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Central Bank President Explains Changing

Twelve years after leaving his post as president of the Central Bank of Costa Rica (BCCR), Rodrigo Bolaños accepted President Laura Chinchilla s invitation to return to the job after former bank head Francisco de Paula Gutiérrez (2002-2010) stepped down in April.

While Chinchilla said that she felt comfortable appointing Bolaños because he had occupied the post before, he readily admits the country s situation today presents significantly different challenges that during his first term as head of the Central Bank, from 1995-1998.

The economic landscape of Costa Rica has changed drastically in the last 12-15 years, Bolaños said. We were an export economy then, but not nearly at the level that we are now. Also, foreign direct investment was just taking off in the 90s, which is around the time Intel (the nation s largest exporter in terms of sales) arrived. The arrival of Intel sparked the movement of foreign direct investment into Costa Rica, which has given the country a much greater presence in the international economy.

Nevertheless, the mild-mannered, 30-year veteran of the Costa Rican and Latin American economic scene appears ready for the second go-round. Bolaños, 59, holds a doctorate in economics from the University of Chicago, and served as Costa Rica s Finance Minister from 1989-1990 and as manager of the National Stock Market from 1986-1995.

Prior to returning to his role at the Central Bank, he presided over the Colombia-based Latin American Reserves Fund.

While Bolaños buttoned-up demeanor is a departure from the affable, outgoing Gutiérrez, his strength is his precise understanding of the country s monetary system.

Bolaños recites Costa Rican financial history as if he wrote it himself, and draws from his understanding of past crises to guide financial policy towards what he hopes will be a more stable future.

The following is an excerpt from his interview with The Tico Times, held in Bolaños fourth floor office at the Central Bank s downtown San José office.

TT: What are the biggest differences in the position as Central Bank president now compared to when you first held the job?

RB: Basically, there is an important difference regarding the management of the exchange rate system. I like the changes I see in the financial system; it s a much more complete system than it was in the past.

In the 1990s, the financial system was managed using (automatic) mini-devaluations.

At that time, managing the exchange rate was a much more serious problem for the Central Bank and required much more attention than it does today. Today, the Central Bank is in a much better financial situation (with $4 billion in cash reserves) with a much better balance in the monetary system. That is one of the principal reasons why today we are able to maintain a much lower level of inflation than we ve had in the past.

Another important difference in this role is the management of the exchange rate with the new bands system that was established by the Central Bank (where the exchange rate is allowed to float within upper and lower limits set by the bank). The bands system allows the Central Bank to control the exchange rate by managing the amount of colones and dollars circulating in the national financial market. This allows for better control of the aggregate financial system, and, as we begin to work our way out of the worldwide economic crisis, we can monitor the fluctuations in monetary demands.

What goals top your list of priorities for this term as Central Bank president?

The principal goal is to keep inflation at a low level. We have the inflation rate down to around where we d like it to be, but it hasn t been at that level for very long. The challenge of the Central Bank will be to maintain it.

As the inflation rate stays low, the economy reacts with a higher demand.

The other objective of the Central Bank, which is tied to the inflation rate, is to monitor the extent of the dollarization of the national economy. When a foreign economy relies too much on the dollar, it carries certain risks that put the country in danger of external shock that is out of their hands. So, part of our objective is to de- dollarize the Costa Rican economy.

Why has the inflation rate in Costa Rica historically been one of the highest in Latin America?

This has been one of the biggest concerns of the Central Bank during the last 10 to 15 years. While the rest of the world was already attempting to lower their inflation rate, Costa Rica, well, we weren t doing that. We worked at it some, but not as much as the rest of the world. We were delayed in our efforts to monitor the inflation rate.

In the late 1970s and early 1980s, the world fuel price, particularly in Arabic countries, altered the monetary flow of the world s economies. Demand for fuel was increasing but other countries controlled the prices. In response, many countries began borrowing money. In many cases, countries began to borrow irresponsibly. This was the case with Costa Rica, as well as many other Latin American countries.

In order for the Costa Rican government to go into debt for external credit, it needed the authorization (of the Legislative Assembly) for each specific credit. But, the Central Bank didn t have to obtain any sort of authorization like that. For that reason, there was plenty of money available for the Central Bank. The Central Bank borrowed large amounts, which resulted in tremendous debts for Costa Rica.

While this happened in other countries, other countries immediately began to attempt to eliminate debts and lower inflation. (In) Costa Rica we didn t know how much external debt we had. The deficit at that time was massive and the economy had very few reserves. Costa Rica had to print money, which in turn resulted in rising inflation.

When I entered this position in March 1995, the consumer price index, our primary indicator to gauge inflation, rose around 24 percent in a 12-month period. When I left, it was around 10-11 percent and now it is around 6 percent.

I think there is a great opportunity for Costa Rica to continue to slow the inflation rate, and it is one of the primary goals of the Central Bank s policy.

Could the Costa Rican economy ever be dollarized?

From what I understand, the people who want to dollarize the Costa Rican economy want to do so as a measure to lower inflation.

That is their stated objective, which is our objective as well. However, we believe that inflation can be lowered without dollarizing the economy.

The problem with dollarization is that it ties your hands. It is like saying, Because we don t believe the Central Bank can handle the national financial system, well, we prefer that if the Central Bank must exist it not intervene in the national money system.

So, when small economies like ours open to and integrate into international markets, (and these markets) experience a large economic shock, such as a big increase in the price of fuel, we can manage our own monetary policy to adjust to the shock if the economy is not dollarized; it would be less costly than if the economy was dollarized.

So what am I trying to say with this? If there were a shock, such as a large increase in the price of fuel, it would have the biggest effect on the poorest Costa Ricans. They wouldn t be able to adjust to the higher prices. But a flexible exchange rate, such as the one in place now, makes something like an external economic shock more manageable for the national economy. If a flexible exchange rate did not exist because of dollarization, it would tie the hands of the Central Bank and the exchange rate could not be adjusted. This could severely damage many sectors of the Costa Rican economy.

The exchange rate hasn t experienced the same rhythm of dramatic jumps and falls as it did earlier in the year. Do you think the exchange rate will remain around its current level throughout the remainder of the year?

It is very difficult to comment on, and probably inconvenient for the Central Bank to predict because the Central Bank looks for the markets to determine the exchange rate. If I were to try to guess where the exchange rate would go from here, I would say that the Central Bank is going to keep the limits that have been established where they are with the hopes that the exchange rate continues to remain within those bands.

Whenever the Central Bank has to intervene to control the fluctuation of the exchange rate, it weakens the natural activity of the monetary system.

So, I would say that my objective is to look for a way to monitor the exchange rate in case of external economic shocks and to attempt to limit the Central Bank s intervention in adjusting the value of colones to dollars.


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