The transition strategy from administratively set interest rates to market rates is discussed. Despite worldwide trends toward financial liberalization, few monetary authorities are prepared to accept as reasonable any interest rate level that is market determined. The paper suggests some helpful indicators to assess the adequacy of interest rates and discusses factors that contribute to a smooth liberalization process. The main conclusion is that interest rate liberalization is not synonymous with laissez-faire policies, but requires the replacement of the administratively set interest rates by indirect monetary management techniques that operate through the market.
This paper estimates a model of financial markets in Colombia to examine: 1) the authorities’ control over domestic interest rates and the money stock; and 2) the effects of the crawling peg exchange rate policy on exchange rate expectations and domestic interest rates. The authorities appeared to possess some control over the money stock in the short run, mostly because of the existence of capital controls, but most of this control was eroded once asset demands adjust to their desired banks. The expected rate of depreciation is not closely linked to the crawling peg.
During the past decade or so economists have emphasized the critical role that interest rate policies play in the development process. The growing literature on financial “reforms” and financial “liberalization” in developing countries has dealt with a variety of issues, such as the relation between financial intermediation and economic growth, the sensitivity of the volume of savings to changes in real interest rates, and the relation between investment and interest rates. Generally speaking, the empirical evidence indicates that there is indeed a positive association between the degree of development of the financial sector, including in particular freer interest rates, and economic performance in developing countries.1 This finding has undoubtedly prompted the authorities in a number of such countries to pursue policies to remove controls on interest rates and to allow market forces to play a relatively greater role in the determination of interest rates.
Colombia's economic performance deteriorated markedly in the last half of 1998 and during 1999 under the combined influence of external shocks and a weakening of confidence. In an effort to reverse the deterioration, the authorities developed a multiyear stabilization and reform program based on fiscal consolidation, exchange rate flexibility bank restructuring, and structural reforms. Indications suggested that economic activity in Colombia has been recovering and the IMF-supported extended program remains on track. The IMF staff welcomed the authorities' reaffirmation of the strategies and policies underlying the program.