Fluctuating Exchange Rate Will Be A Reality Next Month, Central Bank President Affirms
"The new system 'cambiario de bandas' will begin in the last quarter", affirmed the president of the Banco Central de Costa Rica (BCCR), Francisco de Paula Gutiérrez.

The declaration was made Wednesday at the monthly seminar of the Consejeros Económicos y Financieros (Cefsa), a private firm established in 1978, that provides economic forecasts, both national and international.

The head of the Central Bank said that Costa Rica will abandon the policy of "minidevaluaciones" (mini devaluations) that was established 22 years ago by the then BCCR president, Eduardo Lizano.

The new system which goes into effect at the beginning of October allows the market to determine the exchange rate of the Colon to the U.S. dollar, of course within upper and lower limits established by the Central Bank.

The new system will allow commercial banks to compete for the exchange and set the rate. The banks will publish their established exchange rates, which will be offered online, in real time, on the Banco Central's website.

Gutiérrez said the objective of the new system is to allow the Central Bank greater freedoms to combat inflation, bringing it closer to international rates of inflation, which is much lower that the Costa Rican inflation rate.

The fluctuating exchange rate will mean that the Central Bank will not have the responsibility to float the Colon and thus eliminate the losses by the Central Bank, losses which Gutiérrez says contributes to the inflation rate.

The Central Bank president said that the such losses began at the end of the 1970's and have continued to present day.

According to Gutiérrez, the exchange fluctuations limits will be tight at the beginning as the market adapts and will be expanded with time. "The fluctuations will be narrow and sliding", said Gutiérrez.

In the long term, the Central Bank president said he hopes the exchange rate is determined by offer and demand, and flexible, with little intervention by the Central Bank. Gutiérrez said that in Chile, for example, the system took two years to adapt.

The flexibility of the exchange system will be "gradual", according to Gutiérrez and with time, the Central Bank president said it will permit the resolution of the problem of "impossibly trinity".

The "Impossible Trinity" is the hypothesis in international economics that it is not possible to have

* A fixed exchange rate
* Free capital movement
* An independent monetary policy.

Quoting from a Slate tribute to Robert Mundell written by Paul Krugman in October 1999:

"[...] The point is that you can't have it all: A country must pick two out of three. It can fix its exchange rate without emasculating its central bank, but only by maintaining controls on capital flows (like China today); it can leave capital movement free but retain monetary autonomy, but only by letting the exchange rate fluctuate (like Britain--or Canada); or it can choose to leave capital free and stabilize the currency, but only by abandoning any ability to adjust interest rates to fight inflation or recession (like Argentina today, or for that matter most of Europe)."

The formal model for this hypothesis is the Mundell-Fleming model developed in the 60s by Robert Mundell and Marcus Fleming.