Monetary Policy in Developing Countries

Sheila Page

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136139246
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Business allgemein

Developing countries now use monetary policy as part of their adjustment programmes but its targets, the tools, and the theory were developed for advanced countries. Low income countries do not have the sophisticated financial sectors that rich ones can assume, and the shocks and size of adjustment which they face may be much greater. Using six country studies, with special analysis of the roles of the external sector and the informal financial sector, this book analyses the interaction among monetary policy, the financial sector, and development.

Part I
The Nature of Monetary Policy and the Financial Sector

1
The New Demand for Monetary Development

Sheila Page

Practical need, new empirical evidence, and intellectual fashion have all contributed to a new interest in the role of the formal monetary sector and of monetary policy in developing countries. This poses particular problems for those which are least developed. Their interests and their problems were furthest removed from traditional analysis, so that both the problem (short-term stabilisation) and the recommended monetary instruments (broadly based and market-oriented banking systems and bond markets) are remote from their experience and remain under-researched in the context of their economies.

After the initial attempts to use monetary approaches, a widespread failure of governments to adhere to monetary ceilings or other policies was observed. This led to a variety of questions and possible explanations. Clearly these failures in part reflected the difficult political choices any policy of restraint entails. In this, they are similar to failures in developed countries. There are familiar disputes over the relationship between monetary instruments and policy targets such as the inflation rate and the balance of payments, and whether these targets can be met without imposing large costs on the 'real' economy. But there are major technical problems involved in monetary control and some of these can be more serious in developing countries. Other problems arise from the process of development. Financial systems are changing and becoming more sophisticated at the same time as they are being used to implement monetary policy.

The focus of this set of studies of monetary policy and of the financial sector is on how they affect development. It is necessary to say this because the assumptions, methods, and even the terminology of the study of developing country monetary policy are in some ways very different from those found in other development studies. Although the empirical evidence of what governments have done and of how the economies have changed is not sensitive to the intentions of those who examine them, the criteria for success or failure and the choice of significant results are. This is true in any social science study, but it has been particularly important in the field of monetary economics in developing countries. Much recent work on money in developed and developing countries has been directed specifically at how to implement monetary policy, rather than treating policy in the context of a study of the economic relationships within the financial sector and between that sector and other aspects of an economy, as is done in other branches of economics.

In developing countries, one of the major actors, the International Monetary Fund, has had a particular point of view, namely that macroeconomic intervention is good, even necessary, with sectoral intervention regarded, at least implicitly, as undesirable. Another major set of actors, the most vocal developing country governments themselves, appear to have held the view (for example in international negotiations like the GATT) that the development of their own financial institutions is so important in itself that it cannot be restricted by international agreements, although, as will be seen in the country studies presented here, others individually, in their own countries, have shown less commitment to this. Even those which do not accept the development of the sector as an end in itself may nevertheless take a direct interest in how it behaves towards other sectors, for example in sectoral lending which can have an impact on development. The criteria for a study of the financial sector are therefore particularly sensitive to the student's point of view.

Much previous work has started from the assumption that countries (or their advisers) have decided that they want to be abie to implement monetary policies, and that they know what these are, and the purpose of a study is to identify the means and then to remove the obstacles. Even within this limited context there are different, not necessarily consistent, objectives. The inconsistencies and potential conflicts (and even the distinction among instruments, intermediate targets, and policies) have not always been recognised because a variety of immediate needs have led governments to seize on monetary instruments and policy as solutions, and in many cases these have been adopted because of external pressure, not from countries' own choice. The terminology used may be confusing, with liberalisation often being used to mean imposing an overall ceiling on credit rather than a set of disaggregated ones, or using indirect controls rather than direct ones.

It is necessary to go beyond this limited view of the study of monetary policy, and to ask additional questions. What do countries and analysts expect from monetary policy, and is it the same as in more developed countries? Are there additional benefits from strengthening the formal financial structure in a developing country? A variety of developmental arguments are now advanced for giving more attention to the financial sector. Although these may be well-founded, they are not newly relevant. It seems probable, therefore, that it is the changes stemming from monetary policy that explain the increase in interest. Taking both types of benefit into account, is developing the financial sector to permit monetary intervention an appropriate use of scarce resources? Under what circumstances, or how early in the growth process? All these uncertainties make it essential to be cautious in analysing the present and potential ability of governments to achieve the targets of their monetary policy.

This book, and in particular the country studies which form the central part of it, therefore starts by asking when countries have followed monetary policies, and for what purposes. It then attempts to assess how effective these have been. This provides the background to examine the first questions identified above, those of why many countries have found monetary policies difficult to implement, or have used direct intervention rather than financial sector tools. It focuses on whether the explanations can be found in factors peculiar to developing countries, and, if so, whether these can be changed by policy. This leads us back to the question of whether removing obstacles to, or developing the instruments of, monetary intervention does serve other purposes. A well-functioning formal financial system may improve the efficiency of the economy through its transfer-of-funds role, as well as the allocative functions emphasised in policy studies. It may mobilise or redirect domestic saving. One element in this analysis must be how far informal financial institutions can and do replace formal ones in developing countries.

To ask these questions together, about the effectiveness of monetary policy and the advantages of developing a financial system, illustrates two of the contradictions implicit in much discussion of the role of an efficient financial sector in implementing monetary policy. It is normally assumed to be preferable to use the financial sector, rather than more direct intervention, because this process permits the allocation of credit and the distribution of the effects of restraint to be determined by the market. But having an overall credit limit at all amounts to rationing, not a market solution, while deliberately developing the financial sector for this purpose amounts to accepting and implementing a sectoral priority.

The first part of this book will look at possible objectives for a financial sector and for monetary policy, and then identify possible ways in which developing countries and the financial sectors characteristic of them may differ from the conditions assumed in traditional approaches to monetary policy.

The country chapters in Part II will illustrate not merely the variety of experiences and degree of success, but the importance which policy in the individual countries gives to the different possible reasons for developing the formal financial sector. The six Asian and African countries included are not intended to be a representative sample of the developing world. They are all in the 'low' or 'low-middle' income category by per capita income. Foreign trade (exports/GDP) is relatively small for Bangladesh (6 per cent) and China (11 per cent), but the other four - Côte d'Ivoire (40 per cent), Kenya (27 per cent), Indonesia (25 per cent) and Ghana (21 per cent) - are fairly 'open' economies. The studies focus mainly on their experience during the two decades of the 1970s and 1980s. Over that period major changes occurred in many of their own policies, as well in the international environment facing them, but the countries chosen have all actively followed monetary policies during at least part of the period.

The chapters in Part III examine how the existence of informal monetary institutions and transactions and different international monetary arrangements, in particular the role of the exchange rate, affect the feasibility of operating different policies. The concluding Part IV will consider how successful monetary policy has been, and whether it could have been more successful, in terms of its direct objectives and of its more general effects on economic development.

A constraint on the methodology and any interpretation of the conclusions to the country and the special studies derives from the character of the financial sector. Because it functions efficiently through anticipation of effects, and because its participants tend to be more aware of this than other economic practitioners, it is particularly difficult to accept normal, sequential, 'proofs' of causality. It is therefore essential not to depend only on statistical relationships, but to use plausible models of transmission of effects, and to understand the operations (and failings) of the institutions and actors involved. It is also necessary to be clear about what, in the absence of intervention, the financial sector is determining or influencing, through both its existence and its degree of effectiveness - whether levels of output or prices, or allocation of resources, or control of inflation.

The New Interest in Monetary Policy

Monetary policy and the financial sector in low-income developing countries have been so neglected in development research that it may be an exaggeration even to identify a 'traditional view'. Whether the choice of priority activities or sectors was assigned to the public sector or 'the market', it was assumed that it was the 'real' choice which mattered and that such a choice could be made: either the financial sector was irrelevant, because intervention was direct, or it was assumed to function adequately (perhaps because finance and banking activities were importable). In the face of the many serious 'real' problems facing developing countries, developing the banking and financial sector took second place in the concerns of analysts and policy-makers. At the same time, the low incomes and savings capacities of poor people and poor countries, and the unfamiliar problems raised by heavy dependence on single commodities, often with a strong seasonal pattern of need for finance, did not attract the interest of commercial banks as providers of financial services. In practice, in most of Africa and Asia, the profitable parts of the market, upper-income groups and trade finance, could be assumed to be taken care of by expatriate banks. Research on monetary policy in developing countries was largely confined to the upper-middle-income countries of Latin America and East Asia, where the level of development made them nearer to familiar ground, and also where restrictions on foreign ownership limited the activities of foreign banks. It is also these countries which have led developing country concerns in international trade policy negotiations on the role of financial services.

The recent interest in monetary policy and financial sectors in low-income countries does not arise out of this background. In them, monetary policy has been introduced for external, macroeconomic, reasons. The countries which have introduced it have been forced, by external shocks (sometimes reinforced by domestic events or natural disasters), to make short-term adjustments of expenditure to income. Short-term adjustments used to be considered unsuitable for poor countries, a distraction from development, but they are now unavoidable, in the face of much more limited and policy-constrained external finance. External real interest rates are higher than in the past. This not only reinforces the need to adjust, rather than borrow, but increases the differential between world rates and the low or negative ones found in many developing countries, and therefore the strains and costs from isolating their financial system through controls. Countries must therefore act to reduce the strains, whether through direct intervention or financial policy.

Lower capital (lows overall may also require countries to make more medium- to long-term adjustments in their dependence on deficit financing (whether external or domestic). They may therefore be using fiscal instruments and reforms more actively than in the past and they may need to make and implement decisions on where to cut investment, and how to mobilise savings other than through taxation. Another possible influence is the increasing exchange of experiences among developing countries: awareness of the success of the more advanced in developing their financial sectors to the point at which they become attractive to foreign portfolio investment has encouraged the less advanced to see a sophisticated financial sector as normal.

There are also some structural changes which may have encouraged the development of the financial sector, and would certainly be helped by it, but these seem in practice to have been secondary. More diverse economies, higher incomes, and more trade increase the demand for financial services, but the slow growth of low-income countries in the 1980s, and even in the 1970s, makes these unlikely to have been new or increasing forces for change in recent years. The general switch towards increasing the share of the private sector requires a mechanism for mobilising and allocating funds among possible investments. The shortage of external savings has encouraged more attention to mobilising domestic savings, and extending the financial system is an obvious means for this. There is, however, a potential conflict. The studies presented here confirm previous findings that it is the extent of a financial system (which may require subsidisation, like other physical infrastr...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Figures and tables
• Acknowledgements
• Part I The nature of monetary policy and the financial sector
• Part II Country studies
• Part III Special studies
• Part IV Monetary policy and the financial sector
• Notes
• References
• Index