WHY HAS THE CENTRAL BANK OF EGYPT BEEN UNABLE TO ACHIEVE THE GOAL OF PRICE STABILITY UNDER THE ECONOMIC REFORM PROGRAM?

This paper assesses the performance of the monetary policy in Egypt during the periods following the introduction of the economic reform and structural adjustment program (ERSAP). It sets out to answer the question why the Central Bank of Egypt (CBE) has not been able to achieve the goal of price stability under the ERSAP? The study compares the economic performance from the 1990s with both its counterpart in Germany, during the same periods, and with the economic performance of the Egyptian economy during the periods before the 1990s, i.e., 1975-1990. The study concludes that the CBE could have brought the rate of infl ation down; nevertheless, the unemployment and real GDP growth rates have worsened and a price stability is still far away. The failure to achieve price stability is explained by two reasons, namely, a confl ict between monetary policy objectives and a chronic budget defi cit fi nanced by issuing new money.


Introduction
The most radical changes in macroeconomic policy in Egypt since the 1950s occurred in the early 1990s when the Egyptian government endorsed an agreement with the IMF and the WB, known as the economic reform and structural adjustment program (ERSAP). 1 This agreement came into being in the aftermath of a critical economic performance of the Egyptian economy in the late 1980s, where the ratio of external debt (% of nominal GDP) reached 131.7% and 115.23% in the years 1988 and 1989 respectively. 2 The ERSAP incorporated two broad objectives, namely (i) switching the economy to a market-based economy via price liberalization, FX rate, interest rate and trade; and (ii) stabilizing the economy and rectifying macroeconomic policies.
Because the ERSAP represents a watershed between two identifi able phases of macroeconomic policy in Egypt, this paper assesses the performance of the monetary policy during the periods following the introduction of the ERSAP.It sets out to answer the question why the central bank of Egypt (CBE) has not been able to achieve the goal of price stability under the ERSAP. 3I organized this paper as follows: Section 2 highlights the monetary policy objectives and tools under the ERSAP.Section 3 assesses the performance of the monetary policy under the ERSAP.Section 4 concludes.
1 Before the ERSAP, Egypt signed three stand-by agreements with the IMF, in 1976IMF, in , 1978IMF, in and 1987.These agreements were very similar to the ERSAP.For social, political and economic reasons these agreements were discontinued.For more details about the ERSAP, see Awad (2002), Richards (2001), andKorayem (1997). 2 Calculated from WDI, CD-R 2008 where the total debt (USD billions) was 46.147 and 45.684 for the years 1988 and 1989 respectively, whereas the corresponding nominal GDP (USD billions) was 35.045 and 39.648 respectively.3 An operational defi nition of price stability that is now broadly accepted among economists is the one presented by Alan Greenspan: price stability is obtained when economic agents no longer take account of the prospective change in the general price level in their economic decision-making (Batini et al., 2005, p. 161).

Monetary policy objectives and tools under the ERSAP
Before the 1990s, the Egyptian economy was described as a centralized economy.
Central planning and the public sector were dominating the whole economy; thus, economic policy was implemented by direct means, i.e., orders or instructions.As the government was controlling and managing the vast majority of prices, the function of prices as guidance for economic activities was disrupted in the whole economy.The private sector was not completely absent; however, its role was very limited (Awad, 2002).
Abu-Elayoun (2003) indicated that monetary authorities applied a monetary targeting regime during the periods before the ERSAP to achieve the goal of price stability but the association between the intermediate target, i.e.M2, and the ultimate goal of monetary policy, i.e. price stability, was not strong enough.Indeed, during these periods the CBE did not announce any targets for the monetary growth.In addition, the foreign exchange (FX) rate was pegged vis-à-vis the US dollar both during these periods and even after the introduction of the ERSAP until the start of 2003.Furthermore, the government was controlling an infl uential part of prices of goods and services in the economy and both fi scal dominance and fi nancial repression were practised during all these periods.

Monetary policy objectives under the ERSAP
One of the most diffi cult challenges for a researcher is to determine exactly the objectives of the monetary policy that the CBE was actually intending to achieve, especially during the period following the introduction of the ERSAP in 1990, until the decision of fl oating the FX rate in January 2003.One reason for this is that the CBE adopted inconsistent objectives for its monetary policy during this period (Moursi, et  al., 2007; Kamar and Bakardzhieva, 2003; and Panizza, 2001). 4  After the introduction of the ERSAP, the ultimate objective of the monetary policy was determined to achieve both internal and external stability of the domestic currency in line with the national objectives of spurring economic growth and creating more job opportunities.During this period, the intermediate target of the monetary policy was determined to be the net of domestic credit and, later, the rate of growth in money supply (M2).The daily operational target of the monetary policy was determined to be banks' excess reserves (Abu-Elayoun, 2003). 5  4 One example of such inconsistent objectives as Moursi, et al. (2007, p. 4) mentioned is that the CBE adopted confl icting objectives especially during the period 1992/1993-1996/1997. In 1992/1993, while the CBE aimed at controlling the monetary expansion, it also called for a reduction in the interest rate on the Egyptian pound to encourage investment and promote economic activity.During the period 1993/1994-1995/1996, monetary policy objectives were swaying between the two objectives of both economic growth and price stability.In 1996/1997, the CBE reverted to the objective of economic growth via monetary stabilization.5 During the fi scal year 2002-2003, the monetary policy targeted the rate of growth of domestic liquidity at a rate of 10%, irrespective of the changes in the exchange rate.The actual rate of liquidity growth reached 9.4% (CBE, 2002(CBE, -2003, p. 30), p. 30).
During the aforementioned period, from 1990 to the start of 2003, and for long periods the CBE was targeting the FX rate, as can be inferred from Figure 1. 6 Taking into account that the CBE liberalized domestic interest rates on loans and deposits in 1991, 7 one may ask how the CBE can maintain the FX rate target and, at the same time, achieve the goal of price stability through maintaining an implicit target for the money supply (M2). 8Because of this dilemma, the CBE was unable to effi ciently use either a short-term nominal interest rate or banks' excess reserves to manage the monetary policy during this period, especially when the economy incurred external and domestic shocks in the latter half of the 1990s, as we will see later.
After liberalizing the FX rate and issuing new legislation in 2003, governing the CBE, the banking sector and the money, the ultimate objective of the monetary policy has changed to focus primarily on the goal of price stability.Galal (2003) assesses the decision of fl oating the FX rate as an attempt to resolve policy inconsistency originating from the combination of FX rate rigidity, reluctance to use international 6 During the period 1960-2003, different varieties of exchange rate regimes had been experimented with in the Egyptian economy, i.e., conventional peg in the 1960s, crawling peg in the 70s and 80s, crawling bands in the 90s, and managed fl oating as of 2003.Beside the offi cial price, the FX market witnessed multiple prices including prices of both a parallel market and a black market.In 2004, Egypt successfully unifi ed its FX markets (Kamar and Bakardzhieva, 2003).7 By January 1991, the CBE had liberalized interest rates on loans and deposits.Accordingly, banks were given the freedom to set their loan and deposit interest rates subject to the restriction that the 3-month interest rate on deposits should not fall below 12 percent per annum.This restriction was cancelled in 1993/1994 (Moursi, et al., 2007, pp. 6-7).8 The sterilized intervention policy may give an answer to this question.Nevertheless, a sterilized intervention policy itself is fragile and can lead to dramatic consequences, as we will see in the next section.reserves to support the peg to the dollar, and the attempt to reduce the interest rate to activate the economy.9 As of June 5, 2005, the CBE developed a new framework for monetary policy implementation.This framework relies on the use of the overnight interest rate on the inter-bank transactions as an operational target for the monetary policy, instead of banks' excess reserves.The new framework represented the central bank's main policy instrument, providing the outer bounds of a corridor within which the ceiling is the overnight interest rate on lending from the CBE, and the fl oor is the overnight deposit interest rate at the CBE (CBE, 2005(CBE, -2006, p. 1), p. 1).

Monetary policy tools under the ERSAP
Under the assumption that the infl uential part of infl ation in the Egyptian economy refers to the demand side, the ERSAP was designed to fi ght the accelerating infl ation which occurred in the late 1980s via controlling aggregate demand.That is why the CBE applied a contractionary monetary policy especially during the fi rst stages of the ERSAP.By liberalizing the interest rate in 1991, the direct means to conduct monetary policy that were used in the previous periods (e.g., credit ceilings, interest rate ceilings, and discriminatory interest rates) were abolished.Since then, the CBE no longer determines the interest rate administratively but rather it affects market conditions using monetary policy tools to conduct nominal rates towards the desired path.
Liberalizing the interest rate coexisted with developing a new tool to fi nance budget defi cit using real resources, especially in the fi rst half of the 1990s.Treasury bills (TBs) were used intensively to play a central role and interest rates on TBs served as an indicator for the directions of both the short-term interest rate within the market and the discount rate determined by the CBE.By activating the TB mechanism, the nominal interest rate began to rise.As a result, the real interest rate registered positive values, especially when the rate of infl ation began to recede during the fi rst half of the 1990s.
Monetary policy tools used under the ERSAP are: (i) Open market operation (OMO); as the goal of price stability represents a cornerstone among the other objectives of the ERSAP, the CBE intended to restrict aggregate demand via absorbing excess liquidity in the economy.The preliminary step in this direction was the use of real resources to fi nance budget defi cit rather than the monetary means that were used extensively before the ERSAP.The TB mechanism, as a new tool, was developed to play that role.During the fi rst half of the 1990s, the main focus was basically on the primary TB market.The role of CBE was just to organize the process of selling TBs to commercial banks and individuals on behalf of the government. 10During the latter half of the 1990s, the CBE aimed at maintaining price stability via stabilizing banks' reserves and hence stabilizing domestic credit and domestic liquidity.To achieve this objective, the CBE focused on the secondary TB market.Thus, repos and reverse repos were used extensively.In 2001, the CBE permitted repos for one night at the prevailing discount rate.In September 2002, the CBE shifted from accepting deposits in the local currency, in virtue of mutual agreements between the CBE and some other banks, to a new market-based system.According to the new system, the CBE specifi es the quantity of deposits required to be deposited and the date and maturity of the transaction.On their part, banks are to submit their bids specifying the required quantity and interest rate (CBE, 2002(CBE, -2003)). 11As of August 2005, a new instrument dubbed "the central bank notes" was developed.These notes are issued with a maturity spanning up to two years and are used to absorb banks' excess liquidity, instead of the reverse repos of the TBs (CBE, 2005(CBE, -2006, p. 6, p. 6).

Assessing the monetary policy performance under the ERSAP
To gauge the performance of the monetary policy under the ERSAP, the study compares the economic performance during the period beginning in 1991 with both its counterpart in an advanced economy, e.g.Germany, during the same period, and with the economic performance of the Egyptian economy during the period before the introduction of the ERSAP, i.e., 1975ERSAP, i.e., -1990.Although infl ation, unemployment, and real GDP growth are used to gauge the performance of the monetary policy, the behavior of the infl ation rate is given priority as it represents the main objective of the monetary policy.To explain changes in these variables, particularly the change in the infl ation rate, the study focuses on another group of variables related to fi scal policy, trade policy and monetary policy.
In what follows, the study sheds light on the economic performance of the Egyptian economy during the period 1975-1990, which represents a base period in our assessment of the performance of the monetary policy under the ERSAP.

The period 1974-1981
Beginning in this period, the Egyptian government adopted an "export leading growth strategy".The government began to introduce more facilities to foreign and Arab investments by issuing Act no.43/1974.The Egyptian economy became more oriented towards Western Europe and the USA compared with the previous periods.A large number of taxes that had been imposed on imports during the previous periods were cut.The role of the private sector in the economy began to revive once again.During this period, The Egyptian government applied an "open-door policy".One of the consequences of this policy is a deterioration in the trade balance because of the high scale of consuming imports (see Figure 3).
The rise in the price level was induced by both external and domestic factors.Because the FX rate was pegged to the US dollar and, at the same time, the infl ation rates in the worldwide economy surged during this period, the domestic prices were affected negatively because of imported infl ation.The prices of tradable and intermediate goods moved up as most of those imports were coming from Western Europe and USA, which witnessed the highest levels of infl ation during this period. 12Domestic factors also played a central role in the domestic infl ation.During this period, a notable improvement in the sources of foreign currencies occurred.Some of these sources refer to external factors, i.e., FDI, loans and grants, and others refer to internal factors, i.e., oil exports, tourism, the Suez Canal and remittances of Egyptian laborers abroad, especially in the Arabian oil countries.The improvement in foreign sources affected the aggregate demand and led to a demand-pull infl ation.In addition, the structure of the aggregate demand might have changed because of a change in the consumers' preferences and the problems of urbanization.
12 During the period 1974-1978, the exchange rate was pegged and imported infl ation was positive as reported by Awad (2002); thus, the domestic price level deteriorated during that time because of unfavorable shifts n terms of trade.Another channel that may explain the high infl ation rates during this period is the defi cit in the general budget supported by bank fi nancing.During this period, the government was still supporting food subsidies and controlling prices of basic goods.When the infl ation rate increased on the world market, the government did not cut the food subsidies and continued controlling prices of public sector products, which were lower than market prices.Since most intermediate goods prices increased on the world market during this period, the public sector losses increased accordingly and hence budget defi cit was exacerbated.The government was unwilling to impose additional burdens on people through higher taxes after the war of 1973.Thus, both external debt and bank fi nancing of budget defi cit rose dramatically during this period (see Figure 3).

The period 1982-1990
During this period, the government stepped more towards encouraging the private sector.Act no.43/1974 was superseded by Act no.159/1981, which permitted foreigners a stake of 51% in business capital.The central planning, which had ended in the aftermath of the 1967 events, was resumed through articulating the second quinquennial plan over the period 1982-1986.
The most distinguishing features of the 1980s was the eruption of the unemployment problem.Nassar (1989) concluded that the investment policies during this period were anti-employment.Beginning in the latter half of the 1980s, the government moved gradually to relinquishing the adherence of appointing graduates because of successive public sector losses.During that time, the demand on Egyptian labor in the Gulf countries and Iraq was relaxed because of receding oil prices and higher competition from Asian and Indian laborers.As a result, the formal unemployment rate began to rise from 6.75% in 1986 to 9.6% in 1989.The budget defi cit (% of GDP) registered the highest level during this period, e.g., 27% in 1981 and 26% in 1985.Banking fi nance represented the main tool to fi nance the budget defi cit, e.g., 30.6% in 1980 and 51.5% in 1990.As a result, both the rate of growth of M2 and the formal infl ation rate stood at high levels during this period (Figure 4).In the late 1980s, the economic performance of the Egyptian economy was critical.A chronic defi cit in the general budget supported by banking fi nance created a demand-pull infl ation.The unemployment rate increased continuously and registered high levels at the end of this period.The rate of growth of the GDP was diminishing and approached zero at the end of this period (Figure 5).The failure to achieve the goal of price stability under the ERSAP can be explained by two reasons, namely, a confl ict between monetary policy objectives, i.e., pegging the FX rate and the attempt to use an independent monetary policy to achieve some other goals (e.g., price stability and economic growth), and a chronic defi cit in the general budget fi nanced by issuing new money.I will discuss these two reasons in detail.

Conflict between monetary policy objectives
As mentioned above, after the introduction of the ERSAP in 1990 and liberalizing the interest rate in 1991, the CBE adopted a dual target policy, i.e., targeting the M2 growth rate and pegging the FX rate vis-à-vis the US dollar.The evolution of both CPI infl ation and FX rate under the ERSAP Source: prepared using data from IFS, CD-R 2010.
- As Figure 6 indicates, the CBE could have brought the infl ation rate down during the 1990s while pegging the FX rate.Nevertheless, the infl ation rate was revived once more when the CBE was forced to devaluate the domestic currency as of 2001 in the aftermath of the economic shocks that occurred during the latter half of the 1990s.
Literally, such a policy is both inconsistent and fragile.It is inconsistent because monetary policy cannot simultaneously follow an internal and external policy target under free capital mobility (Flemming, 1962;Mundell, 1963). 14Alternatively, a country willing to secure an independent monetary policy along with a fi xed exchange rate has two options: to impose control on the international mobility of capital, or to satisfy the net demand for foreign exchange at the fi xed FX rate with sterilized foreign exchange intervention.Both the policies are fragile (Goodfriend, 2008).
Under fi nancial liberalization, it becomes very diffi cult, if not impossible, to impose control on speculative capital fl ows especially when interest rate differentials are high.Figure 7 and Tables 2 and 3 indicate the following fi ndings: (i) during the period 1995-2003, the CBE intended to maintain the deposit rate, DEPR, higher than the federal fund rate, FFR, as can be inferred from the mean value of the two variables; (ii) according to the standard deviation value , the CBE during this period did not use the deposit rate to support the domestic currency after the economic shocks during the latter half of the 1990s; (iii) according to the correlation coeffi cient and Granger causality test, the CBE did not follow an independent monetary policy during the above period, where the correlation coeffi cient between both DEPR and FFR was high, 66%, and FFR Granger causes DEPR; and (iv) after fl oating the FX rate in 2003, deposit rates moved gradually to approach FFR as shown in Figure 7. 14 This idea is known in literature as the 'impossible trinity hypothesis', i.e., a country can only pick two out of the following three objectives: (i) fi xed exchange rate, (ii) free capital mobility, and (iii) monetary policy independence.
-5.00 10.00 15.00 20.00 25.00 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6   The remaining option to secure interest rate policy independence with a fi xed FX rate is to satisfy the net demand for foreign exchange at the fi xed FX rate with sterilized foreign exchange intervention.Sterilized intervention means that the CB will accommodate capital fl ows by sterilizing their effect on the money supply.For instance, if the CB were faced by capital outfl ows that had a negative effect on the money supply, the CB could maintain its target of money supply through purchasing securities (repo) with the same amount of capital outfl ows.The important issue in such a case, i.e., the case of capital outfl ows, is the extent to which the CB is ready to defend the pegged rate.When the CB does not have either enough foreign reserves or the desire to sacrifi ce a high amount of its foreign reserves, this policy ends with devaluating the domestic currency.The picture becomes darkened when the passthrough effect, which fuels domestic infl ation, is high.
The above scenario describes, partly, the monetary policy followed by the CBE from the 1990s until the decision to fl oat the FX rate at the beginning of 2003.It also answers the question why the CBE could not maintain price stability for a long time, especially with successive devaluations of the domestic currency from 2001.Abu-Elayoun (2003) and Kamar and Bakardzhieva (2003) mentioned a number of external and domestic economic shocks that negatively affected the performance of the external sector especially in the latter half of the 1990s.These economic shocks included: (i) the East Asian crisis in June 1997, which, fi rstly, provoked capital outfl ows and negatively affected the performance of capital market investment and, secondly, deteriorated the performance of the trade balance because of devaluation of Asian currencies, which made their exports more competitive than Egyptian goods; (ii) the terrorist attack in Luxor in November 1997, which negatively affected the revenues from tourism; (iii) the fall of oil prices in 1998, which exacerbated the negative infl uence on the current account.3.
Because of these shocks, the external sector performance and hence the economic performance were negatively affected during the latter half of the 1990s.As shown in Figure 8, the exports (% of GDP) stepped down (from 22.6% in 1995 to 16.2% in 2000), the trade balance defi cit went up (from 5.2% to 6.6% during the same period), and the current account hit negative values only during this period.However, foreign direct investment (FDI) was nearly at the same level during this period.
Despite the negative consequences of these shocks on the economic performance, the CBE did not respond, i.e., the CBE did not devaluate the domestic currency to support the competitiveness of the export sector by cutting deposit rates.As mentioned above, during this period the CBE was anchoring the domestic currency vis-à-vis the US dollar as a policy target.Another reason that might explain the behavior of the CBE is the concerns of the pass-through effect.Panizza (2001) mentioned that beside 35.00 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 External balance of goods and services (% of GDP) Exports of goods and services (% of GDP) Current account balance (% of GDP) FDI net infl ows (% of GDP) External balance of goods and services (% of GDP) Exports of goods and services (% of GDP) Current account balance (% of GDP) the economic shocks that negatively affected the current account in the late 1990s, the appreciation of the real exchange rate by itself darkened the picture of the economic performance.
However, as the CBE insisted on defending an unrealistic value of the Egyptian pound during this period, the problems of dollar shortages exacerbated in the economy,15 the CBE lost an infl uential part of its international reserves (during 1998-2000, international reserves decreased from 18 to 14 billion dollars) and the black market FX rate revived in the economy.To stop losses in foreign reserves, the CBE conducted successive devaluations on domestic currency as of 2001 and fl oated the domestic currency in early 2003.Price levels have gone up since then.
Table 4 sheds light on the variability of the FX rate during the period 1991 Q1 -2008 Q1 .The low variability of the FX rate during 1991-1999 (0.04) refers to the fi xed peg pursued by the CBE during that time.During the period 1999 Q1 -2008 Q1 , the FX rate variability fell to 0.24.However, the FX rate variability is still high when compared to the Euro during the same periods.To summarize, a confl ict between monetary policy objectives renders the CBE unable to maintain the goal of price stability.Such a confl ict is mainly because a monetary policy that includes both internal and external policy targets is fragile by itself.Although the fear of a high pass-through effect represented a justifi cation of pegging the FX rate during the 1990s, the CBE was forced to conduct successive devaluations on the local currency as of 2001 and to fl oat the FX rate in early 2003.After devaluations, domestic prices went up.

Deficit in the general budget financed by issuing new money
Although the above conclusion may explain the failure of the CBE to maintain price stability during the periods before fl oating the FX rate in 2003, it does not completely explain the persistence of high infl ation even after the fl oating of the FX rate.Literally, the fl oating of the FX rate should have ended a confl iction between monetary policy objectives and enable the CBE to pursue the goal of price stability.Floating the foreign exchange rate, fi rstly, clears the foreign exchange market and, secondly, enables the interest rate policy to target domestic infl ation freely.Nevertheless, the magnitude of the defi cit in the general budget and the use of monetary means to fi nance it can preclude monetary policy from pursuing the goal of price stability.
Table 5 compares budget defi cit and CPI infl ation (and its variability) in Egypt and Germany.It compares the period 2003-2007, the period after the fl oating, with the previous periods, 1996-2003, where data for Germany is not available for periods before 1995.
The increase in the budget defi cit during the period 2003-2007 by nearly 73% compared to previous periods was in conjunction with an increase in the infl ation rate by nearly 83% during the same periods.In addition, the infl ation variability worsened during the periods 2003-2007 compared to the previous periods.In general, while low and stable infl ation rates were coexisting with a low budget defi cit in Germany, high and variable infl ation rates were coexisting with a soaring budget defi cit in Egypt during the last periods.Literally, fi scal expansion fi nanced by issuing new money can lead to a demand-pull infl ation.Figure 9 depicts the behavior of the demand-pull infl ation (DPI), the GDP defl ator-infl ation (GDPD), and the budget defi cit (BD).The DPI was calculated using the following formula: DPI = [(1+ M2 growth rate) / (1+ GDP growth rate)] -1. 16 (1) 16 This formula is derived from the quantity equation: M x v = p x q (1).At the end of the year, Equation (1) can be written as follow: M (1+Rm) x v (1+Rv) = p (1+Rp) x q (1+Rq) (2), where Rm, Rv, Rp and Rq are the M2 growth rate, v, p and q.Let Rv = 0, under the assumption that (v) is constant, and divide (2) by (1); this yields the formula used in the text; Rp = (1+Rm) / (1+Rq) -1 (3).It is important to notice that even if we dropped the above assumption, the value of the demand-pull infl ation would not change so much or it not on average.

Figure 9
Demand-pull infl ation, formal infl ation and budget defi cit  Source: prepared using data from Awad (2002) and WDI, CD-R 2009.
The difference between DPI and open infl ation (measured by annual change in GDPD) represents the suppressed infl ation, that is, Suppressed Infl ation = Demand-pull infl ation -Open Infl ation. (2) As mentioned, before the 1990s, the suppressed infl ation was high because the government was controlling price levels.After the introduction of the ERSAP, the suppressed infl ation receded as the government privatized the economy and liberalized most prices. 17This point is obvious if we compare the correlation coeffi cients between GDPD and DPI for the periods 1991-2007 (Table 8), being 51%, with the correlation coeffi cients for the periods 1974-2007 (Table 6), being 44.6%.However, the important issue here is that a high correlation is found between DPI and BD, 58.5%, as shown in Table 6.Moreover, according to the Granger causality test for the period 1974-2007 (Table 7) BD Granger causes DPI.During the period 1991-2007, the correlation between GDPD and DPI was high, as mentioned, and BD (Granger) causes DPI at a 10% level (Table 9).17 The contribution of the private sector to the real GDP has increased after the introduction of the ERSAP to more than 67% on average compared to 25% in the past (calculated from the data available on the CBE website: http://www.cbe.org.eg/timeSeries.htm).
(  Figure 10 sheds light on the contribution of the banking system (including the CBE) to fi nancing the budget defi cit (cash) during the period 1975-2005.During the fi rst half of the 1990s, the government used treasury bills to fi nance the budget defi cit.Therefore, banking fi nance to the budget defi cit was negative during this period (1990/1991-1994/1995) at 31.2%.In the latter half of the 1990s (1995/1996-1999/2000), banking fi nance to the budget defi cit was nearly 96.75%.Thus, for the whole period (1990/1991-1999/2000), it reached 33% on average.

Figure 10
Budget defi cit and banking fi nance to budget defi cit  Source: Prepared using data from Appendix 1, Table 1.In addition, the CBE is regularly fi nancing the budget defi cit via issuing new money ('seigniorage').18 Table 10 shows budget defi cits and domestic sources of 18 The role of the CBE in fi nancing the budget defi cit was not interrupted during the periods before the introduction of the ERSAP and even after the ERSAP.The new legislation on the CBE, the banking sector, and the money issued in 2003 obliged the CBE to fi nance the budget defi cit.
-2 48 98 148 1 9 7 5 1 9 7 8 1 9 8 1 1 9 8 4 1 9 8 7 1 9 9 0 1 9 9 3 1 9 9 6 1 9 9 9 2 0 0 2 2 0 0 5 Budget deficit (% of GDP) Banking finance (% of budget deficit) fi nancing during the period 2001/02-2006/07.The high numbers of both cash defi cit and overall defi cit are supported by high contributions of the CBE to fi nancing the budget defi cit.The contribution of the CBE to fi nancing the budget defi cit will cause an increase in the money supply; thereby, the price level will soar.That explains the causality between the budget defi cit and the demand-pull infl ation in Egypt as shown in Table 9.In other words, the causality between the budget defi cit and the demand-pull infl ation in Egypt is because the CBE is obliged to fi nance the budget defi cit.
To summarize, the failure of the CBE to maintain price stability even after fl oating the FX rate in 2003 is explained by the high budget fi nanced by means of issuing new money.The increase in the budget defi cit especially after 2003 and the use of monetary means to fi nance it have created a demand-pull infl ation.Since the majority of prices became free after the introduction of the ERSAP, the demand-pull infl ation expressed itself through a growing formal price level measured by the GDP defl ator.

Conclusions
This paper assesses the performance of the monetary policy in Egypt during the periods following the introduction of the ERSAP in the early 1990s.The paper intends to answer the question why the CBE has not been able not achieve the goal of price stability under the ERSAP.The study compares economic performance since the 1990s with both its counterpart in Germany, during the same periods, and with the economic performance of the Egyptian economy during the periods before the 1990s, i.e., 1975-1990.The main conclusion of the study is that although Egypt could have brought the infl ation rate down after the introduction of the ERSAP, the unemployment and real GDP growth rates have worsened, and price stability was not attained.The failure to achieve the goal of price stability is explained by two reasons: (i) a confl ict between monetary policy objectives which renders the CBE unable to effi ciently use monetary policy tools to maintain the goal of price stability; (ii) a high budget defi cit fi nanced by the issuing of new money, which fuels a demand-pull infl ation.
In the light of this, to improve the performance of the monetary policy in Egypt in the future, the CBE should be factually independent.In addition, the CBE should not maintain an implicit target for other variables, e.g., the FX rate.As indicated by Awad (2008), the CBE is not factually independent.A CB is factually independent if it satisfi es three conditions (Awad, 2009): (i) legal instrument independence; (ii) nonexistence of government representatives in the Monetary Policy Committee as voting members; and (iii) no obligation for the CB to fi nance budget defi cit.

Figure 8
Figure 8Performance of the external sector under the ERSAP Table1depicts the behavior of the rate of growth of the real GDP, the unemployment rate (% of the total labor force), and the CPI infl ation.Comparing the rate of infl ation under theERSAP, 1991ERSAP,  -2008ERSAP,  , with the previous period, 1975ERSAP,  -1990, Egypt could have brought the rate of infl ation down by nearly 50%.Nevertheless, the unemployment rate increased by 66.67% and the rate of growth of the real GDP slumped by 35.4%.However, the ERSAP did not yet stabilize the economy.The rate of infl ation under the ERSAP, nearly 8% on average, is very high compared to Germany, 2%, during the same periods.1313Onecandescribe the case depicted in Table1as 'stagfl ation', where higher rates of both infl ation and unemployment occur.

Table 5
Budget defi cit and infl ation in Egypt and Germany