## 1. Financial System Developments

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---

### I. Introduction and background
- Bolivia experienced very high inflation in the 1980s, including a hyperinflation episode in 1984, followed by sustained high financial dollarization.
- Since the 1990s inflation has remained under control, with occasional spikes mainly from volatile food prices sensitive to weather conditions.
- Financial dollarization declined steadily since 2003 in a context of exchange rate stabilization, an export commodity boom, and real exchange rate appreciation.
- The nationalization of the hydrocarbon industry in 2006 marked:
  - a steady expansion and sustained liquidity inflows into the financial system;
  - large government hydrocarbon revenues in US$ deposited at the central bank;
  - increases in international reserves and financing of higher government spending;
  - an expansion of the central bank balance sheet since 2010 also due to direct lending operations to state-owned enterprises (SOEs).
- Despite high liquidity since 2006, inflation has remained at around 5 percent per year.
- Main policy instruments used by the central bank:
  - open market operations (OMO) as the main instrument to manage liquidity and control inflation;
  - one-off savings bonds issuances accessible to the general public;
  - management of banks’ reserve requirements to control excess reserves.
- The central bank sometimes used the nominal exchange rate as a policy instrument to control inflation pressures and avert second-round effects.
- The central bank’s quantitative targets are anchored mainly on the growth rate of net domestic credit, set in a Monetary Program together with fiscal balance and net credit to the public sector; the program includes an inflation estimate indicative of the central bank’s inflation target for the year.
- Since 2006 interventions were mostly one-sided (sterilizing excess money and accumulating international reserves), increasing the stock of central bank sterilization bills.
- The Global Financial Crisis of 2008–2009 tested the framework: commodity prices collapsed and external demand decelerated, but the central bank managed short-lived speculative FX pressure with market interventions and conditions reversed within a year.

### II. Empirical strategy
- Methodology: Vector Auto-regression (VAR) model estimated with monthly data from January 2006 to July 2015 (period with surge in gas export revenues).
- Model specification:
  - Vector y of endogenous variables includes 11 indicators.
  - Exogenous variables matrix X included as controls.
  - Two lags for each endogenous variable are included (p = 2); model tested with 1 to 3 lags; lag exclusion tests indicated lag 3 statistically significant in only one of the 11 equations; impulse-response functions and variance decompositions robust to specification with 2 or 3 lags.
  - Identification via Cholesky decomposition with ordering from most rapidly moving to slowest.
- Endogenous variables (grouped):
  - Monetary policy instruments: stock of central bank bills issued in OMO; interest rate on 91 day-central bank bills; central bank flow intervention in foreign exchange markets.
  - Nominal anchors: nominal exchange rate and base money.
  - Monetary policy transmission indicators: interbank interest rate; banks’ lending rate; stock of bank credit to the private sector.
  - Monetary policy impact indicators: consumer price level; index of economic activity (proxy of GDP); real effective exchange rate.
- Endogenous ordering used in VAR:
  1. stock of OMO bills
  2. interest rate on 91 day OMO bills
  3. central bank intervention in FX markets
  4. nominal exchange rate
  5. base money
  6. interbank interest rate
  7. banks’ lending rate
  8. stock of banks’ credit to the private sector
  9. consumer price index
  10. real effective exchange rate
  11. index of economic activity
- Rationale for using base money rather than net domestic credit:
  - (i) closely related to central bank balance sheet identity and quantitative targets;
  - (ii) aligned with theoretical literature on nominal anchoring of the price level;
  - (iii) directly linked to liquidity held by households in currency in circulation, explaining inflationary pressures outside the bank lending channel.
- Several regressors are non-stationary but strong evidence of cointegration implies estimated coefficients are super-consistent.

### III. Monetary policy power (variance decomposition)
- Monetary policy instruments explain about 20 percent of price variability in the near term and close to 30 percent in the medium term.
- Monetary policy variables combined include OMO, interest rate on central bank bills, base money, and the nominal exchange rate.
- Inflation inertia (consumer prices explained by own lags) is a major component of price variability.
- Bank credit intermediation:
  - Interbank interest rate, banks’ lending rate, and banks’ credit to the private sector explain a small share of price variance in the near term but become substantial after about six months.
  - At a horizon of one year, banks’ lending behavior explains about 20 percent of price variance; after two years it is near 35 percent — capturing the indirect effect of monetary policy through lending channels.

### IV. Monetary policy reaction function (impulse-response evidence)
- Central bank responses evaluated to four shocks: consumer prices, core prices, food prices, and economic activity.
- Response to an increase in consumer prices:
  - Triggers contractionary monetary reaction: increase in OMO bills and higher interest rates on 91 day bills.
  - Includes an appreciation of the central bank nominal exchange rate (small but statistically significant).
  - About three months after tightening, central bank faces a decline in demand for foreign exchange and an increase in demand for base money.
- Response to an increase in core prices:
  - Similar contractionary tightening: higher OMO, higher short-term interest rates — indicating decisive intervention to avert second-round inflation pressures.
- Response to an increase in food prices (negative supply shock):
  - Central bank reaction is contractionary (liquidity withdrawal), consistent with pro-cyclical tightening to avert second-round effects or indicating inflation expectations may not be well anchored.
- Response to an increase in economic activity:
  - Interventions to withdraw liquidity typically took place when economic activity was above anticipated levels; overall intervention has been mostly countercyclical.

### V. Monetary policy transmission and impact
- Shocks analyzed: OMO (stock), interest rate on central bank bills, and the exchange rate. Transmission assessed through interbank rate, banks’ lending rate, and volume of bank lending; impact on consumer prices, real effective exchange rate, and economic activity.
- Increase in the stock of OMO bills (monetary contraction) leads to:
  - Decline in bank lending and economic activity.
  - No immediate increase in the interest rate on 91 day bills within the first 6 months.
  - Decline in sales volume of foreign exchange by the central bank lasting three months.
  - Small but statistically significant appreciation of the nominal exchange rate.
  - Decline in base money indicating intervention amount beyond neutral position.
  - Liquidity absorption followed by slowdown in banks’ credit to the private sector; in the near term banks’ lending rate is lower than without OMO interventions, but after one quarter interbank rates increase and volume of credit declines.
  - Possible explanation for near-term decline in banks’ lending rates: red-lining of riskier borrowers reducing average lending rates.
- Increase in OMO interest rates (cutoff rate) leads to:
  - Contractionary impact with clearer effects on lending rates.
  - Higher cutoff rates are followed by increases in interbank and lending rates (lending rates capture full impact with a lag of about six months) and lower bank credit volumes.
  - These interest-rate-driven responses tend to occur when demand pressures dominate (prices above normal and real exchange rate appreciation).
- Exchange rate as a policy instrument:
  - Exchange rate stability since 2006 has been a pillar of price stability and likely important in forming inflation expectations given historical inflation and dollarization.
  - Appreciations tended to coincide with contractionary monetary stances: increases in stock of central bank bills, higher interbank interest rates, higher base money, inflation pressures, and relatively high economic activity.
  - Exchange rate interventions were relatively sporadic and measured compared to OMOs, and they correlated with lower purchases of foreign exchange at the central bank window.
  - Caution: responses to exchange rate shocks are context-specific to 2006–2015 (appreciation environment, high GDP growth ~5 percent per year, de-dollarization, high export prices); dynamics could differ under depreciation scenarios, especially if inflation expectations are anchored on the nominal exchange rate.

### VI. Conclusions and policy considerations
- Bolivia’s monetary policy framework since 2006 has been effective in controlling inflation in a high-liquidity environment:
  - Monetary policy instruments explain about 20 percent of price variability in the near term and close to 30 percent in the medium term.
  - Bank lending channels become increasingly important after six months (about 20 percent of price variance at one year, near 35 percent after two years).
  - Central bank reacts to inflation and activity shocks with liquidity withdrawal via OMO and interest-rate adjustments; the nominal exchange rate has been used as an auxiliary instrument.
- Key trade-offs and recommendations:
  - Trade-offs between managing liquidity volumes (OMOs) and focusing on short-term policy interest rates; interest-rate-focused policy may be more direct in affecting lending rates.
  - Importance of anchoring inflation expectations to avoid pro-cyclical tightening in response to supply shocks.
  - The exchange rate’s role in expectations formation implies that under less benign external conditions (e.g., a depreciation), policy dynamics could differ materially from the 2006–2015 experience.
- Transition considerations:
  - Results suggest considering a transition to a monetary policy framework with two-sided exchange rate flexibility and using interest rates as the primary instrument.
  - Operational and institutional requisites include developing a deep and liquid foreign exchange market; formulating intervention policies consistent with the new regime; establishing an alternative nominal anchor; building market participants’ capacity to manage exchange rate risks; strengthening supervisory authorities; and sequencing exchange rate flexibility with capital account liberalization.
  - Preconditions for success: (i) maintaining a solid fiscal position anchored on medium-term fiscal plans and solid fiscal institutions; (ii) strengthening institutions for central bank independence and appropriate central bank capitalization.

### 2006—central bank interventions and implications
- Central bank responded decisively with liquidity withdrawal when inflation trended above target levels in the monetary program.
- Central bank supplied additional liquidity to support aggregate demand during economic slowdowns.
- Interventions have significant transmission power, affecting bank lending activities, economic activity, and the price level.
- Higher central bank tolerance to short term deviations in inflation from the programmed target could facilitate smoother cyclical adjustment if inflation expectations are well anchored.
- Transitioning away from anchoring inflation expectations on the exchange rate would facilitate allowing more exchange rate flexibility when appropriate.

### VII. Model diagnostic tests and key statistics
- Sample period for unit root tests: January 2006 to June 2015.
- t-statistic estimates include a constant and no trend.
- Augmented Dickey-Fuller and Phillips-Perron tests (selected series and reported statistics):
  - Open Market Operation Stock: ADF t-stat. -0.6890 Prob. 0.846; PP Adj. t-stat. -0.0380 Prob. 0.953
  - Interest rate on 91 day central bank bills: ADF t-stat. -1.7760 Prob. 0.391; PP Adj. t-stat. -1.3410 Prob. 0.608
  - Nominal exchange rate: ADF t-stat. -2.2320 Prob. 0.196; PP Adj. t-stat. -2.1010 Prob. 0.245
  - Central bank intervention in FX market: ADF t-stat. -3.8210 Prob. 0.004; PP Adj. t-stat. -4.0100 Prob. 0.002
  - Base money: ADF t-stat. 0.0790 Prob. 0.963; PP Adj. t-stat. -0.3700 Prob. 0.909
  - Banks' loans: ADF t-stat. 3.6601.000; PP Adj. t-stat. 5.0851.000
  - Index of economic activity: ADF t-stat. 3.0241.000; PP Adj. t-stat. -3.4270.012
- Cointegration test (Unrestricted Cointegration Rank, sample adjusted 2006M03–2014M03, included observations 97 after adjustments):
  - Result summaries across trend assumptions include: 7 cointegrating eqn(s) at the 0.05 level; 9 cointegrating eqn(s) at the 0.05 level; 8 cointegrating eqn(s) at the 0.05 level; 8 cointegrating eqn(s) at the 0.05 level; 7 cointegrating eqn(s) at the 0.05 level.
  - Maximum-Eigen test results (examples):
    - None: Eigenvalue 0.6664 Statistic 62.126 Critical Value 3.30 Prob. 0.000*
    - At most 1: Eigenvalue 0.5643 Statistic 55.621 Critical Value 9.40 Prob. 0.000*
    - At most 2: Eigenvalue 0.5222 Statistic 75.017 Critical Value 9.50 Prob. 0.000*
  - * denotes rejection of the hypothesis at the 0.05 level.
- VAR diagnostics:
  - Sample: 2006M01 2015M06.
  - VAR Residual Normality Tests (selected examples):
    - Component 1: Skewness 0.421 Chi-sq 3.048 Prob. 0.081; Kurtosis 3.048 Chi-sq 0.056 Prob. 0.813; Jarque-Bera 3.104 Prob. 0.212
    - Component 2: Skewness -1.565 Chi-sq 42.125 Prob. 0.000; Kurtosis 10.193 Chi-sq 247.940 Prob. 0.000; Jarque-Bera 290.065 Prob. 0.000
  - Lag order selection criteria (selected):
    - Lag 0: LogLL -6297.63; SC 137.4766; HQ 135.3759
    - Lag 1: LogLL -4941.636; LR 2062.241; AIC 3.08E+33; SC 108.2216*; HQ 114.9797*; 110.9533*
    - * indicates lag order selected by the criterion.

*Source: _wp15266 — https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15266.pdf*

### 1. Financial System Developments .......................................................................................

### 1. Financial System Developments

### Major sections in this content unit
- 1. Financial System Developments ............................................................................................6
- 2. Determinants of Consumer Price Variability .......................................................................10
- 3. Central Bank Reaction to an Increase in Consumer Prices..................................................11
- 4. Central Bank Reaction to an Increase in Core Prices ..........................................................12
- 5. Central Bank Reaction to an Increase in Food Prices ..........................................................13
- 6. Central Bank Reaction to an Increase in Economic Activity ..............................................13
- 7. Increase in the Stock of Central Bank’s Open Market Operation Bills ...............................15
- 8. Increase in the Interest Rate on Central Bank’s 91-day Bills ..............................................16
- 9. Depreciation of the Central Bank Exchange Rate ...............................................................17

### Appendix
- I. Model Diagnostic Tests ........................................................................................................21

*Source: _wp15266 - 1. Financial System Developments .......................................................................................*

### References .............................................................................................................

### References

### I. INTRODUCTION AND BACKGROUND
- Bolivia experienced very high inflation in the 1980s, including a hyperinflation episode in 1984, followed by sustained high financial dollarization.
- Since the 1990s inflation has remained under control, with occasional spikes mainly from volatile food prices sensitive to weather conditions.
- Financial dollarization declined steadily since 2003 in a context of exchange rate stabilization, an export commodity boom, and real exchange rate appreciation.
- The nationalization of the hydrocarbon industry in 2006 marked:
  - a steady expansion and sustained liquidity inflows into the financial system;
  - large government hydrocarbon revenues in US$ deposited at the central bank;
  - increases in international reserves and financing of higher government spending;
  - an expansion of the central bank balance sheet since 2010 also due to direct lending operations to state-owned enterprises (SOEs).
- Despite high liquidity since 2006, inflation has remained at around 5 percent per year.
- Main policy instruments used by the central bank:
  - open market operations (OMO) as the main instrument to manage liquidity and control inflation;
  - one-off savings bonds issuances accessible to the general public;
  - management of banks’ reserve requirements to control excess reserves.
- The central bank sometimes used the nominal exchange rate as a policy instrument to control inflation pressures and avert second-round effects.
- The central bank’s quantitative targets are anchored mainly on the growth rate of net domestic credit, set in a Monetary Program together with fiscal balance and net credit to the public sector; the program includes an inflation estimate indicative of the central bank’s inflation target for the year.
- The favorable conditions since 2006 led to mostly one-sided central bank intervention (sterilizing excess money and accumulating international reserves), increasing the stock of central bank sterilization bills.
- The Global Financial Crisis of 2008–2009 tested the framework: commodity prices collapsed and external demand decelerated, but the central bank managed short-lived speculative FX pressure with market interventions and conditions reversed within a year.

### II. EMPIRICAL STRATEGY
- Methodology: Vector Auto-regression (VAR) model estimated with monthly data from January 2006 to July 2015 (period with surge in gas export revenues).
- Model specification details:
  - Vector y of endogenous variables includes 11 indicators.
  - Exogenous variables matrix X included as controls.
  - Two lags for each endogenous variable are included (p = 2); model tested with 1 to 3 lags; lag exclusion tests indicated lag 3 statistically significant in only one of the 11 equations; impulse-response functions and variance decompositions robust to specification with 2 or 3 lags.
  - Identification via Cholesky decomposition with ordering from most rapidly moving to slowest.
- Endogenous variables (grouped):
  - Monetary policy instruments: stock of central bank bills issued in OMO; interest rate on 91 day-central bank bills; central bank flow intervention in foreign exchange markets.
  - Nominal anchors: nominal exchange rate and base money.
  - Monetary policy transmission indicators: interbank interest rate; banks’ lending rate; stock of bank credit to the private sector.
  - Monetary policy impact indicators: consumer price level; index of economic activity (proxy of GDP); real effective exchange rate.
- Endogenous ordering used in VAR:
  1. stock of OMO bills
  2. interest rate on 91 day OMO bills
  3. central bank intervention in FX markets
  4. nominal exchange rate
  5. base money
  6. interbank interest rate
  7. banks’ lending rate
  8. stock of banks’ credit to the private sector
  9. consumer price index
  10. real effective exchange rate
  11. index of economic activity
- Rationale for using base money rather than net domestic credit: (i) closely related to central bank balance sheet identity and quantitative targets; (ii) aligned with theoretical literature on nominal anchoring of the price level; (iii) directly linked to liquidity held by households in currency in circulation, explaining inflationary pressures outside the bank lending channel.
- Several regressors are non-stationary but strong evidence of cointegration implies estimated coefficients are super-consistent.

### III. MONETARY POLICY POWER
- Variance decomposition findings:
  - Monetary policy instruments explain about 20 percent of price variability in the near term and close to 30 percent in the medium term.
  - Monetary policy variables combined include OMO, interest rate on central bank bills, base money, and the nominal exchange rate.
  - Inflation inertia (consumer prices explained by own lags) is a major component of price variability.
- Bank credit intermediation:
  - Interbank interest rate, banks’ lending rate, and banks’ credit to the private sector explain a small share of price variance in the near term but become substantial after about six months.
  - At a horizon of one year, banks’ lending behavior explains about 20 percent of price variance; after two years it is near 35 percent — capturing the indirect effect of monetary policy through lending channels.

### IV. MONETARY POLICY REACTION FUNCTION
- Central bank responses evaluated using impulse-response functions to four shocks: consumer prices, core prices, food prices, and economic activity.
- Response to an increase in consumer prices:
  - Triggers contractionary monetary reaction: increase in OMO bills and higher interest rates on 91 day bills.
  - Includes an appreciation of the central bank nominal exchange rate (small but statistically significant).
  - About three months after tightening, central bank faces a decline in demand for foreign exchange and an increase in demand for base money.
- Response to an increase in core prices:
  - Similar contractionary tightening: higher OMO, higher short-term interest rates — indicating decisive intervention to avert second-round inflation pressures.
- Response to a negative supply shock (increase in food prices):
  - Central bank reaction is contractionary (liquidity withdrawal), consistent with pro-cyclical tightening to avert second-round effects or indicating inflation expectations may not be well anchored.
- Response to an increase in economic activity:
  - Interventions to withdraw liquidity typically took place when economic activity was above anticipated levels; overall intervention has been mostly countercyclical.

### V. MONETARY POLICY TRANSMISSION AND IMPACT
- Shocks analyzed: OMO (stock), interest rate on central bank bills, and the exchange rate. Transmission assessed through interbank rate, banks’ lending rate, and volume of bank lending; impact on consumer prices, real effective exchange rate, and economic activity.
- Increase in the stock of OMO bills (monetary contraction) leads to:
  - Decline in bank lending and economic activity.
  - No immediate increase in the interest rate on 91 day bills within the first 6 months (central bank interventions not necessarily targeted at raising short-term rates).
  - Decline in sales volume of foreign exchange by the central bank lasting three months.
  - Small but statistically significant appreciation of the nominal exchange rate.
  - Decline in money base indicating intervention amount beyond neutral position, possibly to avert second-round inflation pressures.
  - Liquidity absorption followed by slowdown in banks’ credit to the private sector; in the near term banks’ lending rate is lower than without OMO interventions, but after one quarter interbank rates increase and volume of credit declines.
  - Possible explanation for near-term decline in banks’ lending rates: red-lining of riskier borrowers reducing average lending rates.
- Increase in OMO interest rates (cutoff rate) leads to:
  - Contractionary impact with clearer effects on lending rates.
  - Higher cutoff rates are followed by increases in interbank and lending rates (lending rates capture full impact with a lag of about six months) and lower bank credit volumes.
  - These interest-rate-driven responses tend to occur when demand pressures dominate (prices above normal and real exchange rate appreciation).
- Policy implication:
  - A monetary policy focused on interest rates rather than on liquidity volumes may be effective in managing demand shocks because interest-rate-focused policy has a more direct impact on lending interest rates.
  - For interest-rate policy to be effective, medium-term inflation expectations should be well anchored to avoid pro-cyclical tightening in response to supply shocks.
- Exchange rate as a policy instrument:
  - Exchange rate stability since 2006 has been a pillar of price stability and likely important in forming inflation expectations given historical inflation and dollarization.
  - Impulse responses indicate appreciations tended to coincide with contractionary monetary stances: increases in stock of central bank bills, higher interbank interest rates, higher base money, inflation pressures, and relatively high economic activity.
  - Exchange rate interventions were relatively sporadic and measured compared to OMOs, and they correlated with lower purchases of foreign exchange at the central bank window.
  - Caution: responses to exchange rate shocks are context-specific to 2006–2015 (appreciation environment, high GDP growth ~5 percent per year, de-dollarization, high export prices); dynamics could differ under depreciation scenarios, especially if inflation expectations are anchored on the nominal exchange rate.

### VI. CONCLUSIONS AND CHALLENGES AHEAD
- The analysis documents that Bolivia’s monetary policy framework since 2006 has been effective in controlling inflation in a high-liquidity environment, with:
  - Monetary policy instruments explaining a sizable share of price variability (about 20 percent near term, close to 30 percent medium term).
  - Bank lending channels becoming increasingly important after six months (about 20 percent of price variance at one year, near 35 percent after two years).
  - Central bank reacting to inflation and activity shocks with liquidity withdrawal via OMO and interest-rate adjustments; the nominal exchange rate has been used as an auxiliary instrument.
- Key considerations and challenges highlighted:
  - Trade-offs between managing liquidity volumes (OMOs) and focusing on short-term policy interest rates, with interest-rate policy potentially more direct for transmitting to lending rates.
  - Importance of anchoring inflation expectations to avoid pro-cyclical tightening in response to supply shocks.
  - The exchange rate’s role in expectations formation implies that under less benign external conditions (e.g., a depreciation), policy dynamics could differ materially from the 2006–2015 experience.

*Source: References section (pages 4–18) of the PDF content unit provided.*

### 2006. The results in this paper indicate that the central bank responded decisively with

### _wp15266 - 2006. The results in this paper indicate that the central bank responded decisively with

### Monetary policy interventions and transmission
- Central bank responded decisively with liquidity withdrawal when inflation trended above target levels in the monetary program.
- Central bank supplied additional liquidity to support aggregate demand during economic slowdowns.
- These interventions are found to have a significant transmission power, affecting bank lending activities and ultimately economic activity and the price level.
- Results cannot reject that the central bank appears to intervene to stabilize near-term inflation, keeping it as close as possible to the indicative target in the monetary program.
- Higher central bank tolerance to short term deviations in inflation from the programmed target could facilitate a smoother cyclical adjustment in the face of shocks, provided inflation expectations are well anchored.
- To facilitate this, the central bank would possibly need to set up policies that delink inflation expectations away from the exchange rate.

### Exchange rate regime, peg history, and use as instrument
- Inflation stabilization was also supported by an exchange rate peg to the US dollar, which has remained unchanged since 2011 and showed only small and appreciating variations since 2008.
- The exchange rate was occasionally used as an additional instrument to address inflation pressures.
- More exchange rate flexibility could facilitate economic adjustment if a deterioration in economic conditions was highly persistent.
- Costs to allowing more exchange rate flexibility include potential disruption if inflation expectations are anchored on the exchange rate; a central bank might optimally delay allowing depreciation under a negative shock if conditions might revert.
- Excessive delay in abandoning a peg when weaker conditions are persistent could be costly, involve excessive loss of international reserves, and further disrupt economic activity.
- Cited finding: Rebelo and Vegh (2008) show delaying abandonment of a peg and allowing a loss of reserves in the face of a permanent fiscal shock is suboptimal; optimal exit timing is a decreasing function of the size of the fiscal shock.
- Asici et. al. (2008) suggest post-exit outcomes are better when abandonment of a currency peg occurs under good macroeconomic conditions.
- Eichengreen and Rose (2011) identify 51 instances since 1957 when an economy abandoned a fixed exchange rate for greater flexibility and saw its currency appreciate or remain broadly unchanged.

### Transition to a flexible exchange rate / monetary framework
- Results suggest transitioning to a monetary policy framework with two-sided exchange rate flexibility and using interest rates as the primary instrument is worth consideration.
- Careful planning and development of appropriate money and exchange rate markets’ infrastructure are key ingredients for a smooth transition.
- Operational and institutional requisites highlighted include:
  - developing a deep and liquid foreign exchange market,
  - formulating intervention policies consistent with the new regime,
  - establishing an alternative nominal anchor in the context of a new monetary policy framework,
  - building market participants’ capacity to manage exchange rate risks and strengthening supervisory authorities to regulate and monitor them,
  - sequencing of exchange rate flexibility and capital account liberalization.
- Some country experiences indicate a transition to higher exchange rate flexibility requires careful planning and could take several years.
- The Polish monetary strategy toward higher monetary and exchange rate flexibility was performed smoothly, gradually and planned, resulting in a better transition compared to the Slovak and Czech cases.
- If properly managed, this transition can be smooth (Eichengreen (1999) practical suggestions and framework).

### Preconditions and institutional recommendations
- Success of a monetary policy regime with more exchange rate flexibility depends on:
  - (i) maintaining a solid fiscal position, and
  - (ii) strengthening institutions for central bank independence.
- Fiscal stance needs to be anchored on medium-term fiscal plans that ensure public debt sustainability and on solid fiscal institutions (i.e. the budget process; a medium term fiscal framework; fiscal rules; etc.) that make these plans credible.
- Bolivia has made progress in implementation of a medium-term fiscal framework.
- Credible institutions are important to ensure the central bank has the authority to act when inflation stabilization objectives enter in conflict with other government objectives.
- It is important that a central bank is appropriately capitalized so its ability to back up its monetary liabilities does not depend on discretionary government transfers.

### Model diagnostic tests and key statistics
- Sample period for unit root tests: January 2006 to June 2015.
- t-statistic estimates include a constant and no trend.
- Augmented Dickey-Fuller and Phillips-Perron tests (selected series and reported statistics):
  - Open Market Operation Stock: ADF t-stat. -0.6890 Prob. 0.846; PP Adj. t-stat. -0.0380 Prob. 0.953
  - Interest rate on 91 day central bank bills: ADF t-stat. -1.7760 Prob. 0.391; PP Adj. t-stat. -1.3410 Prob. 0.608
  - Nominal exchange rate: ADF t-stat. -2.2320 Prob. 0.196; PP Adj. t-stat. -2.1010 Prob. 0.245
  - Central bank intervention in FX market: ADF t-stat. -3.8210 Prob. 0.004; PP Adj. t-stat. -4.0100 Prob. 0.002
  - Base money: ADF t-stat. 0.0790 Prob. 0.963; PP Adj. t-stat. -0.3700 Prob. 0.909
  - Banks' loans: ADF t-stat. 3.6601.000; PP Adj. t-stat. 5.0851.000
  - Index of economic activity: ADF t-stat. 3.0241.000; PP Adj. t-stat. -3.4270.012
- Cointegration test (Unrestricted Cointegration Rank, sample adjusted 2006M03–2014M03, included observations 97 after adjustments):
  - Result summaries across trend assumptions include: 7 cointegrating eqn(s) at the 0.05 level; 9 cointegrating eqn(s) at the 0.05 level; 8 cointegrating eqn(s) at the 0.05 level; 8 cointegrating eqn(s) at the 0.05 level; 7 cointegrating eqn(s) at the 0.05 level (reported in one table).
  - Maximum-Eigen test results reported with multiple eigenvalues and statistics (examples):
    - None: Eigenvalue 0.6664 Statistic 62.126 Critical Value 3.30 Prob. 0.000*
    - At most 1: Eigenvalue 0.5643 Statistic 55.621 Critical Value 9.40 Prob. 0.000*
    - At most 2: Eigenvalue 0.5222 Statistic 75.017 Critical Value 9.50 Prob. 0.000*
  - * denotes rejection of the hypothesis at the 0.05 level.
- VAR diagnostics:
  - Sample: 2006M01 2015M06.
  - VAR Residual Normality Tests: reported component skewness, kurtosis, Jarque-Bera probabilities (selected examples):
    - Component 1: Skewness 0.421 Chi-sq 3.048 Prob. 0.081; Kurtosis 3.048 Chi-sq 0.056 Prob. 0.813; Jarque-Bera 3.104 Prob. 0.212
    - Component 2: Skewness -1.565 Chi-sq 42.125 Prob. 0.000; Kurtosis 10.193 Chi-sq 247.940 Prob. 0.000; Jarque-Bera 290.065 Prob. 0.000
  - Lag order selection criteria (selected):
    - Lag 0: LogLL -6297.63; SC 137.4766; HQ 135.3759
    - Lag 1: LogLL -4941.636; LR 2062.241; AIC 3.08E+33; SC 108.2216*; HQ 114.9797*; 110.9533*
    - * indicates lag order selected by the criterion.

*Source: _wp15266 — https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15266.pdf*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp15266.pdf_