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© 2005 International Monetary Fund
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Cataloging-in-Publication Data
Laurens, Bernard.
Monetary policy implementation at different stages of market development / By A Staff Team Led by Bernard J. Laurens — Washington, D.C. : International Monetary Fund, 2005.
p. cm.—(Occasional paper; 244)
Includes bibliographical references.
ISBN 1-58906-438-0
1. Monetary policy. 2. International Monetary Fund. I. Series: Occasional paper (International Monetary Fund); no. 244
HG230.3.L37 2005
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Contents
Preface
Glossary of Monetary Instruments
Part I. A Framework for Sequencing Reforms
I Overview
II The Growing Reliance on Money Market Operations for Monetary Policy
III Lessons from Country Experiences
IV Implications for Policy Design and Coordination
V Agenda for Action to Enhance Monetary Policy Effectiveness
VI Sequencing Reforms
VII Implications for Fund Operations
Part II. Selected Country Experiences with Money Market Operations
VIII Case Studies
Democratic Republic of the Congo
Eastern Caribbean Currency Union
Egypt
The Gambia
Kyrgyz Republic
Malta
Tonga
Tunisia
Uganda
Ukraine
Vanuatu
Zambia
Appendixes
I Channels of Transmission of Monetary Policy
II Eligible Assets: European Central Bank and Banque de France
III Enhancing Liquidity Management and Forecasting
IV Cross-Country Experiences with a Liquidity Surplus
V Selected Country Experiences with Interbank Market Development
References
Boxes
2.1. The Conduct of Monetary Policy
3.1. Country Examples of Fiscal Dominance
3.2. Country Examples of Structural Liquidity Surplus
3.3. Country Examples of Market Participation and Institutional Limitations
3.4. Liquidity Forecasting Frameworks
4.1. Initial Conditions for Inflation Targeting
4.2. Successful Money Market Experiences in Small Countries
4.3. Typology of Money Market Operations
5.1. Fostering Fiscal Discipline in the Eastern Caribbean Currency Union
5.2. Measures to Limit the Distortionary Effects of Rules-Based Instruments
6.1. Monetary Policy Implementation in Small Countries
7.1. Synergies Between Fund Operations: Selected Country Experiences
8.1. Democratic Republic of the Congo: Monetary Policy Instruments
8.2. Democratic Republic of the Congo: Forms of Dollarization
8.3. Eastern Caribbean Central Bank: Monetary Policy Instruments
8.4. Egypt: Monetary Policy Instruments
8.5. The Gambia: Monetary Policy Instruments
8.6. Kyrgyz Republic: Monetary Policy Instruments
8.7. Malta: Monetary Policy Instruments
8.8. Tonga: Monetary Policy Instruments
8.9. Tunisia: Monetary Policy Instruments
8.10. Uganda: Monetary Policy Instruments
8.11. Ukraine: Monetary Policy Instruments
8.12. Vanuatu: Monetary Policy Instruments
8.13. Zambia: Government Securities Market
8.14. Zambia: Instruments of Monetary Policy
Tables
2.1. Use of Monetary Instruments in a Sample of Countries
2.2. Fund Technical Assistance in Monetary Policy Implementation (1999–2004)
4.1. Stylized Structure of Central Bank Interest Rates
6.1. Functions of Monetary Instruments at Stages Two and Three
8.1. Democratic Republic of the Congo: Financial System Structure
8.2. Eastern Caribbean Currency Union: Financial System Structure
8.3. Egypt: Financial System Structure
8.4. The Gambia: Banking System Structure
8.5. Kyrgyz Republic: Financial System Structure
8.6. Malta: Financial System Structure
8.7. Tonga: Financial System Structure
8.8. Tunisia: Adoption of Money Market Operations
8.9. Tunisia: Financial System Structure
8.10. Uganda: Financial System Structure
8.11. Ukraine: Financial System Structure
8.12. Vanuatu: Financial System Structure
8.13. Zambia: Financial System Structure
A.2.1. Eligible Assets in Germany, France, Austria, and Ireland
A.3.1. Standardized Central Bank Balance Sheet
Figures
6.1. Monetary Policy Implementation at Different Stages of Market Development
A.1. Stylized Representation of the Channels of Transmission
Preface
The single most salient trend in the practice of monetary policy over the last two decades has been a move toward reliance on money market operations for monetary policy implementation. Nowadays, central bankers around the world agree on the economic benefits of market-based monetary instruments. The move has taken place in an environment where financial markets have become more integrated domestically and internationally. It also reflects the belief that allowing market forces to allocate financial resources brings about increased economic efficiency and growth. However, small economies, or countries with undeveloped financial markets, have found that a lack of competition in financial markets has complicated reliance on money market operations, at times forcing them to rely on direct instruments or moral suasion. In some larger countries, the process has been gradual and at times full of difficulties. Drawing on a variety of country experiences, this paper analyzes the reasons for these difficulties and proposes a stylized sequencing of reforms that enables an introduction of money market operations tailored to each country’s particular circumstances.
The material in this paper was prepared in response to questions raised by some Executive Directors regarding the use of market-based monetary instruments in small economies or in countries with undeveloped financial markets and was discussed at an IMF Executive Board seminar on November 17, 2004. It was prepared under the direction of Hervé Ferhani (Senior Advisor, Monetary and Financial Systems Department) by a staff team led by Bernard J. Laurens that included Marco Arnone, Alina Carare, George Iden, Kentaro Iwatsubo, Rodolfo Maino, Obert Nyawata, Andrea Schaechter, and Stephen Swaray. Patricia Mendoza and Galina Menchikova provided outstanding secretarial support. Linda Griffin Kean edited the manuscript and coordinated production.
The paper has benefited from the comments of IMF Executive Directors and colleagues in the Monetary and Financial Systems Department (MFD) and in other departments in the IMF. This paper should not be reported as representing views or policies of the International Monetary Fund. The views expressed in the paper are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.
Stefan Ingves
Director
Monetary and Financial Systems Department
Glossary of Monetary Instruments
The instruments are ordered starting with those that can be used in shallow money markets and ending with those that are effective only in developed money markets. Some of the instruments, i.e., reserve requirements and standing facilities, may be used at all stages of money market development.
Rules-based instruments: Monetary instruments based on the regulatory power of the central bank. These include:
Liquid asset ratios (LARs): Requirements for a bank to hold minimum amounts of specified liquid assets, typically as a percentage of the bank’s liabilities.
Reserve requirements (RRs): Requirements for a bank to hold minimum balances with the central bank, typically as a percentage of its liabilities. When averaging provisions are allowed, banks can fulfill reserve requirements on the basis of average reserve holdings during the maintenance period.
Standing facilities: Monetary instruments used at the initiative of banks and bearing a pre-specified interest rate which allow banks to borrow from the central bank (refinance standing facility) or deposit funds with the central bank (deposit standing facility).
Money market operations: Monetary instruments used at the discretion of the central bank and bearing an interest rate linked to money market conditions. These are meant to influence the underlying demand and supply conditions for central bank money. They include:
Open market–type operations: Market-based monetary operations based on auction techniques regulated by the central bank. OMO-type operations involve (1) lending/borrowing with underlying assets as collateral, (2) primary market issuance of central bank securities or government securities for monetary policy purposes, and (3) acceptance of fixed-term deposits.
Open market operations (OMOs): Market-based monetary operations conducted by the central bank as a participant in the money market. OMOs involve (1) buying/selling assets outright on the secondary market and (2) buying/selling assets under a repurchase agreement in the repo market or through foreign exchange swaps.
Auction techniques: Used by central banks in their money market operations, these include: (1) volume tenders, with banks bidding only for volumes supplied by the central bank at a preset interest rate; and (2) interest rate tenders, with banks bidding for both the amount and the rate; the central bank charges the rates offered (multiple-rate auction) or the cutoff rate (uniform-rate auction).
Fine-tuning operation: An irregular money market operation executed mainly to deal with unexpected liquidity fluctuations in the market.