THE METHODS EMPLOYED in analyzing the effects of economic changes on a country’s balance of payments have undergone drastic revision in the course of the last 50 years. The evolution of economic ideas and analytical methods generally follows, although sometimes with a considerable lag, the emergence of economic problems requiring solution. Balance of payments analysis, too, has been influenced directly by the changing character of international economic problems; in addition, however, it has also been affected by changing methodological fashions in the mainstream of economic thought.
Mr. Malcolm D. Knight, Arne B. Petersen, and Robert T. Price
For the past six years, the central banks of the Baltics, Russia, and other countries of the former Soviet Union have undertaken ambitious programs of reform.1 The reforms have focused first on stabilizing monetary policy and then on achieving a market-based determination of interest and exchange rates. The reform of central bank operating procedures has been a key piece of the program. Central banks in the 15 countries have been encouraged to manage banking liquidity through market operations with indirect instruments. There have also been closely coordinated reforms to foster foreign exchange markets, interbank money markets, government securities markets, and to strengthen various central bank functions, including the payment system, central bank accounting and internal audit, and banking supervision and restructuring. This volume examines the progress the 15 countries have made in transforming their financial systems, and highlights the substantial progress achieved by central banks in most of the countries.
IN DISCUSSING MONETARY MEASURES for demand management, two interrelated questions are usually raised: first, how to evaluate the impact of changes in monetary variables on aggregate demand and, second, which monetary variable is appropriate from the viewpoint of policy. 1 In examining these questions, but mainly the second, the paper concentrates on the choice between money and credit as the policy-controlled variable—that is, whether the authorities should act (place a ceiling) on credit or on money when they intend to regulate pressures on demand, and particularly pressures on the balance of payments. 2
In addition to facilitating exchanges of goods, services, and financial assets, effective payment systems play a major role in ensuring the soundness of financial systems by limiting the possibility of systemic crises, which could undermine confidence in financial institutions and markets. In the early 1990s, the 15 countries under review were beset with a number of payment system problems. Besides slowness of payment processing, there were, in particular, large interenterprise arrears, defaults, and fraud. A farther complication was the breakdown of the ruble area, which caused cash shortages in some countries and excess cash in others, depending on the timing of the introduction of national currencies. The final step in the breakup of the ruble zone occurred in June 1993 when Russia demonetized all pre-1993 ruble bank notes, expediting the departure of the zone’s last seven non-Russian members.
As a group, the Baltics, Russia, and other countries of the former Soviet Union have achieved substantial progress in the areas of convertibility, foreign exchange market development, and central bank foreign exchange operations over the last six years. The institutional arrangement for an efficient market-based allocation of foreign exchange is in place in most countries; payments and transfers for current account transactions are free of restrictions, except in a limited number of countries; and several countries maintain a liberal system for capital account transactions, or interpret liberally the restrictions in place. Nominal exchange rates have begun to stabilize in most countries (Figure 3.1). The ratio of gross international reserves to imports also indicates that countries are moving to macroeconomic stabilization (Table 3.1). Foreign exchange markets are usually shallow, however, with banking unsoundness often an obstacle to market deepening.
Ms. Claudia H Dziobek and Jan Willem van der Vossen
The perestroika policies of the Soviet Union during the late 1980s set the stage for the rapid rise in the number of banks in individual states, although the ratio of credit to GDP remained low (see Chapter 8, Table 8.7). Concurrently, lax licensing policies and implementation of licensing requirements allowed many unsuitable banks to remain in the system in the early 1990s. At the same time, significant macroeconomic imbalances created conditions that gave banks incentives to engage in high-risk activities, such as foreign currency speculation. Weak banking laws and enforcement mechanisms failed to contain speculation by banks and to enforce safe and sound banking practices. As macroeconomic stabilization took hold, inflation declined and exchange rates stabilized. Banking problems of a systemic nature began to appear in the majority of countries because profits from speculation plummeted. Resulting bank insolvencies, sometimes entailing significant losses to depositors, damaged public confidence. But the countries have undertaken efforts to develop systemwide policies that address these issues and to restore bank soundness and the public confidence necessary to mobilize savings more effectively.
THE PURPOSE OF THIS PAPER is to bring monetary events, monetary data, and monetary problems within the framework of income analysis, and thereby to bridge the gap between (1) the views widely held on the relation between financial policies and payments questions and (2) the analytical tools used to explain payments developments. Broadly, payments problems are associated with inflationary causes; and moderation in credit expansion is generally prescribed as a preventive or a curative of payments difficulties. But since existing analytical studies rarely succeed in integrating monetary and credit factors in the explanation of income or of payments developments, an adequate theoretical basis—in particular, a quantitative basis—for these conclusions seems to be lacking.
THE RELATION between the quantity of money and the level of prices and incomes is generally treated by modern monetary theorists in terms of a “closed” economy, that is, without allowing for international trade as an integral part of the theory. In his “Monetary Analysis of Income Formation and Payments Problems,”1 J. J. Polak has shown how the existence of international trade, and the consequent possibility of balance of payments deficits, modifies in an essential way the theoretical analysis of the monetary system.