This chapter draws on work of the 2017 IMF–World Bank Financial Sector Assessment Program (FSAP) for Indonesia, and in particular the Financial System Stability Assessment, which was considered by the IMF’s Executive Board on May 24, 2017.
Traditionally, the core functions of banking were to (1) accept money from, and collect checks for, customers; (2) honor checks for orders drawn on them by customers; (3) keep current accounts, or something of that kind, in which customers’ debits and credits are entered; and, of course, (4) lend. Banks derived their income largely from the margin between the interest rates they paid on money deposited with them and the interest rates they charged on money lent by them.
Coordination means different things to different people. Webster’s Seventh New Collegiate Dictionary defines it as the “act of coordinating,” or the “state of being coordinated,” and, perhaps more interestingly, “harmonious adjustment or functioning.” Thus, the word coordination conjures up in one’s mind the image of an orchestra that is harmoniously led by a talented conductor. In this analogy the members of the orchestra, the players, would obviously be the countries’ policymakers. It is not clear, however, who would be in the conducting role. That role could be played by the agreement reached by the policymakers at their latest summit or as a consequence of their latest consultations. Such an agreement would presumably concern only the period immediately ahead, since it is unlikely that the policymakers would or even could commit themselves for a longer period. Or, in a more permanent arrangement, the role of the conductor could be played by a set of specific rules (perhaps based on some “economic indicators”) agreed upon by the policymakers. The resolution that set up the European Monetary System (EMS) provides an example of this type of arrangement. Or even, in a futuristic world, where the national authorities have devolved some of their decision-making responsibilities to an international or supranational body, that role could be played by an international organization. In the discussion that follows, only the first of these possibilities is contemplated, since the other two do not seem realistic for fiscal policy at this time.
Mohsin S. Khan, Peter J. Montiel, and Nadeem U. Haque
Most Developing countries at one time or another have faced the need for macroeconomic adjustment. Such a need typically arises when a country experiences a persisting imbalance between aggregate domestic demand and aggregate supply, reflected in a worsening of its external payments and an increase in inflation. While in certain cases external factors, such as an exogenous deterioration of the terms of trade or an increase in foreign interest rates, can be responsible for the emergence of the basic demand-supply imbalances, these imbalances can often be traced to inappropriate domestic policies that expand domestic demand too rapidly relative to the productive capacity of the economy. As long as adequate foreign financing is available, the relative expansion of domestic demand can be sustained for an extended period, albeit at the cost of a widening deficit in the current account of the balance of payments, a loss of international reserves, rising inflation, worsening international competitiveness, falling growth, and a heavier foreign debt burden. Eventually, however, the country would lose international creditworthiness, and as foreign credits ceased, adjustment would be necessary. This type of forced adjustment could prove to be very disruptive for the economy.
HASSANALI MEHRAN,, BERNARD LAURENS,, MARC QUINTYN,, and VICTOR CHANG
Monetary and exchange system reforms in China since the beginning of economic reform in late 1978 emphasized institution building in general and institutional and market development in the foreign exchange system and the capital market in particular.1 The development of nationally integrated money markets—that is, markets for short-term funds—is becoming a priority. This would enhance the effectiveness of monetary policy, support the capital markets in providing liquidity and funding for portfolios, and allow further progress in the operation of the foreign exchange market. Inherently related to all aspects of money market development is interest rate liberalization, an area where reforms are also lagging in China. Moreover, achievements in reforming the foreign exchange system—the exchange rate was unified as of January 1, 1994, and much progress was accomplished toward convertibility of the renminbi—make domestic interest rate flexibility highly desirable as a tool to support the exchange rate.
This chapter examines recent experiences with banking crises in seven countries—Argentina, Chile, Malaysia, Philippines, Spain, Thailand, and Uruguay—focusing on the linkages between macroeconomic conditions, financial sector reforms and financial crisis, and the range and effectiveness of measures to deal with financial crises.1
Russia’s traditional capacity to puzzle and surprise observers has been revealed again in the economic developments of the past decade. Early in the transition, few outsiders could understand how the population survived such a massive decline in output, the collapse of basic infrastructure, and the nonpayment of wages. Similarly surprising has been the recovery since the financial crisis of 1998. Most observers at the time predicted that it would take many years for Russia to recover from the debt default and ensuing loss of international confidence. Instead, Russia has experienced its first period of sustained growth, and financial markets have become increasingly bullish about Russia’s economic prospects, despite a high degree of uncertainty about prospects for the world economy. This recent optimism should not, however, obscure the fact that there are widely divergent views of the nature of Russia’s newfound prosperity and the extent to which it reflects fundamental changes in the economy that can translate into sustained growth. In this book, IMF staff put forward their interpretation of the startling swings in Russia’s economic fortunes that have marked the past five to six years. The following chapters thus attempt to explain recent developments and identify the key economic challenges that Russia faces.
Shocks emanating from domestic policies or from changes in the external economic environment in developing countries invariably set off a dynamic process of adjustment that frequently takes some time to work itself out. Although analysis of the macroeconomic effects of such shocks typically focuses on impact effects or on the eventual steady state at which the economy settles, it is the intermediate run—that is, the “real-time” effect of such shocks—that is often of equal if not even greater concern to policymakers in developing countries. While explicit dynamic solutions to small analytical models can yield valuable insights into particular aspects of the economy’s response to such shocks, general-equilibrium interactions can only be studied in the context of larger models that, unfortunately, do not often prove to be analytically tractable. Thus, numerical simulation experiments with dynamic macroeconomic models become the tool of choice for understanding the real-time effects of policy measures and external shocks in developing countries.
Nadeem U. Haque, Peter J. Montiel, and Mr. Steven A. Symansky
Macroeconomic policy in developing countries has received considerable attention in recent years as continuing external and internal imbalances have contributed to a slowdown in growth, balance of payments difficulties, and high inflation. Many countries have undertaken adjustment programs whose announced objectives have been to reduce external imbalances and to lower inflation while avoiding recession and enhancing medium-term growth. The consequences of such programs for income distribution have also received increased attention. Diverse macroeconomic targets such as these respond to policy and other shocks via fairly complex general equilibrium interactions. Thus, the analysis of the effects of policies on such variables, as well as of the trade-offs among conflicting macroeconomic targets confronted by policymakers, must necessarily be conducted by using reasonably detailed quantitative macroeconomic models. Existing quantitative models for developing countries are not well suited for exploring these issues, however, because they typically incorporate ad hoc behavioral relationships and generally provide inadequate treatment of expectations.1 The formation of expectations is generally modeled in a static or adaptive fashion, even though forward-looking expectations have by now become an important feature of macroeconomic analysis for developing countries.2
The Concept of “growth-oriented adjustment,” or the notion that economic growth is essential for the achievement of the twin goals of a sustained reduction in inflation and a viable balance of payments, has recently received the attention of policymakers and academics alike. Indeed, growth-oriented adjustment is considered a key characteristic of the policy packages that make up Fund-supported programs. Examples of the blossoming literature on the subject of growth-oriented adjustment can be found in Bacha and Edwards (1988), Blejer and Chu (1989), and Corbo, Goldstein, and Khan (1987).1