Monetary and Exchange Rate Policies

Monetary and Exchange Rate Policies

The Central Bank (Banco Central) managed monetary policy and regulated the nation's financial system. Established in 1928, the Central Bank controlled the money supply, restrained inflation, regulated credit, issued currency, and auctioned foreign exchange. In 1985, however, the Central Bank helped to create hyperinflation as it circulated unprecedented quantities of pesos. Hyperinflation ravaged the financial sector, virtually wiping out the country's deposit base and leaving many of the country's financial institutions insolvent by the end of the 1980s. Under Paz Estenssoro's leadership, the Central Bank deregulated the financial sector beginning in 1985 by legalizing deposits in United States dollars, freeing up interest rates, and adjusting reserve ratio requirements. In the late 1980s, the Central Bank's activities focused on keeping inflation in check, improving the financial viability of government banks and enterprises, and resuscitating and improving the ailing commercial banking system.

The peso, which replaced the boliviano in January 1963, was a stable currency until it was devalued in 1972 and remained at $b20=US$1 throughout the 1970s. As the economy deteriorated in the early 1980s, the value of the peso slid drastically from $b25=US$1 in 1980-81 to $b64=US$1 in 1982, $b230=US$1 in 1983, $b2,178=US$1 in 1984, and finally $b75,000=US$1 by 1985. That rate, however, was the enormously overvalued official rate; the black market demanded a rate of over $b1 million=US$1.

The NPE's decision to float the peso against the dollar caused an immediate devaluation to $b1.5 million=US$1 in August 1985. Furthermore, the black market was legalized as the government expected to keep the national currency at market rates. In January 1987, the new boliviano replaced the peso as the official currency. The new currency effectively slashed off the last six zeros of the old peso to redress the damage done to the currency by hyperinflation. By 1988 the currency was relatively stable at B2.3=US$1, and the difference between the official rate and the black market, or parallel rate, did not exceed 1 percent. The floating of the boliviano was administered by the Central Bank, whose Committee for Exchange and Reserves held a daily auction of foreign exchange called the bolsín. The new system also removed all taxes and commissions on the purchase of foreign exchange.

Exchange rate policies were an important element in Paz Estenssoro's stabilization and reactivation policies. The initially drastic devaluation of the peso in 1985 helped restore confidence in the national currency after it had lost most of its value. The stabilized currency and the end of speculation were leading factors in the overall economic stability that emerged after 1985. On the one hand, the lower exchange rate constrained imports by making them more expensive, which hurt the poor and the manufacturers the most; on the other hand, the exchange rate functioned as an incentive for exporters, whose products became cheaper and more competitive in international markets. Although nontraditional exports responded positively and helped to reactivate the economy, lower prices for natural gas and tin prevented the floating exchange rate policy from improving the country's balance of payments, at least in the late 1980s.

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