SPECIALISATION ECONOMICS AND INTERNATIONAL BUSINESS [621471]

UNIVERSITY OF CRAIOVA
FACULTY OF ECONOMICS AND BUINESS ADMINSTRATION
SPECIALISATION ECONOMICS AND INTERNATIONAL BUSINESS

BACHELORS DEGREE THESIS

Coordinator:
Assoc. Prof. PhD Ciobanu George

Student: [anonimizat], 2017

UNIVERSITY OF CRAIOVA
FACULTY OF ECONOMICS AND BUSINESS ADMINISTRATION
SPECIALISATION ECONOMICS AND INTERNATIONAL BUSINESS

MACROECONOMIC POLICY IN A OPEN
ECONOMY

Coordinator:
Assoc. Prof. PhD Ciobanu George

Student: [anonimizat], 2017

1
TABLE OF CONTENTS

INTRODUCTION ………………………….. ………………………….. ………………………….. ……………………. 2
CHAPTER I. MACROECONOMIC POLICIES ………………………….. ………………………….. …… 3
1.1. The nations economic objectives: ………………………….. ………………………….. …………………….. 3
1.2. Tools and political purposes ………………………….. ………………………….. ………………………….. .. 7
1.2.1. The typology of the political tools policies ………………………….. ………………………….. ……….. 8
1.3. Political mixes: fiscal and monetary ………………………….. ………………………….. ………………… 9
1.3.1. Fiscal policy ………………………….. ………………………….. ………………………….. …………………….. 9
1.3.2. Monetary policy ………………………….. ………………………….. ………………………….. ……………… 10
1.3.3. Fiscal and monetary policies in AD -AS model ………………………….. ………………………….. … 11
CHAPTER II. OBJECTIVES OF THE ROMANIAN GOVERNMENT POLICIES ……… 13
2.1. The evolution of the inflation ………………………….. ………………………….. ………………………… 13
2.2. Evolutions of the economic activity ………………………….. ………………………….. ……………….. 16
2.2.1. Demand and supply ………………………….. ………………………….. ………………………….. …………. 16
2.2.2. Work productivity ………………………….. ………………………….. ………………………….. …………… 19
2.3. Perspectives of inflation ………………………….. ………………………….. ………………………….. ……. 22
2.3.1. GDP Deviation ………………………….. ………………………….. ………………………….. ……………….. 23
2.3.2. Components of aggregate demand ………………………….. ………………………….. …………………. 25
2.3.3. Monetary conditions in a broad sense ………………………….. ………………………….. …………….. 26
2.4. Internal macr oeconomic developments ………………………….. ………………………….. ………….. 27
BIBLIOGRAPHY ………………………….. ………………………….. ………………………….. ………………….. 34

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INTRODUCTION

Macroeconomics policy is usually put into action trough two sets of policy:fiscal and monetary.
The fiscal and monetary policy are applied to stabilize the entire economy, which means boosting
the economy to the level of GDP which is consistent with employ ment.
Why is so important the macroeconomic policy? Here are the reasons for it:
a) It helps to accomplish the aim of economic growth, a bigger level of employment and a
greater GDP level then in the previous years.
b) It helps understanding the way of action of a difficult economic system. It defines how the
economy is functioning as a whole.
c) It analyse the factors which decided the balance of payments. Meanwhile it establish the
deficit in the balance of payment and advise immediate measures.
d) It helps to ach ieve stability in the prices and evaluating in business activities. It means the
policy measure in controlling and overs eeing the inflation and deflation.
e) With an exact and accurate knowledge of the working of an economy at a bigger level of
scale, formula ting the potential correct policies of the economy and also coordinating the
international policies.
f) It use to clear up and decide to solve the problems in the economy such as unemployment,
inflation, poverty etc etera . whose result of the solution it is ac hievable at the level of
macroeconomic only.
g) One of the last reasons but also an important one is the theories for the macroeconomic level
who has helped us to see and resolve the dangers of putting them to use in the microeconomy
level. Achieving the solu tions to the all problems at the level of an entire economy.
The state achieve an important and pronounced economic role in all the countries . In our days
the state represent an important mechanism of influencing the economy especially at the level of
macroeconomics.
The causes of state involvement in economic life are multiple, being in direct link with the
evolution of the factors of production, with scientific and technical progress, emphasizing the
complexity of the economy, but also with issues such as social, cultural, political, military
etcetera . Fulfilling the role of the state is provided by a system of norms, principles, tools and
levels of economic, monetary, fiscal, exchange etc etera . In this context is enrolled in economic
policy. Macroeconomic policy is the conscious action of politic power while is translating in
establishing economic and social objectives pursued at a time, in a country, as their achievement
through the use of the appropriate means and techniques.
Economic policy has as aims to modify the spontaneous evolution or the natural economy
activity for correcting market deficiency. In some situations it follows to create conditions to
accelerate economic and social progress, while in others the prevention or eliminations of some
economic dysfunctions. The economic policy has as its starting point the general interest of the
nation, the national state, within a certain time frame . The policy decisions are take by authorities
from an economic and monetary cou ntry.
This policy is one of the most important actions of the modern state. Through it aims to
influence the conduct of major economic aggregates in order to improve economic performances.

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CHAPTER I. MACROECONOMIC POLICIES

The achievement of the macroeconomic stability is reflected in the way which are reached
the stability objectives trough macroeconomic policy and, not least, of the nature of the
objective s had in view. The objectives considered through macroeconomic policy targets the
economic act ivity; the economic activity which can be represented by several variables such as
GDP, employment, inflation rate etcetera . Achieving a certain level of these macroeconomic
variables constitutes the fundamental objective of macroeconomic policy of the sta te in general
and monetary policy in particular.

1.1. The nations economic objectives:

a) Occupancy of labour

The biggest objective with the social impact is represented by the labour force occupancy rate ,
going on maximizing it. Regarding this objective, it is almost clear the willingness of registration
to a higher level of employment, on the one hand to ensure a decent standard of living, and on the
other to ensure a high level of the supply of goods . Providing such an objective means numerous
problems. A first problem is related , since the beginning of defining the level which characterize
the highest level of occupancy. It would be a big mistake if it will be considered that there are
economies where t here is full employment of labour . At the level of any economy there is
permanently, frictional unemployment. "The consensus at the level of economic analysts, in
terms of friction factors is that the highest level of employment exist when the unemployment rate
is between 3% – 4% of the total civilian labour force" .1
In the current economy, on macroeconomic framework , the level of frictional unemployment
increased a lot. Therefore, the authorities are trying to determine carefully which are the causes
that determined this increase. The complexity of the current savings automatically lead to the
manifestation of certain forces that generate pressures on the labour market.
The f actors that generates frictional unemployment are represented by:
❖
seasonal factors : based on their job application varies depending on weather and time of
year, a good example being the activity of construction, tourism etc etera;
❖
geographic factors : influencing the demand for labour depending on the geographical
location of the employment; the demand for labour not having high elasticity to this factor;
❖
structural factors : restructuring of some fields within o f the economy automatically implies
a labour retraining because, most times, those who are redundant can not find ano ther job on
the old field;
❖
discriminator factors : despite economic developments, cultural and social recorded
worldwide, still it shows discrimination in respect of employment for a job, or discrimination
due to nationality , or race , or political and reli gious options , either due to age or sex. All this
leads to an increase in frictional unemployment.

However it is considered that the level of any economy, there is frictional unemployment and
the only problem taken into account by the authorities is to reduce as much of this side of
unemployment. In addition to frictional unemployment , in the unemployment it is also include d

1 MARSHALL, Robert & SWANSON, Rodney – The monetary process: Essentials of money and
banking, Hanghton Miffin Company Boston, 1974, p .412.

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another aspect, the so -called hidden unemployment caused in fact by purely subjective factors
(specific person who seeks a job, wh ich includes people who "say they want to work but not seek
for a job because they believe that any search will be in vain "2
All these components can be identified with some difficulty at any level of the economy, not to
mention also about the existenc e of undeclared work that distorts in some measure the
unemployment situation. Therefore, quite a few economists believe that the optimal level of
unemployment is that which , in correlation with the inflation rate will not result /generate in
accelerated gr owth.3 However, no one can say with accuracy what is the optimal level of
unemployment rate that generates , indeed , full employment of labour .
In literature the most common correlation is related to unemployment and inflation. Even if this
correlation (Philips curve) experienced changes in time, on short term is important, which is why
another objective of economic policy is considered as being represented by price stability.

b) Price stability

If we start from what is expressed the curve of Philips : that an low unemployment rate
corresponds to a high inflation rate, it is obvious that maintaining a high level of employment,
without taking into account other economic factors drive automatically to record ing high costs at
certain levels. These costs represented mainly by the price level in the economy, they can not
passed, further, on the level of purchasing power because a price increase (ge neralized) generates
automatically a rise in demand for a rise in wages and hence an increase in production costs
which is reflected foreword on the prices of products on the market.
Given that at the level of a n economy the rate of inflation is high ( over 2 digits) the economic
inefficiency manifests acute , the phenomenon most frequent encountered being that of increasing
the aggregate demand, while the supply maintain the previous growth rate . The demand is
increasing, it automatically reach a new change of prices which leads to an increase in demand
for changing the wage s, demand which, it is most often satisfied only to a lesser extent, because
this represent an expense which generates new price increases. It should be added that, regardless
of the p roductivity of the business sector, the demand for the increase wage s is the same, which is
why the efficiency in certain sectors is supported by other sectors. On the other hand, a high rate
of inflation generate an arbitrary distribution of income at the level of the economy; so that those
who will register variable income will benefit automatically a increase in the salary much faster
than those who have a fixed income.
If we consider the external economy, we must not forget the impact of price volatility on the
balance of payments. The drop in the economy efficiency lead to a reduc tion in the
competitiveness of exported products, which is why the foreign market outlets can shrink. On the
other hand, increasing the production costs, it is possib le that on the external market to exist
producers more competitive at least in terms of prices. A high inflation leads to currency
devaluation, which could generate an inhibiti on on the exports. On the other hand, if domestic
production is dependent , to so me extent , on the imported raw materials, the continuation of the

2 MARSHALL, Robert & SWANSON, Rodney – The monetary process: Essentials of money
and banking, Hanghton Miffin Company B oston, 1974, p.415
3 MAYER, Thomas, DUESENBERRY, James S., ALIBER, Robert Z. – Money, Banking and the
Econom y, W.W. Norton &Company, Inc, 1984, p.360: „many economists define the proper level
of unemployment, and hence by implication full employment, as t he minimum level that is
consistent with the inflation rate not not accelerating”.

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activity is equivalent to an increase of produc tion prices, leading to a further adjustment of prices
in the economy, reaching, thus, to an inflationary spiral whose elimination costs are ve ry high.
These significant price fluctuations recorded worldwide in recent years, have led to the
reorientation of authorities policy , in the way of giving up the pursuit of ensuring a certain level
of economic growth in order to e stablish a relative st ability in prices, which would allow to
rebuild the general economic equilibrium. In this regard, Marshall & Swanson [1974] stated that
"the stability of the level price represent an important goal of the stabilization of economic policy
because the price level instability, manifested mainly , in the form of inflation , may have adverse
and spread effects in economy. The unfavourably s ide of effects, starting from the raise in the
inflation, include a drop of economic efficiency, a unfair and capricious disto rtion in terms of the
income distribution and worsening of the position of the international balance of payments "4
The p rice stability is emerging as one of the most important objectives of economic policy. In
terms of following to accomplish this object it should be taken into account that the concept of
price stability does not mean that all prices are stable or fixed. On a pragmatic level, the focus is
on maintaining stability to an average price, aiming ultimately to their relative stability and , not,
the to the absolute one. Economists consider that t he relative stability in prices exist in condition
which the annual rate of price growth is determined from a representative price index , it is at
most 2%.
If the price stability is , in present, one of the main guidelines of the authorities, we must bear in
mind that one of the problems is due to inflation and economic stagnation. There are thus cases in
which the economic policy of the state have in view to ensure a sustainable economic growth.

c) Sustainable economic growth

In terms of ensuring a certain level of economic growth, this represent , for some countries, one
of the most important coordinate of the stabilization of macroeconomic policy.
If we consider the semantic aspects, the concept of economic growth has many aspects , both
quantitative and qualitative. We must not forget that there are several ways to measure the level
of economic growth; However, analysts incline to use the growth rate of the gross domestic
product of the co untry analysed , considering that it best reflects the degree of development of
economy envisaged , for the simple reason that it reflects the actual level of economic activity in
the territory analysed country. Of course, that has in view the real GDP level, because they
wanted to highlight the actual level of growth without considering the inflationary developments.
The pace of economic growth is based on quantitative records from previous years, to this
factor adding , of course the contex tual factors that most of the time significantly influence the
economic growth. If in the early twentieth century the idea was going to ensure the economic
growth of at least 3% – 4%, in present these expectations can be more pessimistic.
To speak of a sustained economic growth it must register an actual increase in the production of
a country (quantitative) and not simply an increase in the national currency. To these must be
added the fact that the mix of products and services should be to compose as to boost real
demand and th erefore to stimulate consumption. Ensuring the economic growth depends on the

4 MARSHALL, Robert & SWANSON, Rodney – The monetary process: Essentials of money
and banking, Hanghton Miffin Company Boston, 1974, p.417: „…..price level stability is an
important goal of economic stabilization policy because price level instability, especially in the
form if inflation, can have widespread and adverse effects in the economy. The unfavourable side
effects arising from inflation include a lessening of the dis tribution of income, and a weakened
international balance -of-payments position

6
market economy, on the one hand on the situation of aggregate supply ( the surplus of aggregate
supply generates economic stagnation), and secondly adjus ting the range of products and services
offered on the market at the needs of customers ( is known where the stock production which
have led to a sharp drop in economic growth in many countries).
Ensuring a certain level of economic growth involves two a spects:

➢ by providing extensive economic growth (based on increasing the number of employees, for
example);

➢ either improve existing working conditions to enable increased productivity (assuming such
intensive economic growth).
If we consider the latt er aspect, it must be recognized that the realization of new investment s is
the best way for ensuring the economic growth. The problem which appear is related to creating
the frame to allow the attract ion of investors (both financially and fiscal ly, and in terms of
political stability5, the country specific military taken into consideration even area which includes
country analysed).
All these targets of macroeconomic stabilization are considering only domestic economic
issues.

d) Foreign exchange market stability

Lately, however, is known the impasse experienced by many countries , impasse generated by
the worsening of the trade balance position .
Choosing such an objective is determined precisely by the need to support the national
currency, which could lead to worsening the economic situation of the country analysed at all
levels, no longer considering that a deficit of the balance of payments involves an additional
financial effort, precisely for its coverage.
Instability in this market led lately to plan major changes in the world economy, which is why
many central banks have decided to float its own currency.

e) The control of the budget deficit

The m onetary depreciation represent another factor that requires the adoption of a strong and
firm policy of macroeconomic stabilization. The f inanc e of government deficits based on
currency issue may accentuate the inflationary pressures from the economy , these having
repercussions, primarily on the value of the national currency , value that leads forward on at
lower ing the purchasing power and hence the level of living.
As a result, in recent years, among the objectives of economic policy there is also the assurance
and control of the state budget deficit.
The s pending of th e state is quite high, to which is added the extensive phenomenon of arrears
(manifested mainly in the economies which are in transition to market economy) have led in
recent years, at the existence of significant budget deficits that have imposed signific ant financial
burdens from the state to cover them, not to mention the fact that, most often, to obtain the
external financing (especially the IMF) one of the conditions was that t o respect a certain share of
the budget deficit within the GDP.
The s imultaneous achievement of these objectives would be ideal for any country. However,
the practice has demonstrated, th at exist situations when even reaching to one objective is quite
difficult and most often involves the adoption of restrictive economic polici es.

5 Idem, p.418

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f)Public debt

Public debt means the state's debt to third parties, such as private individuals, legal persons,
banks, businesses, domestic or foreign enterprises , who have purchased government bonds to
cover the country's financial needs. The loan s may be contracted by the State, through the
Ministry of Finance, in its own name or guaranteed by it.
Public debt is denominated in national currency or in foreign currency, depending on where it
is contracted and the terms of the loan. In order to as sess Romania's public debt, the liabilities
denominated in a currency other than the national one are calculated in national currency, using
the exchange rate communicated by the National Bank of Romania. Also, the total public debt of
a country can be exp ressed in absolute terms6, in relative values, as a percentage of G.D.P. (to
allow comparisons over time and across countries) and average per capita l (to allow comparisons
and analyses in time and space).
The t otal public debt is calculated and managed separately in its two forms, namely the
domestic public debt and the external public debt. The i nternal public debt is an integral part of
the total public debt and highlights the government borrowings on the domestic financial market,
from individuals an d legal entities, in national currency or foreign currencies, as well as loans
borrowed by third parties, guaranteed by the state, not reimbursed at any given time.
External public debt is also an integral part of total public debt and is defined by ext ernal
borrowings contracted and committed by the state in its own name or by the local public
administration authorities as well as external credits contracted and committed by other
autonomous subjects, with the guarantee of the state.
The degree of eligibility of public debt is expressed by floating debt and consolidated debt.
The f loating public debt is a short -term public debt and includes borrowings contracted for
periods of up to one year to cover house gaps generated by inconsistent over time r evenue –
sharing with budget expenditures.
Consolidated government debt comprises all liabilities arising from medium and long -term
government borrowings, as well as those resulting from the prolongation of short -term loan
repayment terms over medium and long term periods.

1.2. Tools and political purposes

In many cases, the regional problem exist and some areas were not properly adapted to
economic changes, ( example: shipbuilding or extraction of ore in north -eastern England or
elsewhere). Usually , this results in excess of demand of manpower in those areas. In theory, the
government could try to promote a wage policy that would lead to relative reduction of wages in
that area, to balance domestic labour market . The e xamples include the reform of the unions and
giving up in wage negotiations.
The g overnment have two types of alternative policy : the first one may try to increase demand
for workforce in the regions with problem s, encouraging the firms to move into those areas, or
may increase the public expenditure in these regions; secondly, can try a reduction in workforce
mobility , favouring its mobility in other regions.
Jan Tinbergen, one of the founders of the theory of macroeconomic policies, has formulated the
basic steps to be taken f or the construction of optimal macroeconomic policy.

6 In order to know the burden subjected to the country's economy respectively to its creditors .

8
So, the first step requires the decision maker to formulate clear objectives of macroeconomic
policy, even if it can under a form of welfare social functions that the political decision -makers
are ex pected to maximize. Starting from this position, the decision maker identify the goals they
are trying to achieve.
In the second step, the decision maker must specify the policy instruments at its disposal to
achieve these goals.
In the third step, the decision maker must choose a political model, linking the tools to the
purposes, by choosing the optimal values of policy instruments .

1.2.1. The typology of the political tools policies

To analyse the macroeconomic policy we must , first ly, speci fy the general objectives and then
those private. Of course, at the most general level, the macroeconomic policy aims to maximize
the 'social welfare'7, but this goal is too vaguely defined.
Therefore, a lot of other specific objectives and goals are d erived from this overall goal. Such
specific targets have been already outlined. Even the m, however, are quite generally formulated.
What does means the full use of labour ? This objective may have different formulations in
different countries, depending on the natural rate of unemployment below which we can not go
down.
There is also controversy over whether a zero inflation is optimal or not. Some economists,
such as M. Friedman, believe that a negative inflation rate is optimal. According to other
theories, an inflation rate positive ensure growth in taxes. However, the goals that are mention
above, the most controversial one is about inflation, the deficit of the balance of payments.
Once the macroeconomic goals were correctly and clearly formulated, the political decision –
makers must specify the tools available to d etermine the economy to achieve these goals. The
available tools depend, however, to the existing institutional framework in each economy.
The most commonly it use two main types of instruments: instruments of fiscal policy and the
instruments of the monetary policy. The f iscal policy instruments are those that affect the real
economy, influencing the demand for goods and services, the household savings, the investment
firms etcetera .
The most important instruments of fiscal policy are considered: the government spending and
the tax system .
The m onetary policy instruments affects the monetary economy, influencing the money supply,
the value flows in the economy etcetera . The most important monetary policy instruments are
considered to be the variati on in the money supply and operations on the open market.
After both goals and tools were specified, the issue of macroeconomic policy can be formulated
in the following way: for a social welfare function (eventually) time , to determine the optimal
levels of the goals and instruments through which these goals can be achieved.
The economy, however, may deviate from the optimal goals because appear shocks and
disturbances occur. In these circumstances, the policy makers have to choose the tools they will
use and set their values in order to determine the economy moving again optimally. For this, the
government uses the information on the structure of the economy and, in particular, about the
relationship between goals and instruments.

7 Social welfare is the provision of a minimal level of well-being and social support for citizens
without current means to support basic needs .

9

1.3. Political mixes: fiscal and monetary

1.3.1. Fiscal policy

By fiscal policy, a government tries to influence the aggregate demand in the economy through
public spending and tax rates. This policy is more flexible because the government does not have
to maintai n the 'balanced budget'8- he may have a budget surplus, spending less than to collected
from taxes, or it may face with a budget deficit, spending more than the amount produced from
taxes. In the latter case, the excess of spending can be financed either b y budget or by issuing
currency. Yet that should not be overlooked the fact that an extremely high budget deficit is
dangerous especially if the deficit financ ed is performed mostly by increasing the money supply,
which has a clear inflationary trend.
An increase in public spending have a reduction in taxes which increase the national income
balance, while a drop in public spending or a raise in taxes reduces the national income balance.
The demonstration can be done using the IS -LM model. An expansionar y fiscal policy9 will shift
the IS curve to the right, while a fiscal policy contraction will move to the left.

Fig. 1.1. The form of LM curve and the efficiency of fiscal policy.(a)With a vertical LM curve the fiscal policy does
not even an effect on national income.(b)With a horizontal LM curve the fiscal policy acts on national income, but
lets the interest rate unchanged.

8 A balanced budget (particularly that of a government) refers to a budget in which revenues are
equal to expenditures. Thus, neither a budget deficit nor a budget surplus exists (the accounts
"balance").
9 Philip Hardwick, John Langmead, Bahadur Khan – Introducere in economia politica moderna
‘’(which means an increase in public spending or a decrease in taxes) ’’,2002,p.581.

10

Fig. 1.2. The form of IS curve and the efficiency of fiscal policy.(a)With a horizontal IS curve the fiscal
policy does not have an effect on national income, neither on the interest rate.(b)With a vertical IS curve the fiscal
policy affects the national income but also the interest rate.

1.3.2. Monetary policy

Through monetary policy the government is tryi ng to influence the aggregate demand in the
economy by adjusting the cost and the credit availability . The central bank can influence both the
cost and the credit availability through measures capable of damaging monetar y demand – this
offer include the open-market operations designed to influence the loan granted by the banks and
other financial institutions.
If we analyse the monetary policy in an IS -LM model, we will be able to compare its
effectiveness in relation with fiscal policy. Let us remember t hat an expansionary monetary
policy moves the LM curve to the right, while a contractile policy will shift to the left.
As the fiscal policy, the effectiveness of monetary policy depends on the elasticity of the
money demand and elasticity of the inves tments depending on the interest rate if the LM curve is
vertical (a monetary demand perfectly inelastic depending on the interest rate) and IS curve is
horizontal ( an investment perfectly elastic according to the interest rate) , monetary policy has the
most influence s on national income balance and the use of labo ur. On the other hand, when LM
curve is horizontal (liquidity trap)10 and the IS curve is vertical (a perfect inelastic investment
depending on the interest rate), the monetary policy becomes com pletely ineffective. We can say
that the fiscal policy seems more effective than the monetary one, to the extent which the
monetary demand is more elastic depending on the interest rate and how the investments are
more inelastic depending on the interest r ate.

10 A liquidity trap is a situation, described in Keyne sian Economics, in which injections of cash
into the private banking system by a central bank fail to decrease interest rates and hence make
monetary policy ineffective.

11

Fig. 1.3. The efficiency of monetary policy.

Regarding the different schools of economic thought s, in general, the Keynesian believe that a
monetary demand can be quite elastic and tend to distrust the responsiveness of reaction of the
investments to the interest rate changes. Consequently, Keynesian incline to view the fiscal
policy as a more efficient and more useful to influence the aggregate demand, compared with
monetary policy . Instead, the monetarists say that the monetary demand is rather inelastic
depending on changes in interest rates and the money supply have a more direct effect on the
aggregate demand, compared with the forecasts of the Keynesian11.

1.3.3. Fiscal and monetary policies in AD -AS model

From t he previous analysis we can conclude that as long as the IS curve is not horizontal and
the LM curve vertical, the expansionary fiscal policy will increase the aggregate demand.
Similarly, as long as the IS curve is not vertical and the LM curve horizontal , the expansionary
monetary policy also increase the level of aggregate demand. These increases in the aggregate
demand sizes depend on a number of factors such as the elasticity of the investments based on

11 Hardwick, Langmead, Khan – Introducere in economia politica moderna, 2002, p.583

12
interest rates and the elasticity of the monetary demand depending on interest rates. In the model
IS-LM, in which it is assumed that there exist a price level fixed, any increase in aggregate
demand will entail an increase in the actual level of balance and will determinate , consequently, a
higher level of use of labour in the economy.
The result is not yet guaranteed when the level of prices may vary. In an AD -AS model
generalized12, consequently increasing the aggregate demand on the real income depends by the
AS curve. Simpl y put : only a horizontal force of the AS curve will make the full effect to be felt
on real income; if the AS curve has a upward trend , but quite low, the effect therefore falls
primarily on the real income, but will also be a small increase in the price levels; if the same AS
curve is steep, the effect will influence specially on the price level s with a small increase in real
income; if the AS curve is vertical, the effect will be reflected fully on the price level s.

12 Idem, 2002, p.584

13

CHAPTER II. OBJECTIVES OF THE ROMANIAN GOVERNMENT
POLICIES

2.1. The evolution of the inflation

During the third quarter, the annual inflation rate has mitigated its negative value to -0.57
percent. While continuing to evolve below the lower margin of ± 1 percentage emphasized on
the target of 2.5 percent, the annual dynamics of the consumer price s (excluding the direct effect
of lower VAT13 rates at the start of the current year) has halted its decline, positioning recent on a
slightly upward trajectory (+ 0.1 percentage points to 0.8 percent in September). The trend is
favoured by the emergence of the first signs of dissipation of disinflationary influences from the
external environment, their potential to compensate for the increased pressures that are
accumulat ing internally ( all together with the expansion of the surplus of demand) gradually
diminishing. At the same time, towards the end of the quarter, it became visible a slight
adjustment of the expectations concerning the inflation. In this context , the core inflation CORE2
adjusted (net of the direct effect of fiscal changes) advanced to 1.4 percent at the end of the
analysed period (Chart 1).
Chart 1. Inflation Developments

The h igher price increases in annual terms are becoming visible on the food segment and are
mainly located at the level of processed consumer products such as sugar, milk and dairy
products, and meat. In fact, these products also show a reversal of the downward trajectory at
European level, where slowly are starting to feel the effects of the restrains of oversupply (milk,
meat) or even the appearance of a market deficit (sugar) , including as a result of the
implementation in the last years in the EU, a support scheme for producers affected directly and
indirectly by the closure of the Russian market (Chart 2).

13 It is an indirect tax supported by the final consumer of that good / service .

14

Chart 2. Stable Food Prices

At the same time, after the decline in recent years, the quotations evolution of most raw
material on international mar kets signalled a recovery, their annual dynamics advancing from
double -digit contractions at the end of the second quarter ( -22 percent for oil) to values close to
zero in September. The e volution was reflected directly in the domestic fuel prices, resulti ng in a
consistent decline of fuel prices14. Looking ahead, it is conditioned by maintaining the recent
tendencies, is anticipated the dissipation of this important disinflationary influence, which has
contributed so far to the neutralization of domestic in flationary pressures (Chart 3).

Chart 3. Domestic Fuel Prices and International Oil Prices

On the domestic market, the surplus of demand continue to increase, indicating the build -up of
price rises. Different measures of the inflation generated on the domestic plan (DGI), respectively
the unit costs with the labour from the economy, the unit labour costs from the industry, and also
GDP deflator, which essentially capture the evolution costs and from profit margins of the
companies , following in the recent period a upward trend, with rhythms variate from 3.7 to 8.6

14 (+4.2 percentage points to -2.6 percent)

15
percent in the second quarter (Chart 4). Therefore, given the observed link between these
measures and the price index15 of adjusted CORE2, it is expected that recent trends will finally
surface and at the level of consumer prices. During the third quarter, there was an outline of the
rise in the basic inflation (+ 0.1 percentage points, to 0.5 percent and 1.4 percent respectively, in
case of the isolation of the direct impact of the last cut of VAT rate in January 2016).
In the structure, is being observed a gradual expansion of the range of non -food products whose
prices tend to increase in a rate still slightly higher than in the previous period – various types of
clothing and footwear, b ooks, newspapers , magazines and some medical articles. Concerning the
food group, beyond the dynamics of consumption in the domestic market, the recent supply -side
factors also contributed significantly to the above -mentioned supply factors. Instead, the tariffs of
the market services have diminished marginally, in line with the appreciation of the national
currency against the Euro in July -September.

Chart 4. Domestically Generated Inflation*(DGI) and Adjusted CORE2

For the third quarter, the evolution of administered tariffs was the only notable source of
disinflation. Their annual rate has sunken i n the negative territory ( -2.5 percentage points to -4.7
percent), under the impact of movement produced in the July on the energy segment.
Determinants in this regard were the change in market conditions, which led to the suspension of
the gas liberalization calendar until March 2017 and until the reduction of transport costs. To this
was added the correction of the electr icity tariff, the influence of the continuation of the
liberalization process on this market being counteracted by a new downward adjustment of the
price on the competitive market, but also by the decrease of the contribution for cogeneration and
the for the transport tariffs .

15 Positive relationship between the evolution of the various measures of IGI and the future
dynamics of the CORE2 index adjusted over a one -year horizon (confirmed by statistically
correlation coefficients significant statistically and the Granger causality tests).

16

Chart 5. Price Expectations

The expectations of the b anking analysts concerning the inflation have interrupted
during the third quarter the downward trend , registering recent some increases, with the
exception of short -term on es (at the end of this year). On the other hand, the economic operators
from industry, the construction and services maintain their expectations of relative price
stability16. Instead, from the opinion of commercial agents can not be drawn a clear trend, wh ich
probably indicates the high degree of uncertainty in the run -up to the actual implementation of
recent legislative changes to the sector. Over a longer time span (12 months), the short -term
balance of consumer opinions remained moderately positive (Cha rt 5).
The average annual rate HICP reappeared on a upward path in the third quarter , once with the
elimination from this calculation the first annual variations affected by the first round impact of
the reduction of VAT rate in June 2015, rising to -1.3 percent in September. The negative spread
towards the EU average has fallen to -1.4 percentage points, the trend being partly mitigated by
the rise in inflation at the European level, impacted by the oil price trajectory.
The a nnual variation of consumer price inflation stood at 0.17 percentage points below the
projected value in August 2016 of the Inflation Report. Determinants for such an evolution were
the wider fall in volatile food prices ( VFE ) and the relative appreciation of the do mestic currency
in July -September

2.2. Evolutions of the economic activity

2.2.1. Demand and supply

The e xpansion of the domestic absorption in the second quarter (+8.2 percent) led to a further
acceleration of the annual growth rate of economic activity, up to 6 percent (Chart 6). The
demand addition came mainly from the population and was only partly adjusted by the domest ic
supply, in conditions which the consumer behaviour and the the evolution of relative prices gave

16 The p rices should not register significant increases (inflation) and also to avoid periods of
continuous ly lower price s (deflation).

17
new imp ulse to import purchases. The erosion effect on real GDP17 growth was however
mitigated by the increase in exports of goods, doubled with the strength ening of external service
revenues.
Chart 6. Demand

The dominant contribution to the economic growth returned on the demand for consumption,
driven by the further increase in purchasing power of the population, on the background of the
wages increased in the last period, but also t he evolution of consumer prices. As a result, the
volume of trade turnover has kept its positive growth rate, the slowdown in annual food price
dynamics compared to first quarter – essentially the attribute of the di ssipation base effect
associated with the widening of the reduced VAT rate (June 2015) – being in good measure
counterbalanced by the dynamics of vehicle sales with the resumption of the car renewal program
(Chart 7). Is to be expected the c onsumption demand to conti nue its upward trend in the second
half of 2016, but at a less pronounced pace. Declining values recorded by the trust indicators
concerning the trade and services activity in the period September -November (INS / EC -DG
ECFIN survey) suggests that the downw ard trend observed in trade receipts has decreased in
July-August.
Chart 7. Supply

17 Is trying to measure the production of the goods and services of an economy (Output) by
valuing in cash the go ods produced by that economy .

18
The implementation of the consolidated general government generated a deficit of 6.9 billion
RON18 (equivalent to 0.9 percent of GDP19) after the first 3 months of the ye ar in have recorded a
surplus of 3.01 billion RON (0,4 percent of GDP). The change in the characteristics of the
budgetary execution20 was mainly due to the drop in the negative territory of the annual change
in the total budgetary revenues( -2.7%21, compared with an advance of 3.8% in the previous
quarter), mainly as a result of the compression of receipts of VAT ( -15.1% versus 0.9%); in the
same sense has acted the relative deterioration in the dynamics of the amounts received from the
EU, a non-tax revenues and corporate income taxes. In their turn, the budget expenditures
accelerated their growth rate (to 8.6 percent, from 7.8 percent), due to the evolutions of capital
expenditures developments (45.7 percent versus 15.8 percent ), as well as some current
expenditure categories22; their impact was partly counterbalanced by the reduction of expenditure
on projects funded by non -reimbursable foreign funds.
The g rowth in the domestic demand contributed significantly during the second quarter and the
demand f or investment (annual growth from 2.3 to 10.7 percent) a lso the positive evolution
which could characterize the second half of 2016 ( Chart 8). The e quipment purchases have kept
their alert dynamics (over 9 percent), with significant capital accumulations continuing to be
achieved in the automotive sector (including related industries) , in the context of increased
external demand and high integration of th is sector into international networks of added value.
Similar concerns are also observed among the comp anies in certain consumer goods industries,
aiming to better capitalize both on the demand surplus on the local market in last year and on the
increase in external demand on this segment (especially at European level) .

Chart 8. Investment

18 The operational data published by MFP in the context of the June 2016 the budget execution
were used for the analysis; For this year GDP , the level published in the most recent budget
execution published by MFP was used.
19 Corresponding to a primary deficit of 0.3 percent of GDP.
20 In the same period of the previous year a deficit of RO N 0.7 billion (corresponding to a
primary surplus of 0.5 percent of GDP).
21 In the absence of further specification, the percentage changes refer to the annual growth rates
expressed in real terms.
22 (of staff, with subsidies, other expenditures on the nature of transfers) .

19
An ascendin g trajectory have followed the construction works, the decisive contribution
returning the engineering projects – the main stimulating factor is a short -term one, namely the
electoral calendar, whose influence was felt at the level of the second quarter (re vival up to 13.4
percent in annual terms, associated with the local elections) and is possible to mark , also, the
evolution of public investment in the late part of the year. As regards the building construction,
the growth remained modest (0.5 percent), mainly due to the uncertainty associated with the Law
on debt discharge . However, for the second half of the year, a favourable outlook emerges, given
that in January -August the area authorized for housing construction increased by about 8 percent
and the real estate market projections for the second half of 2016 indicate the expansion
deliveries of new premises, especially on the sectors of retail and logistics.

2.2.2. Work productivity

The labour productivity contributed positively to economic grow th in the second quarter of
2016, with the most significant contribution from the commercial and construction sector (Chart
9).

Chart 9. Labour Productivity

Also, the negative annual productivity growth in industry has moderated from the previous
period (close to zero), a development that can be attributed largely to cyclical factors, as it shows
the increase in the utilization of production capacities in most manufacturi ng23 sub-sectors (Chart
10). Beyond these influences, the signals from the economy also show a positive contribution
from some factors with persistent actions , on the fond of the recent increase in the appetite
investment the of companies in the consumer goods industries, but also in sectors such as
chemistry and metallurgy, where simul taneously has took place a process of restructuring and
efficiency (primarily energy) of the activity. Also, the investment interest continued to manifest

23 (+0.7 percentage points to 77.9 percent, the average per 4 quarters) .

20
itself in the transport ation industry and in the electrical equipment industry, where the
productivity pulse was achieved in parallel with the expansion of the personnel schemes.
Strengthening during the third quarter the favourable trend of labour productivity in industry is
uncertain, t he strong downward movement visible in July and essential ly attributable to a
calendar effect at the level of production (manifested not only internally, but also in the case of
important external partners), but partially corrected only in August.
Forward , a number of measures recently adopted may be of nature to encourage the interest to
innovation and efficiency, with potential gains in the labour productivity. Among t hese are
include d the exemption on income tax for people which are earning income from research and
development activities or technological d evelopment , as well as measures to unblock and relieve
the labour market.

Chart 10. Capacity Utilization Rate

The d evelopments in the labour market24 in the economy has maintained their relatively robust
pace of growth in periods between April and July 2016 (3.4 percent in annual terms). And this
time, more intense recruiters were visible in market services, particularly in the support and
administrative, professional, scientific and technical, as well as in hotels and restaurants . Also, in
computer services the dynamic of hiring was placed over 20 percent , similar to the last two
years25. Instead, the recruitment pace slowed down in construction and industry, however
remaining consistent in the automotive industry, electrical equip ment and rubber sector (Chart
11).
Increasing the labour force's ability to absorb the workforce also reflected in a decrease in
the ILO unemployment rate by 0.3 percentage points to 6.1 percent – the low post -crisis level. In
this context, it is becoming more difficult for companies, whose demand for labour is growing, to
identify the suitable candidates, the process being also hampered by the persistence of structural

24 Analysed based on seasonally adjusted data.
25 In the context of the investments made in this field, the number of employees increased by
about 15 times compared to 2000 .

21
problems – the long -term unemployed continue to have a significant share in total (about half ),
and young people fail to meet the demands of the labour market26 .

Chart 11. Number of Employees Economy -Wide and Gross Wage

Consequently, the labour market conditions continue to strain, and it is more necessary to
extend active measu res to the labour market (supporting the internal mobility, the professional
reconversion programs) and matching the skills developed in the education system to the
requirement of firms (Chart 12). In this respect, an improvement in the internal mobility c ould
occur as a result of a more consistent instalment premium (since December) for unemployed
people which are not finding a job that requires a change of domicile, as well as an increase in
the financial support to companies that employ s unemployed peopl e.

Chart 12. Labour Market Tightness

26 the unemployment rate remains at more than 20 percent, ranking among the highest in the EU

22

For the period September -December 2016, both the manpower survey results and the INS / EC –
DG ECFIN poll indicate strong employment intentions in industry and market services.
In contrast, mixed p erspectives characterize the construction sector (expectations varying
between stability and decline) and trade, where the level of uncertainty is even higher – the
companies interviewed in the INS / EC -DG ECFIN survey are rather pessimistic, while the
manpower survey respondents anticipates the most robust labour market in the last four years.
Between April and August 2016, the growth rate of net average earnings per economy has
accelerated to 13.4 percent (+1.4 percentage points versus the first q uarter ). The adva nce was
driven solely by the rise in private sector dynamics, which exceeded the 10 percent threshold for
the first time in the post -crisis period. To this dynamism contributed the increase of the minimum
gross wage in economy in May by 19 percent, to 1250 RON27. The impact of this measure was
more pronounced in construction s, hotels and restaurants, transport s and trade, branches with
more than 40 percent from the directly affected staff .

2.3. Perspectives of inflation

The a nnual CPI inflation rate is projected to increase over the entire forecast range from -0.4
percent at the end of 2016 to 2.1 percent at the end of 2017 and 3.1 percent at the forecast
horizon (3rd quarter 2018 ). The upward trend is even more pronounced in the adjusted CORE2
index.
In the case of this component, the gradual accumulation of inflationary pressures will be mainly
driven by the anticipated surge in the excess of demand, plus the gradual dynamics expectations
concerning inflation of economic agents from today's low leve ls, as well as the mitigation of the
disinflationary pressures of import prices. In addition, in the beginning of 2017 and 2018, the
first-round effects will be exhausted of indirect tax cuts in January 2016 and January 2017,
impacting the increase in the annual rate of the indicator. The risk balance for the projection of
the annual inflation rate is evaluated to be balanced relative to the path outlined in the baseline
scenario, in the context of the opposite influences related with the risk sources locat ed in the
external and internal environment.

27 With an estimated effect of 2 percentage points on the private salary sector .

23

2.3.1. GDP Deviation

In the second quarter of 2016, the real GDP seasonally adjusted has registered a new quarterly
increased (1.5 percent28), similar to the previous period. The d omestic demand has maintained its
decisive role in economic growth. For the second half of 2016, the real GDP is anticipated to
continue its positive quarterly dynamics, but with a slowing pace. The favourable signals come
from indicators such as confidenc e in the economy (growth in third quarter in 2016 by 0.2 points
– Chart 13) or industrial production (+1.1 percent in July -August 2016 compared to the second
average quarter), while the volume of the retail trade (excluding the moto r vehicles ) has
increase d by only 0.6 percent during the mentioned period, while that for the new constructions
decreased by 2.2 percent.

Chart 13. Economic Sentiment Indicator* and Economic Growth

Over the forecast horizon, the potential GDP is anticipated to accelerate gradually, due to the
increase in the capital stock (due to the recent dynamics and projected investments) and
mitigating the unfavourable contribution of the labour force (supported by the rate of activity and
by unemployment). The projected dynamics of the total productivity of factors (TFP) reflects the
assumption of continued economic agents efforts to capitalize on European structural and
cohesion funds29 and the low levels of the real interest rates in their work efficiency programs.
For the current year, the evolution of the TFP remains staggered by a statistical carry -over effect
associated with agricultural performance in 2015.

28 NIS Communication no. 257 of 7 October 2016. In annual terms, the economic growth in the
second quarter of 2016 was 6 percent .

29 On September 30 th e, the effective absorption rate of European funds for th e operational
programs related to the 2007 -2013 budget year was 75.7 percent, rising from 58.9 percent at the
end of 2015.

24
The positive breakdown of GDP in the second quarter of 2016 was revised at the higher levels
compared to the previous forecast, mainly due to GDP growth over this quarter. The assessment
of GDP deviation values at the end of this year is supported by correlated indicators such as the
ILO unemployment rate (in continuous reduction over the course of 2015 and the first half of the
current one) or the degree of utilization of industrial production capacities (which re cord values
higher during the current year compared to the previous one).
Compared to the previous Inflation Report, the revision of the projection of the GDP
deviation reflects, on the one hand:
 the wider dynamics of GDP growth in the first ha lf of this year, and greater incentive of
fiscal policy (through the fiscal impulse), especially in the second half of the current year
and, on the other hand,
 the real monetary conditions, whose character is projected to be less stimulating (due to the
lower contribution from the the share of the exchange rate through the net exports channel).


Chart 14. Output Gap

The e xcess of the demand is projected to have an upward trend up to the horizon of the forecast
(Figure 14). Its evolution ref lects the dynamics of the real disposable income (supported by the
impact of fiscal relaxation measures and the anticipated wage increase d in the economy) as well
as the gradual reduction of the external demand deficit and the stimulating nature of real
monetary conditions in a broad sense. Effects in terms of alleviating excess the demand are
associated with the Brexit implementation process (through actual external demand30) and the
Law on debt discharge31.

30 On short term, the outlook for EU economic activity reflects a limited impact of the Brexit.
However, in the medium term, in the co ntext of the uncertainties surrounding the start of
negotiations on the UK exit from the EU, it is anticipated that the economic activity in the
community space (Romania's main trading partner) will be unfavourable affected.
31 The tightening of lending sta ndards of credit institutions for the purchase of housing and land
by the population in the second quarter was partially offset , during the third quarter , by a
reduction in the advances they had made on mortgages.

25
The baseline scenario foresees acceleration of the economic growth in 2016. During the forecast
horizon, it is anticipated to continue to be above potential , but below the current year values , with
the mitigation of the effects of fiscal policy measures and the wage rises on the components of
domestic demand and the outcomes of Britain's outgoing referendum in the EU. The main
positive contributions to economic growth come from the actual individual consumption of
households by population ( favoured by the evolution of their real disposable income) and
investments (in the context of further absorption of structural and cohesion funds). In terms of
domestic demand growth, the increase in imports of goods and services is projected to remain
above that of exports, contributing to this , at the deepening of th e balance of goods and services.
Thus, the contribution of net exports to GDP growth is expected to be negative, with a tendency
to mitigate over the forecast horizon, conditioned by the strengthening of the economic activity
of the foreign trade partners, implicitly on the demand for the Romanian products coming from
them.

2.3.2. Components of aggregate demand

The i ndividual households actual consumption recorded a 2.9 percent increase in the second
quarter of 2016 compared to the previous one, benef iting from support from the increased wage
and from also a negative marginal inflation rate32. For the third and fourth quarters of 2016, the
assessments concerning the evolution of this component indicate the maintaining of a positive
dynamics, but in attenuation. This is supported by the further increase in real disposable income
under the impact of the wage component (1.9 percent real growth in the net average wage in
economy in July -August 2016 compared to the average second quarter). The s ignals to mode rate
the consumption of dynamics come from the volume of retail, excluding moto r
vehicles (increased with only 0.6 percent in the July -August period compared to the second
average q uarter), or the consumer confidence indicator ( breeched by 1.2 point s in thi rd quarter ).
During the projection period33, the actual individual consumption of households is anticipated
to record growth alert rates relative to post critical values, but in deceleration. Under the
incentive cumulative impact of the factors mentione d, the cyclical component of the actual
individual consumption of households is assessed to advance positively across the forecast range.
In the third and fourth quarters of 2016, the actual collective consumption of public
administration is projected t o grow, but its dynamics is appreciated to remain consistent with the
maintaining the current government deficit in the current year within the 3 percent benchmark of
the Stability and Growth Pact. Over the projection horizon, the collective consumption of
government is expected to see a positive average annual dynamics in both 2016 and 2017.
Gross fixed capital formation (GFCF) increased in the second quarter of 2016 compared to the
previous one (6.6 percent), favoured by both equipment acquisitions and construction works.
And in case of this component, is expected a moderate dynamics in third and fourth quarter .
The p ositive signals concerning the GFCF dynamics come from the industrial production of
capital goods, w hich grew by 4.4 percent between July and August compared to the second

32 Under the impact of the dynamics of this quarter on volatile food prices and prices of
administered products .
33 The forecast reflects the diminishing impact on the real disposable income of households from
fiscal policy and that of income, as well as the increases in wages anticipated occurring in the
private sector, in correlation with the dynamics of the labour productivity.

26
quarter, but also by the confidence indicator for construction operators (up by 2.1 points in the
third quarter of 2016 compared to the previous one).
The i mports of goods and services has increased in the second quarter of 2016 compared to the
previous quarter by 5.9 percent. For the third and fourth quarters of 2016 and the remainder of
the forecast horizon, they are expected to continue their positive dyna mics, higher than that of
exports, against the backdrop of domestic demand. An additional drive effect comes from the
favourable anticipated developments in exports of goods and services. Against this background,
the deviation from the medium -term trend of imports of goods and services is expected to remain
positive values . The current account deficit in the balance of payments increased to 1.2 percent of
nominal GDP in 2015, amid the accentuation of the primary of the balance of payments deficit,
with the evolution of the latter contributing to the dynamics of domestic demand. Over the
projection horizon, the current account deficit is anticipated to continue to deepen. The main
determinant of this evolution is the dynamics of imports of services and goods amid on advance
of domestic demand. In this context, the share of current account deficit in GDP is forecast to
position itself in the medium term close to 2.5 percent. The recorded level of international
reserves and, in general, the expected sources of c urrent account deficit financing are estimated to
be appropriate and favourably distributed from the perspective of the non -debt-generating nature
of capital inflows (mainly foreign direct investment and capital transfers34). However, the
reopening of the c urrent account deficit due to the acceleration of consumption and the increase
of the budget deficit presents the potential to endanger the macroeconomic balances of Romania
in the situation of the increase of the volatility of the capital towards the emer ging economies.

2.3.3. Monetary conditions in a broad sense

The b road monetary conditions evaluate the impact on future aggregate demand for real interest
rates in RO N practised by institutions of credit in relation with non-bank customers and the
evolution of the real effective exchange rate35 of the RON . The exchange rate operates through
both the net exports channel , also through wealth and balance sheet of economic agents36. The
average nominal interest rates in RO N on credits and new time deposits b y credit institutions in
relation to non -bank customers are estimated to be decreas ing in the third quarter of 2016. For the
fourth quarter, is anticipated a the further decline in the nominal interest rate on loans and
maintaining the one on deposits in the previous quarter. Cumulatively, the deviations from real
interest rate trends are estimated to exert a stimulating influence on economic activity over the
coming periods.
Chart 15. Quarterly Change in the Effective Exchange Rate

34 Associated to structural and cohesion fund raising from the European Union.
35 The exchange rate is relevant to the NBR's macroeconomic analysis and the forecasting model
is built on the basis of the RON and the Euro , respectively the RON and the US dollar, the
weighting system reflecting the importance of the two currencies in Romania's foreign trade.
36 The relevance of this channel has known a gradually diminishing in recent periods, given the
increase in the share of credits denominated in RON in the total stock of loans granted to the
private sector.

27

In the third quarte r of 2016, compared to the previous quarter, the national currency was
appreciated in nominal terms, due to developments in relation to the Euro . In real terms,
however, the national currency has registered a new depreciated on the basis of the quarterly
inflation differential compared to trading partners (Chart 15). Overall, the impact of real effective
exchange rate on the aggregate demand (through price competitiveness of price exports) in the
following periods is assessed to remain incentive.

2.4. Internal macroeconomic developments

The model of predominantly consumer -driven growth has strengthened, and this trend is
expected to continue in the coming period.

Chart 16. Determinants of GDP Dynamics

The Romanian economy has registered one of the highest growth rates at European level (5
percent advance in annual terms, seasonally adjusted in the first half of 2016, preliminary data for
January -September 2016 indicating a similar growth rate, respectively 4.8 percent versus the
same period of 2 015, seasonally adjusted data). This evolution was mainly due to the acceleration
of the population consumption (Chart 1 6), both as a result of wage increases (including measures

28
to change the minimum wage37), and also tax measures ( for example VAT reduction from 24
percent to 20 percent as of 1 January 2016). The d ynamics registered by the population
consumption reflected also in the evolution of the trade activities related to the consumption of
the population and the transport ation sector (co ntributing by a quarter GDP growth in 2015 and
35 percent in the first half of 2016).
The positive evolution of investments observed in 2015 remained, with the contribution of the
gross fixed capital formation being 1.6 percentage points in the first ha lf of 2016 (compared with
1.5 percentage points in the first half of the year 2015). The absorption of European structural
funds has improved but there is still significant improvement. The absorption rate of the
European structural funds allocated for 200 7-2013 reached 80.2 percent in November 2016,
against 58.7 percent in November 201538, while the allocation for 2014 -2020 was less than 1
percent compared to 2.6 percent at European level (October 2016). The on going efforts of the
increase in the rate of a bsorption of European funds and the efficiency of their use, including
through regular evaluation of the allocation of funds for priority projects at national and regional
level remains an imperative for increasing the role of these financial resources in Romania's
economic development.
The growth in domestic demand, the main driver of economic growth in 2015 and 2016, was
reflected both in the advance of domestic production and in a deterioration of the trade balance
deficit (Chart 1 7). Thus, the goods deficit narrowed in the first half of 2016 by € 1.2 billion
compared to the same period last year, while the trade balance of consumer goods registered a
deficit of € 1 billion in the first six months of 201639. The increase in domestic demand, the main
factor of economic growth in 2015 and 2016, was predominantly directed towards the domestic
sector. Thus, domestic consumption increased by € 7.4 billion in 2015 and 4.5 billion Euro
respectively in the first half of 2016, while the current account deficit o f the current account
assets increased by 1.3 billion Euro in 2015 and by 1.2 billion Euro in the first half of the year
2016. Compared to 2005 -2008, both the increase in consumption and the increase in the trade
deficit of goods have a much lower amplitud e, which positions recent developments in area of
sustainability .

Chart 17. Annual change in final consumption and in balance on trade in goods

37 Starting May 1, 2016, the minimum gross national salary guaranteed for payment was set at
1250 RON per month for a full work program of 169,333 hours per month in 2016, representing
7,382 RON / hour.
38http://www.fonduri –
ue.ro/images/files/comunicate/2016/17.11/Progrese_implementare_fonduri_europene_2016.pdf.
39 However, the current account defici t is in real terms almost 10 times lower than in 2007 .

29

On the other hand, the majority of additional domestic growth appeared in the economy in
2014 -2016, as a result of revenue -increasing measures and fiscal relaxation, was covered by the
domestic offer, so the external imbalance remained within sustainable limits.
Romania's fiscal position has deteriorated in 2016. The c urrent projections of the general
government deficit show a close proximity to the 3% of GDP (Table 1), representing the highest
level in a regional context (Chart 18), and maintaining it at this level is questioned on the
background of other pro -cyclical fiscal measures. The risk of pro -cyclical fiscal and budgetary
policies materialized only partially due to a budget execution below the foreseen level. Thus, the
deficit for the first 10 months was 0.17 percent of GDP, with 2016 closing with a budget deficit
below 2.9 percent of GDP, as plann ed40 (Table 1) .

Table 1. General government budget deficit

40 According to the Convergence Program 2016 -2019, published in April 2016
(http://ec.europa.eu/europe2020/pdf/csr2016/Cp2016_romania_en.pdf).

30
Government arrears41 in relation to the real sector have seen significant increases over the
year under review. Arrears generated by the consolidated general budget amounted to RON 224.6
million in October 2016, below the level of 295.1 million RON recorded in the same period last
year, but rising from 86 million RON at the end of 2015.
Chart 18. General government balances regional comparisons

Chart 19. Public debt*

41 Arrears are a obligation, an overdue debt and a liabilit y.

31

Public debt has stabilized in 9 months of 2016, representing 36.8 percent of GDP in September
(versus 37.9 percent in December 2015). In the structure, the developments are most likely to
generate favourable effects on the financial stability, in the sense of diminishing the contagion
risk that non -residents could generate and to reduce the currency risk. The external debt
component continued to adjust to a larger extent, from 18.9 percent of GDP at the end of 2015 to
18.1 percent in September 2016, while domestic debt als o experienced a reduction ( around 0.3
percentage points, to 18.7 percent of GDP, Chart 1 9). There are no short -term developments in
the structure: the domestic debt -to-GDP ratio of the domestic debt is 14.4 percent of GDP, while
government continues to att ract mainly medium -term domestic financing, and long-term42. The
additional financing capacity of the public sector by the domestic banking sector remains limited.
Banks have an important and growing exposure to this (about 20 percent of the total active
banking sector, the highest level within the EU).

42 (medium – and long -term domestic debt ratio in GDP is 16.4 percent in September 2016).

32
CONCLUSIONS

The risk of rapidly deteriorating the investor confidence in emerging economies, with
implications for the domestic financial system, has increased since the previously r eport on the
backdrop of the latest international events:
➢ increasing the global geopolitical tensions;
➢ The vote in favour of leaving the EU by the UK. Against this background, the slowdown in
international trade growth, the economic developments in major emerging coun tries
(especially in China) and the persistence of the problems faced by advanced countries in the
resumption of economic growth, while keeping the at minimum the i nterest rate, from
historical perspective, contributes to increas e the uncertainties about t he future developments
of the global economy, with implications on volatility of capital flows.
In the coming period, the global economic growth is expected to continue its moderate
recovery, and the divergence between the monetary policies of the main central banks will most
likely be accentuated.
At European level, the possible exit of the UK from the European Union could have
implications both on the economic growth of the Euro area and on architecture European
institutions.
The economi c growth of our country has accelerated significantly since the previous Report,
reaching the highest level in the European Union in the second quarter of 2016.
However, the pattern of economic growth relies heavily on the p olicies to stimulate domesti c
demand, which are necessary in the future for growth measures, by significantly improving the
performance of the factors of production.
For the year 2017, the economic growth is projected to remain above the potential GDP
growth, but below compared wi th 2016, as the impact of fiscal and wage stimulus on domestic
demand components is mitigated and the Brexit's effects on the external demand for exports
Romanian.
The main determinants of economic growth will remain :
❖ Consumption ;
❖ Investment.
The pr ojected dynamics of individual household consumption will reflect the diminished
impact on real disposable income from fiscal relaxation measures and those targeting revenue
policy in the sector as well as anticipated wage increases occur in the private se ctor, in
correlation with the anticipated labour productivity dynamics.
At the same time, it is envisaged to strengthen the favourable evolution of gross fixed capital
formation over the reference period, in the context of:
✓ continued absorption, although with a slowdown in 2017, the European structural and
cohesion funds and
✓ Favourable lending conditions, with the effect of supporting the dynamics of private sector
investment.
The set of real monetary conditions, which is expected to be stimulating for the entire reference
period, also acts in a favourable way. Against the backdrop of domestic demand, especially in the
current year, the growth rate of imports of goods and services is anticipated to exceed that of
exports, contributing to the positio ning of the current account deficit in the medium term close to
2 , 5 percent of GDP.

33
The recorded level of international reserves and, in general, the forecast sources of current
account deficit financing, predominantly non -generating of new debt (for eign direct investment
and capital transfers), are still considered appropriate.
However, the re -opening of the current account deficit due to the acceleration of consumption
and the increase of the budget deficit, in the event of an increase in the the volatility of capital to
emerging economies, the potential to endanger Romania's macroeconomic balances .
Among the issues of the economic restructuring an important place are the ones in the
industrial sector. The main reasons for the problems in this sector are the lack of efficiency,
oversize capabilities, as well as the intention of the employees administration. Instead of making
effective restructuring, the companies finan cial problems have been "tangled up" by various
instruments of economic policy, such as tax cuts, preferential interest loans, or other forms of
state support.
Based on the experience of the previous years, the businesses knew that whatever the
adminis tration would do would help them, so the compliance with financial discipline fell.
There has been a negative relationship between macroeconomics and structural policy in the
restructuring of the economy. This explains why they have had such a short li fe of applied
macroeconomic stabilization policies. Numerous risk factors continue to generate weights. These
include the possibility of large trade union movements and conflicts at the borders of Romania.
The economic and political strategy adopted by the administration to date can be characterized
as, first and foremost, a survival one. A concrete and coherent program is needed to create a truly
modern and effective economy, so as to increase the population's optimism and confidence in the
reform.

34
BIBLIOGRAPHY

1. MARSHALL, Robert & SWANSON, Rodney – The monetary process: Essentials of money
and banking, Hanghton Miffin Company Boston, 1974 ;
2. MAYER, Thomas, DUESENBERRY, James S., ALIBER, Robert Z. – Money, Banking and
the Econom y, W.W. Norton &Company, In c, 1984 ;
3. Philip Hardwick, John Langmead, Bahadur Khan – Introducere in economia politica moderna,
Editura Polirom, 2002;
4. http://ec.europa.eu/europe2020/pdf/csr2016/Cp2016_romania_ en.pdf ;
5. http://econtutorials.com/blog/category/macroeconomics/;
6. http://www.bnr.ro/PublicationDocuments.aspx?icid=3922 ;
7. http://www.bnro.ro/Home.aspx ;
8. http://www.fonduriue.ro/images/files/comunicate/2016/17.11/Progrese_implementare_fondu
ri_europene_2016.pdf. ;
9. http://www.insse.ro/cms/ ;
10. http://www.scritub.com/economie/finante/Datoria -publica -interna -si-ext9561054.php .