What is the optimal exchange rate for Lebanon? -

Abstract

The Lebanese Civil War (1970-1989) has left the country in need for a rescue plan to rebuild it. In order to finance this program, the government was forced to exponentially increase the issuing of treasury bills which led to the pile-up of a very large public debt. These events, alongside the negative impact of the war on the economy, had applied serious pressure on the flexible exchange of that period. The rate went through a strenuous series of depreciations. In an effort to control this free-fall, the government decided to change the exchange rate regime: from a flexible rate to a pegging system to the US dollar. The fixing of the exchange rate had succeeded in controlling the exchange rate—which by then was fixed at 1507.5 LBP-USD. Another positive impact of this regime change was taming the hyperinflation that had resulted from the economic meltdown. Two decades later, the rate remains fixed at the same level. This long period of time, of having to finance the peg from the treasury, has led Lebanon to having one of the largest debt-gdp ratios in the world. The dollarization of the Lebanese economy is proving to be a stumbling block in the face of economic reform; and in case the government decides to alter the exchange regime, the subject of dollarization should be one of the first issues to be resolved. In this project I discuss various theories that suggest a flexible rate could actually improve the economies of small emerging markets. I talk about the latest studies on “inflation targeting”, and how such a policy can actually benefit the Lebanese economy. This project does not infer what the optimal exchange rate for Lebanon is today; it rather proposes further studies in this area, and points out certain specific topics that have proven to benefit other developing countries with a similar history and economic structure to Lebanon.