Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime?

Ezzahid, Elhadj; Maouhoub, Brahim Article Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? Journal of Central Banking Theory and Practice Provided in Cooperation with: Central Bank of Montenegro, Podgorica Suggested Citation: Ezzahid, Elhadj; Maouhoub, Brahim (2020) : Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime?, Journal of Central Banking Theory and Practice, ISSN 2336-9205, De Gruyter Open, Warsaw, Vol. 9, Iss. 1, pp. 185-218, https://doi.org/10.2478/jcbtp-2020-0010 This Version is available at: https://hdl.handle.net/10419/217701 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 185 * Mohammed V University, Rabat, Morocco E-mail: [email protected] ** Mohammed V University, Rabat, Morocco E-mail: [email protected] Journal of Central Banking Theory and Practice, 2020, 1, pp. 185-218 Received: 25 October 2018; accepted: 18 January 2019 UDK: 339.743(64) DOI: 10.2478/jcbtp-2020-0010 Elhadj Ezzahid *, Brahim Maouhoub ** Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? Abstract: This paper examines the opportunity of exchange rate regime flexibilization in Morocco under the policy of capital account liberalization. Basing on our findings in Ezzahid and Maouhoub (2014), we develop a new theoretical game model with four economic agents, namely: monetary authorities, government, foreign firms and domestic firms. We explore the optimal exchange rate regime for Morocco under new conditions such as the presence of a compensation fund effect, restrictions on capital outflows, etc. Starting with a first simulation based on current economic parameters, the results show that losses under a flexible exchange rate regime are lower than losses under a fixed exchange rate regime. Varying different parameters allow discovering the ‘appropriate level’ from which monetary authorities should move toward the flexible exchange rate. Keywords: Capital account liberalization, Exchange rate regime flexibilization, compensation fund, Real exchange rate, and game theory. Jel classification: F31, F32. 1. Introduction The financial liberalization theory predicts that capital account openness allows developing countries to receive international capital flows and to boost investment, and therefore contribute to more efficient allocation of re- Journal of Central Banking Theory and Practice 186 sources and to more financial development. The confrontation of theoretical predictions and developing countries experiences renews the debate on capital account liberalization effects. Furthermore, to take advantages from capital account liberalization, developing countries adopt various approaches and strategies appropriate to their specific circumstances. Capital account liberalization is not without risks. International capital flows can bring with them their own problems, such as real exchange rate appreciation and inflation increasing under a fixed exchange rate regime (Corbo and Hernández, 1996). The experiences of Latin America and East Asia give us many lessons about the risk associated with capital account liberalization under a fixed exchange rate regime. The important one is that preparing exchange rate flexibilization in parallel with capital account liberalization is required to ensure exchange rate adjustments. Furthermore, referring to the impossible trinity, it’s impossible for an economy to attain simultaneously fixed exchange rate regime, free capital account and autonomy of monetary policy (Mundell, 1963). It is true that the fixed exchange rate regime ensures economic confidence and policy credibility, stabilizes nominal exchange rate and avoids volatility risks; but, it can result in a misallocation of resources and then in a low economic growth. The explanation is that in countries with fixed exchange rate regime and higher investment, the productivity grows more slowly than in countries with floating exchange rates, because nominal exchange rate is unable to be used as an adjustment mechanism (Ghosh et al. 1996). The empirical link between the choice of exchange rate regime and economic growth is a controversial debate. Some studies show that less flexible exchange rate regimes are associated with slower growth in developing countries (for example Levy-Yeyati and Sturzenegger, 2003). Meanwhile, other studies indicate the absence of any robust relationship between the choice of exchange rate regime and economic growth in developing countries (for example De Vita and Kyaw, 2011). Moreover, the majority of empirical findings indicate that the positive relationship between monetary policy and growth is stronger in financially developed countries; however, it is weaker in financially underdeveloped countries with weak integration into global markets (Odhiambo and Twinoburyo, 2018). On the one hand, the exchange rate flexibilization is based on the hypothesis of Friedman (1953) and Mundell (1961), arguing that flexible exchange rates act as a ‘shock absorber’ in a small open economy. Accordingly, the flexible exchange rate regime is favourable for developing countries because it allows the adjustment process that stabilizes the macroeconomic variables when negative external shocks hit the economy (Hoffmann, 2007). On the other hand, the choice of ex- Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 187 change rate regime for developing countries depends on their policy orientations and on their economic settings rather than on theoretical predictions, empirical studies and economic experiences. The International Monetary Fund –as part of his annual consultations for developing countries, among them Morocco– recommends more flexibilization of their exchange rate regimes. In this paper, we assess Moroccan experience and the opportunity for Morocco to move toward more flexible exchange rate regime. The point that we seek to determine is the ‘appropriate level’ – based on Moroccan economic specificities – from which monetary authorities should move to a more flexible exchange rate regime. In other words, we try to determine the optimal exchange rate regime under current economic conditions. The paper proposes a new theoretical model adapted to the Moroccan context and able to take into account the real exchange rate misalignment, the inflation targeting, the gradual capital account liberalization and the Compensation Fund Effect1. Thus, we organize the paper as follows: Section 2 presents the theoretical framework. Section 3 is reserved for the model construction. The parameters are estimated in Section 4. Model simulations and results are discussed in Section 5. The last Section summarizes the concluding remarks. 2. Theoretical and conceptual framework The issue of the exchange rate regime optimality is highly debated by Aizenman (1994), Chin and Miller (1995), Devereux and Engel (2000), etc. An optimal exchange rate regime corresponds to a regime that minimizes risks (currency instability, capital volatility, etc.) and maximizes benefits (policy credibility, economic confidence, economic agent planning, etc.) associated with a given exchange rate regime. Consequently, an optimal exchange rate regime may be a fixed or a flexible regime, all depends on economic conditions and monetary policy objectives. To model the economic agents’ behaviour, we refer to the game theory. The model is represented as a game where monetary authorities make decisions and other economic agents react to these decisions (Figure 1). All economic agents are conscious that their benefits depend not only on their decisions, but also on the reactions of others. To make an optimal decision, monetary authorities have to define their objective function and the objective functions of other economic agents. 1 A Fund created by Moroccan government to subside elementary goods such as liquid petroleum, Butane gas, sugar and national soft wheat flour, in order to stabilize prices. Journal of Central Banking Theory and Practice 188 Figure 1: Economic agents and different choices in the base model The base model considered in this work – see Ezzahid and Maouhoub (2014) – is based on the framework proposed by Agénor (1991, 1994) for developing countries. We consider a small open economy producing tradable and non-tradable goods, where economic agents are monetary authorities and domestic firms interact through an optimization game. Each agent tries to minimize his loss-function using his own instruments: choice of an exchange rate regime for monetary authorities (fixed or flexible) and price fixation for domestic firms (increase or decrease). Many extended models are simulated for developing and emerging countries. For example Zhang (2001) explored the Chinese case, Ben Ali (2006) explored the Tunisian case, and Ezzahid and Maouhoub (2014) explored the Moroccan case. The aim of these simulations is to determine from which economic level the choice of flexible exchange rate regime becomes an optimal choice for monetary authorities. 3. Model construction The base model does not take into consideration Moroccan economic specificities such as the effect of compensation fund on inflation, the government strategy Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 189 to suppress progressively the compensation fund, foreign firms, capital returns, domestic firms, the presence of restrictions on capital outflows, etc. Introducing these facts in the model may significantly improve the results. For this reason, we construct a new model adapted to Moroccan economic conditions and based on the theoretical framework presented above. Consider a model of a small open economy (Figure 2) where monetary authorities (MA) have two options: to stay under a fixed exchange rate regime or move to a flexible exchange rate regime. The choice of an optimal exchange rate regime is required in a context of capital account liberalization. To make an optimal choice, monetary authorities must define the objective functions of all economic agents and then determine the variables that impact their decisions: monetary authorities’ objective function, government’s objective function, domestic firms’ objective function and foreign firms’ objective function. Figure 2: Model developed for Morocco, authors’ design The model developed is based on the following hypothesis: Hypothesis 1: general price level determination ( ). The economy is composed of two-sectors: tradable sector and non-tradable sector. The general price level is assumed to be determined as follows: (eq. 1.1) Journal of Central Banking Theory and Practice 190 Where is the price level of non-tradable goods, is the price level of tradable goods, is the nominal effective exchange rate and is the economic openness rate. In growth rate terms, the equation (eq.1.1) takes the following expression: (eq. 1.2) is the inflation rate without compensation fund effect. Hypothesis 2: tradable prices determination and non-tradable prices determination . The price level of tradables is determined in international markets and is assumed to be equal2 to the world general price level : (eq. 1.2.1) In growth rate terms, the equation (eq. 1.2.1) gives the world inflation rate: (eq. 1.2.2) The price level of non-tradables is domestically determined by the following mechanism: (eq. 2.1) Where is the equilibrium real effective exchange rate, is the money supply, is the elasticity of to the real exchange rate misalignment and is the elasticity of to the money supply. The price level of non-tradable goods is determined by two factors. The first is the deviation of the real exchange rate from its equilibrium level. A real depreciation increases the external competitiveness of the economy, which increases in the tradable goods demand (i.e. an increase in exports). Therefore, domestic firms shift resources from non-tradable sector to tradable sector. The resources transfer lowers the production of non-tradable goods (i.e. a decrease in supply), which raises their prices. A real exchange rate appreciation produces the opposite effects. In growth rate terms, the equation (eq. 2.1) takes the following expression: (eq. 2.2) 2 We suppose that the world general price level is written as follows: with is the world general price level of non-tradable goods, is the world general price level of tradable goods and is the international economic integration. Thus, when international economy is fully interacted: , so . Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 191 Hypothesis 3: compensation fund effect . The government reduces prices using the Compensation Fund Effect . We suppose that the price level of tradables and non-tradables are reduced by the following mechanism: (eq. 3.1) and (eq.3.2) Where is the subsided price level of non-tradables, is the subsided price level of tradables, is the Compensation Fund effect, is the proportion of compensation fund effect allocated to reduce non-tradable prices and is the proportion of compensation fund effect allocated to reduce tradable prices. From (eq. 1.1), (eq.3.1) and (eq.3.2), we write the expression of subsided general price level in function of subsided non-tradable prices and of subsided tradable prices as follows: (eq. 4.1) Or (eq. 4.2) In growth rate terms, the equations (eq.4.1) and (eq.4.2) give the compensated inflation rate: (eq. 5.1) Or (eq.5.2) We can write as follows: (eq. 6.1) In order to simply this equation, we pose two expressions: , where and is the ratio of subsided nontradable prices to non-subsided non-tradable prices; Journal of Central Banking Theory and Practice 192 , where and is the ratio of subsided tradable prices to subsided non-tradable prices. The parameters b and c are introduced to measure the extent of compensation fund effect through the gap between non-subsided price level and subsided price level. As a result, (eq. 6.1) becomes: (eq. 6.2) We consider the equation (eq. 6.2) as the government’s function reaction. Hypothesis 4: real effective exchange rate definition. We adopt the following definition for the real effective exchange rate: (eq. 7.1) Where is the nominal effective exchange rate. In growth rate terms, the equation (eq. 7.1) takes the following expression: (eq. 7.2) Hypothesis 5: capital account restrictions. We denote capital inflows by and capital outflows by . Moroccan monetary authorities impose restrictions on capital outflows to avoid any situation of capital flight. Nevertheless, monetary authorities don’t impose any restrictions on capital inflows and they look for higher capital inflows. However, we suppose that capital inflows must not exceed domestic financial requirement in order to avoid any capital influx. We define the capital account3 as follows: (eq. 8.1) We suppose that restrictions on capital outflows are imposed as follows: (eq. 8.2) Where is a restriction on capital outflows. In other words, the amount of capital authorized to outflow is: 3 Capital outflows are in Moroccan dirhams and capital inflows are are in foreign currencies. Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 199 Fund Effect is totally allocated to reduce non-tradable prices. And vice-versa, if , so the Compensation Fund Effect is totally allocated to reduce tradable prices. We select the value of a = 0.5 for first simulation, and we vary it from 0 to 1 to test its effect on the choice of exchange rate regime. Money supply growth . Money supply is measured by the large aggregate used by Moroccan central Bank (M3). Money supply growth varies between 0.04 and 0.18 with a downward tendency (Graphic 3). We select the mean of recent values and we vary it to test its effect on monetary authorities’ objective function. Capital depreciation growth and . The domestic capital depreciation rate is 0.06 (calculated for African countries6) and the international capital depreciation rate is 0.046 (calculated for Euro zone7). However, the capital depreciation rates are stable and their growth rate are equal to zero: and . Interest rate growth and . Moroccan Central Bank decreases the interest rate periodically. The domestic interest rate (Graphic 4) is reduced from 7% (in 1996) to 2.25% (in 2016). We retain the mean annual growth rate observed for the period 2009-2016: for first simulation and we vary it afterward. For international interest rate, we take the U.S. interest rate (Graphic 5) as the World interest rate and we retain the mean annual growth rate of the same period above 2009-2016: . This indicates that the world interest rate decreases more rapidly than domestic interest rate. Capital account restrictions . Restrictions on capital outflows are estimated according to the following approximation: The value of elasticity turns around 1.1 over the recent period of 2003-2015 (Graphic 6). Elasticities of non-tradable prices to real misalignment and to money supply . The elasticities of non-tradable prices to the real misalignment and to the domestic money supply ν are difficult to estimate. We retain the estimated values 6 Rapport Économique sur l’Afrique (2010), élaboré par la Commission Economique pour l’Afrique, p. 134. 7 Monthly Bulletin of European Central Bank (2006), p. 46 Journal of Central Banking Theory and Practice 200 for the Tunisian case (See Ben Ali, 2006), which shows some similarities with respect to Moroccan economy: and . The parameters and . The ratio may vary from 0 to 1. Thus, when this means that and and when this means that and . Similarly, the ratio may vary from 0 to 1. Thus, when this means that and , and when this means that and . Because of the estimation difficulty to obtain these parameters, we start the simulation with the following assumed values: and . In order to test their robustness, we vary these parameters in the interval of . Economic openness rate : The economic openness rate is measured by the sum of Imports and Exports divided by Gross Domestic Product. We start the first simulation with the value (i.e. Moroccan economy is open at 70%). Elasticities of capital outflows and of capital outflows to real returns. The calculation of and is approximated as follows: varies between 1.39 to 1.53 and turns around a mean of 1.45, and varies between 1.50 and 2.74 and turns around a mean of 1.83 (Graphic 7). We remark that the value of tends to the value of from 1985 to 2011. We select the following values: = 1.45 and = 1.83 for first simulation. Inflation of tradable goods . We consider the inflation rate in EU (major trading partner of Morocco) as the inflation of tradable goods (Graphic 8). The inflation is very low over the recent period of 2013-2015. We select the value of 1%: . 5. Simulations and discussions The recapitulation of estimated and approximated values and of interval of their variations is summarized in Table 1. First, we perform the first simulation basing Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 201 on the selected values to know which exchange rate regime is currently the optimal choice for Moroccan monetary authorities. Second, we vary each parameter according to the interval of variation in order to compare monetary authorities’ objective function under both fixed and flexible exchange rate regimes. Simulation based on selected values The simulation of monetary authorities’ objective function (Table 2) shows that monetary authorities’ losses under the fixed exchange rate regime (0.006855) are relatively higher than losses under the flexible exchange rate regime (0.006280). The exchange rate flexibilization reduces monetary authorities’ losses by 9.16%. The desegregation of monetary authorities’ losses (Table 3) shows that, under the fixed exchange rate regime, 70.20% of monetary authorities’ losses results from real misalignment, 9.20% from inflation deviation and 20.60% from capital account disequilibrium, and that; under the flexible exchange rate regime, 51.99% of monetary authorities’ losses results from real misalignment, 9.46% from inflation deviation and 38.55% from capital account disequilibrium. The desegregation shows that the choice of the flexible exchange rate regime reduces losses relative to real misalignment by -25.94%; but, increases relatively the losses relative to inflation by +2.76% and consequently the losses relative to capital account by +87.16%. The exchange rate regime flexibilization allows monetary authorities to avoid the real exchange rate misalignment and then to preserve the external economic competitiveness. The mechanism is that under the flexible exchange rate regime, the exchange rate adjusts in nominal terms rather than in real terms. The exchange rate regime flexibilization moderately affects inflation because of the compensation fund effect adjustment. However, the nominal exchange rate adjustment is not without risks. As determined in the model, under the flexible exchange rate regime, the nominal exchange rate8 grows by . It is interpreted as a nominal depreciation. Consequently, under unchanged capital account restrictions , capital inflows grow more rapidly ( under fixed exchange rate regime and under flexible exchange rate regime) than capital outflows ( under fixed exchange rate regime and under flexible 8 The equilibrium nominal exchange rate resulted from model resolution. Journal of Central Banking Theory and Practice 202 exchange rate regime). This is why losses relative to capital account under the flexible exchange rate becomes higher. Varying capital account restrictions We vary the parameter (Table 4) to show how more capital account liberalization reduces monetary authorities’ losses under the flexible exchange rate regime and raises them under the fixed exchange rate regime. The flexible exchange rate choice remains the optimal choice as long as the parameter of capital account restrictions is . The minimal monetary authorities’ losses (0.006173) is reached under the flexible exchange rate regime when (Graphic 9). As a result, allowing more capital to outflow with respect to capital inflows (decreasing from 1.10 to 1.04) is compatible with the choice of the flexible exchange rate regime. In cases of massive capital flight and massive capital influx , the fixed exchange rate becomes an optimal choice, because of high monetary authorities’ losses under the flexible exchange rate. The desegregation of monetary authorities’ objective function under flexible exchange rate regime shows the losses’ structure (Graphic 10). The monetary authorities’ losses under the flexible exchange rate regime results from capital account disequilibrium in case of capital flight (high capital account deficits), and from real misalignment in case of capital influx (high real exchange rate appreciation). Varying monetary authorities’ preferences The parameters , and play a crucial role in the exchange rate regime choice. The results change by classing the order of importance of parameters according to six possibilities (Table 5). If the monetary authorities consider the real exchange rate misalignment as the most (least) important objective or when they consider the capital account equilibrium as the least (most) important objective, the flexible (fixed) exchange rate come to be the optimal exchange rate regime. Varying Domestic firms’ preferences Varying domestic firms’ preferences has no effect on monetary authorities’ objective function under both fixed and flexible exchange rate. Regardless the order of importance of domestic firms’ preferences, the flexible exchange rate remains the optimal choice of monetary authorities. Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 203 Varying economic openness rate Increasing the economic openness rate from 50% to 80% decreases monetary authorities’ losses under both fixed and flexible exchange rate regimes; however, the flexible exchange rate regime remains the optimal choice (Table 6). Varying compensation fund repartition The compensation fund repartition between tradables and non tradables (Table 7) has a significant effect on monetary authorities’ choices. As long as , the flexible exchange rate regime remains the optimal choice for Moroccan monetary authorities. At the moment when , monetary authorities’ losses under the fixed exchange rate regime become equal to losses under the flexible exchange rate. Exceeding the limit , non-tradable prices decrease consequently, and given that tradable prices are stable, the inflation decreases with respect to the target level (2%), which raises monetary authorities’ losses under the flexible exchange rate. As a result, the fixed exchange rate regime becomes the optimal choice. The minimal monetary authorities’ losses are reached when under the flexible exchange rate regime choice (Graphic 11). Consequently, the optimal repartition of compensation fund under the flexible exchange rate regime is 80% for non-tradable prices and 20% for tradable prices. Increasing decreases monetary authorities’ losses under both fixed and flexible exchange rate regimes (Tables 8 and 9). However, when , monetary authorities’ losses under the flexible exchange rate regime become higher then losses under the fixed exchange rate regime. In other words, when nontradable prices (or tradable prices) are reduced by more than 50% (or by more than 75%), the fixed exchange rate regime becomes the optimal choice. The desegregation of monetary authorities’ objective function shows that increasing parameters reduces monetary authorities’ losses relative to real misalignment and to capital account, but raises losses relative to the inflation under the flexible exchange rate regime (Graphics 12 and 13). Accordingly, under the fixed exchange rate regime, increasing parameters and raises the compensation funds effect which reduces non-tradable prices and tradable prices, and then reduces the inflation to equalize the target level. However, under the flexible exchange rate regime, increasing raises the exchange rate in nominal Journal of Central Banking Theory and Practice 204 terms9 (nominal depreciation) which raises the inflation. The result indicates that the compensation fund is counter effect under the flexible exchange rate. Varying elasticities of non-tradable prices Varying elasticities of non-tradable prices to the real misalignment and to money supply doesn’t affect largely the results (Tables 10 and 11). The flexible exchange rate regime remains the optimal choice for monetary authorities. Varying elasticities capital flows Increasing the elasticity of capital outflows to real return (Table 12) or the elasticity of capital inflows to real return (Table 13) reduces monetary authorities’ losses under both fixed and flexible exchange rate regimes. However, when , the flexible exchange rate regime becomes the optimal choice, and when , the fixed exchange rate regime becomes the optimal choice. These results indicate that diminishing returns of capital outflows (more capital outflows with fewer returns) are compatible with the flexible exchange rate regime and that the diminishing returns of capital inflows (more capital inflows with fewer returns) are compatible with the fixed exchange rate regime. The desegregation of monetary authorities’ objective function under the fixed exchange rate regime (Graphic 14) shows that increasing doesn’t affect monetary authorities’ losses relative to real misalignment and to inflation deviation; but, it reduces losses relative to capital account resulting from the increase of capital outflows. Therefore, the desegregation under the flexible exchange rate regime shows that the increase of capital outflows reduces consequently losses relative to real misalignment (because of real depreciation) and relatively losses relative to inflation deviation, and raises losses relative to capital account. The desegregation of monetary authorities’ objective function under the fixed exchange rate regime (Graphic 15) shows that increasing reduces consequently losses relative to real misalignment and relatively losses relative to inflation deviation. In contrary, increasing under the flexible exchange raises losses relatives to real misalignment and inflation deviation, and decreases losses relatives to capital account. 9 Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 205 Varying equilibrium real exchange rate growth Decreasing the equilibrium real exchange rate (real appreciation) reduces monetary authorities’ losses under both fixed and flexible exchange rate regimes (Table 14). The results show that the flexible exchange rate regime is compatible with the real appreciation case, which corresponds to the Moroccan case. When the economy is involved in a real depreciation case, the fixed exchange rate regime becomes the optimal choice. Varying money supply growth Increasing money supply growth mt wraises monetary authorities’ losses under both fixed and flexible exchange rate regimes (Table 15). When the money supply is growing by more than 9%, the fixed exchange rate regime becomes the optimal choice (high domestic money supply raises non-tradable prices and then the domestic inflation rate). The results indicate that the fixed exchange rate regime is compatible with an expansionary monetary policy and the flexible exchange rate is compatible with a contractionary monetary policy. Varying interest rates growth The flexible exchange rate is the optimal choice as long as the world interest rate is growing within the interval (Table 16) or as the domestic interest rate is growing within the interval (Table 17). Accordingly, once the gap between the current domestic interest rate growth and the world interest rate growth (evolution) exceeds the interval or once the gap between the domestic interest rate growth (evolution) and the current world interest rate growth exceeds the interval , the fixed exchange rate regime becomes the optimal choice (Graphics 16 and 17). The excess corresponds to capital flight situation when and to capital influx when . This relation between exchange rates and interest rates is of a particular interest for developing countries. Because it has an important role in determining of domestic inflation, real output, exports and imports, etc. (Krušković, 2017). Finally, increasing the inflation of tradable goods raises monetary authorities’ losses under both fixed and flexible exchange rate regime; however, the flexible exchange rate regime remains the optimal choice (Table 18). As a result, the flexible exchange rate regime allows the economy to adjust to any variation of tradable prices through the nominal exchange rate rather than the real exchange rate. Journal of Central Banking Theory and Practice 206 6. Concluding remarks In a context of financial liberalization and economic integration, developing countries adopt their specific liberalization policy approaches taking into account their economic circumstances. In this context, Morocco conducts a gradual liberalization of trade flows and capital flows to maximize its advantages from international capital markets. Moroccan monetary authorities initiated a total liberalization of capital inflows and a partial liberalization of capital outflows. This situation contributes to the real exchange rate appreciation and raises the question of risks under the fixed exchange rate regime. This paper examines the opportunity for the Moroccan monetary authorities to move toward the flexible exchange rate regime under capital account liberalization. Many factors plead for the exchange rate regime flexibilization such as the economic theory predictions (triangle of incompatibilities), recent developing countries experiences and crises (Latin American and East Asia) and institutional recommendations (International Monetary Fund consultations). Moreover, the Moroccan Central Bank has already announced its decision to reform the exchange rate regime. Based on the findings of Ezzahid and Maouhoub (2014), we developed a new theoretical game model adapted to the Moroccan economic circumstance. The model is represented as a game between four economic agents, namely the monetary authorities, the government, foreign firms, and domestic firms. To determine the optimal exchange rate regime, many economic facts are introduced into the model: the presence of the compensation fund effect, the government strategy to reduce progressively the price subsidies, the foreign firms, the international capital returns, the domestic firms and the presence of restrictions on capital outflows, etc. Starting with the first simulation based on current economic parameters, the results show that losses of the Moroccan monetary authorities under the flexible exchange rate regime are lower than losses under the fixed exchange rate regime. The desegregation of the objective function’s losses shows that the main source of risks is the real exchange rate misalignment and the capital account disequilibrium respectively. Consequently, the choice of the flexible exchange rate regime reduces significantly the monetary authorities’ losses. However, losses relative to capital account liberalization under the flexible exchange rate regime remain higher than losses under the fixed exchange rate regime. Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 207 To succeed with their strategy of exchange rate flexibilization, the Moroccan monetary authorities have to liberalize more capital outflows with respect to capital inflows. According to our results, decreasing the parameter n from 1.10 to 1.04 allows the monetary authorities to reduce more losses under the flexible exchange rate regime. Moreover, it is true that the compensation fund allows price stability under the fixed exchange rate; however, its repartition between nontradable prices and tradable prices and its extent is of the crucial importance. The optimal repartition according to the results is to allocate 80% of the compensation fund to non-tradable prices and 20% to tradable prices; because as BalassaSamuelson effect stipulates for developing countries, non-tradable prices grows more rapidly than tradable prices. As well, increasing b and c reduces the inflation with respect to the target level under the fixed exchange rate regime; but, it produces a counter effect under the flexible exchange rate regime. Consequently, reducing the compensation fund is recommended under the choice of a flexible exchange rate regime. Journal of Central Banking Theory and Practice 208 References 1. Agénor, P. (1991). “Credibility and exchange rate management in developing countries”, WP/91/87, IMF working paper. http://papers.ssrn.com/sol3/papers. cfm?abstract_id=885036 2. Agénor, P. 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(2011). “Does the Choice of Exchange Rate Regime Affect the Economic Growth of Developing Countries?” The Journal of Developing Areas, Tennessee State University College of Business, Volume 45, Single Issue, pp. 135-153. https://muse.jhu.edu/article/440739 11. Eduardo, L. and Federico, S. (2003). “To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth”, The American Economic Review, Vol. 93, No. 4 (Sep., 2003), pp. 1173-1193. https://www.aeaweb.org/art icles?id=10.1257/000282803769206250 Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 215 Table 3: Desegregation of monetary authorities’ losses under fixed and flexible regimes Choices objective function’s components Losses Percentage Total Fixed Exchange rate regime Real misalignment RM 0.004812 70.20% 0.006855Inflation targeting IT 0.000631 9.20% Capital account KA 0.001412 20.60% Flexible Exchange rate regime Real misalignment RM 0.003265 51.99% 0.006280Inflation targeting IT 0.000594 9.46% Capital account KA 0.002421 38.55% Table 4: Monetary authorities’ losses and capital account restrictions n0.80 0.85 0.90 0.95 1 Capital flows capital flight Fixed 0.007043 0.007011 0.006979 0.006948 0.006917 Flexible 0.015576 0.010262 0.007811 0.006700 0.006261 n1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40 1.45 Capital flows capital influx Fixed 0.006886 0.006855 0.006825 0.006796 0.006766 0.006737 0.006708 0.006680 0.006652 Flexible 0.006175 0.006280 0.006487 0.006747 0.007031 0.007323 0.007614 0.007897 0.008170 Table 5: Monetary authorities’ losses and preferences Order of importance α = 1/7 β = 2/7 ϑ = 4/7 α = 1/7 ϑ = 2/7 β = 4/7 β = 1/7 α = 2/7 ϑ = 4/7 ϑ = 1/7 α = 2/7 β = 4/7 ϑ = 1/7 β = 2/7 α = 4/7 β = 1/7 ϑ = 2/7 α = 4/7 Fixed 0.008368 0.005861 0.010615 0.006855 0.011350 0.012604 Flexible 0.010251 0.006648 0.012041 0.006280 0.009737 0.011520 Table 6: Monetary authorities’ losses and economic openness rate 1-s 0.50 0.55 0.60 0.65 0.70 0.75 0.80 Fixed 0.009102 0.008417 0.007817 0.007298 0.006855 0.006485 0.006181 Flexible 0.007569 0.007190 0.006849 0.006546 0.006280 0.006052 0.005860 Journal of Central Banking Theory and Practice 216 Table 7: Monetary authorities’ losses and compensation fund repartition a00.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1 Fixed 0.007090 0.007054 0.007014 0.006969 0.006916 0.006855 0.006784 0.006699 0.006596 0.006468 0.006306 Flexible 0.006844 0.006791 0.006699 0.006593 0.006456 0.006280 0.006059 0.005805 0.005635 0.006468 0.022710 Table 8: Monetary authorities’ losses and parameter b b01/3 2/3 1 4/3 5/3 27/3 8/3 3 Fixed 0.007367 0.006855 0.006439 0.006094 0.005805 0.005559 0.005348 0.005165 0.005006 0.004865 Flexible 0.006537 0.006280 0.006096 0.005960 0.005856 0.005777 0.005714 0.005663 0.005623 0.005589 Table 9: Monetary authorities’ losses and parameter c c01/4 1/3 2/3 1 4/3 5/3 27/3 8/3 3 Fixed 0.007079 0.006855 0.006795 0.006600 0.006459 0.006351 0.006267 0.006199 0.006143 0.006069 0.006056 Flexible 0.006822 0.006280 0.006205 0.006045 0.005973 0.005932 0.005906 0.005888 0.005874 0.005864 0.005863 Table 10: Monetary authorities’ losses and elasticity of non-tradable prices to real misalignment ρ0.25 0.30 0.35 0.4 0.45 0.50 0.55 Fixed 0.006858 0.006857 0.006856 0.0068559 0.0068553 0.0068547 0.0068541 Flexible 0.006236 0.006252 0.006267 0.006280 0.006292 0.006304 0.006314 Table 11: Monetary authorities’ losses and elasticity of non-tradable prices to money supply ν0.45 0.50 0.55 0.6 0.65 0.70 0.75 Fixed 0.006757 0.006789 0.006821 0.006855 0.006891 0.006927 0.006964 Flexible 0.006148 0.006181 0.006225 0.006280 0.006347 0.006426 0.006516 Capital Account Liberalization in Morocco: Is it Compatible with Fixed or Flexible Exchange Rate Regime? 217 Table 12: Monetary authorities’ losses and elasticity of capital outflows to real return ϕ1.63 1.68 1.73 1.78 1.83 1.88 1.93 1.98 Fixed 0.007526 0.007307 0.007129 0.006980 0.006855 0.006749 0.006658 0.006579 Flexible 0.007916 0.007454 0.007026 0.006635 0.006280 0.005964 0.005689 0.005455 Table 13: Monetary authorities’ losses and elasticity of capital inflows to real return φ1.30 1.35 1.40 1.45 1.50 1.55 1.60 Fixed 0.012200 0.009687 0.008022 0.006855 0.006004 0.005362 0.004863 Flexible 0.008455 0.007526 0.006814 0.006280 0.005895 0.005633 0.005475 Table 14: Monetary authorities’ losses and Equilibrium real exchange rate growth ert °- 0.03417 -0.02917 -0.02417 - 0.01917 -0.01417 -0.00917 -0.00417 0.0000 +0.00417 +0.00917 +0.01417 Fixed 0.006172 0.006395 0.006623 0.006855 0.007093 0.007315 0.007583 0.007793 0.008006 0.008266 0.008532 Flexible 0.005600 0.005731 0.005958 0.006280 0.006698 0.007212 0.007822 0.008404 0.009052 0.009917 0.010878 Table 15: Monetary authorities’ losses and domestic money supply growth mt0.0109 0.0209 0.0309 0.0409 0.0509 0.0609 0.0709 0.0809 0.0909 0.1009 Fixed 0.006578 0.006638 0.006777 0.006777 0.006855 0.006940 0.007030 0.007127 0.007229 0.007338 Flexible 0.006218 0.006136 0.006120 0.006168 0.006280 0.006457 0.006698 0.007004 0.007374 0.007809 Table 16: Monetary authorities’ losses and world interest rate it *-0.0888 -0.0738 -0.0688 -0.0588 -0.0488 -0.0388 -0.0288 -0.0188 -0.0088 0.0000 +0.0088 +0.0188 +0.0288 Fixed 0.007880 0.007333 0.006855 0.006447 0.006109 0.005840 0.005640 0.0055101 0.005449 0.005453 0.0055109 0.005641 0.005842 Flexible 0.009298 0.007570 0.006280 0.005428 0.005014 0.005037 0.005498 0.006397 0.007734 0.009272 0.011150 0.013695 0.016678 Journal of Central Banking Theory and Practice 218 Table 17: Monetary authorities’ losses and domestic interest rate it-0.1637 -0.1537 -0.1437 -0.1337 -0.1237 - 0.1137 -0.1037 Fixed 0.049478 0.043853 0.038578 0.033653 0.029079 0.024854 0.020979 Flexible 0.050737 0.043922 0.037662 0.031957 0.026806 0.02221 0.018169 it-0.0937 -0.0837 -0.0737 -0.0637 -0.0537 -0.0437 -0.0337 Fixed 0.017545 0.014279 0.011455 0.00898 0.006855 0.005081 0.003656 Flexible 0.014682 0.011749 0.009372 0.007549 0.006280 0.005566 0.0054 it-0.0237 -0.0137 -0.0037 00.0037 0.0137 Fixed 0.002582 0.001858 0.001483 0.001433 0.001432 0.001666 Flexible 0.005407 0.005802 0.006752 0.008257 0.008954 0.009728 Table 18: Monetary authorities’ losses and the inflation of tradable prices πTt 0.005 0.010 0.015 0.020 0.025 0.030 Fixed 0.006264 0.006855 0.007486 0.008154 0.008862 0.009609 Flexible 0.005781 0.006280 0.006855 0.007507 0.008234 0.009038