations.