Putting the Pieces Together: The Moldovan Exchange Rate Policy Puzzle

Abstract

This paper explores the Moldovan exchange rate policy puzzle: why the country has pursued a soft peg to the US dollar, despite the virtual absence of direct trade with the United States, increasing “euroisation” of the economy, and an inflation-targeting monetary policy regime. In an attempt to assess Moldovan exchange rate policy, the paper finds that while changes in both the US dollar exchange rate and the import-weighted exchange rate affect import prices, consumer prices are determined primarily by changes in the dollar exchange rate. It also finds that the Moldovan monetary authorities use the US dollar exchange rate as an instrument for responding to domestic price developments. Thus, the sensitivity of consumer prices to the dollar exchange rate, and systematic use of the dollar exchange rate as an instrument of monetary policy, constitute an important setting against which the dollar peg policy has been maintained.