Based on a lot of opinions that connect the two phrases:
Liberalization of the exchange rate = collapse of the value of the EGP
The following must be clarified:
1. Liberalization of the exchange rate = non-interference of the CBE in the dollar interbank market by pumping reserves. So, in a liberalized exchange rate system, the change in the reserve level at the Central Bank must be close to zero, and intervention is only made in cases of temporary shocks.
2. However, not intervening using the reserve does not equal not interfering at all.
Exchange rate liberalization = domestic spending discipline
In this system, the Central Bank addresses any imbalance in the balance of payments by treating the root cause of the problem, which is the increase in domestic spending over national income, through the management of local liquidity.
The increase in imports results from the increase in domestic spending (consumption and investment) and the support of the currency rate against the dollar.
It is better to raise interest rates to control aggregate demand (the problem’s basis) and not inject reserves to treat supply (pressure on the exchange rate).
3. In the liberalized exchange rate system, the Ministry of Finance is also obligated to control public spending so that the increase in spending, directly or indirectly, does not lead to an exaggerated rise in domestic demand, and consequently imports.
So, in liberalizing the exchange rate…
1. Leave the indicator or thermometer to measure the imbalance in the balance of payments to operate in full freedom so that its indication is accurate of what is happening in the economy.
2. And if you want not to let it slip away, I do not hide it or distort it, but rather control the origin of the disease, which lies in the current account deficit, which reflects an imbalance between domestic spending and national income.
National income-domestic expenditure gap = current account balance.
This is what I mean in all my writing on exchange rate liberalization.
Treat the disease, not the symptoms.
Exchange Rate Liberalization
