III The Money Supply Process and the Use of Monetary Instruments, 1963–74
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The BCEAO area is open to trade and payments, which sets obvious limits on how far it can have an independent monetary policy because the balance of payments outcome is almost exogenously determined by production and prices of exports. This is evident from the factors affecting the money supply.

The BCEAO area is open to trade and payments, which sets obvious limits on how far it can have an independent monetary policy because the balance of payments outcome is almost exogenously determined by production and prices of exports. This is evident from the factors affecting the money supply.

Growth in the Money Supply

Data on money supply growth in the BCEAO area, as well as in individual member countries, between 1963 and 1974 shows that for the area as a whole the average annual rate of growth (in simple arithmetic terms) was 29 percent (Table 2). Senegal had the lowest relative growth (17 percent) and Togo the highest (54 percent), but in absolute terms the growth in the money supply of Ivory Coast contributed most—nearly 60 percent—of the increase in the money supply in the area, followed by Senegal (15 percent).

Table 2.

WAMU and Members: Money Supply, 1963–74

(Quarterly averages: in billions of CFA francs)

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Note: The money supply is defined as currency plus demand deposits. Figures in parentheses are ratios of the money supply lo GDP.Source: International Monetary Fund, International Financial Statistics (Washington: IMF).

The relatively high rate of increase of the money supply in Ivory Coast reflects its rapid GDP growth in the post-independence period. It may also reflect a relatively faster monetization, since the ratio of its nonmonetary to monetary GDP declined from 22 percent in I960 to 13 percent in 1974. Although the absolute level of the money supply was about the same in Ivory Coast and Senegal at the beginning of the period, by 1974 the level in Ivory Coast was more than twice that in Senegal. In Togo, on the other hand, the money supply grew fast from a small base. For the area as a whole, the ratio of the money supply to GDP declined somewhat between 1963 and 1968, to increase between 1969 and 1974. In Ivory Coast, however, the ratio continued to increase until 1972 and declined in the later two years, while in Senegal it generally declined until 1972 and increased in the later two years.

The rate of growth in the money supply accelerated considerably during 1974 in all the countries in the Union. In the area as a whole, the average annual rate of growth reached nearly 30 percent—more than twice the average annual rate of 14 percent between 1963 and 1973. There were similar trends in each member country. As will be discussed in Section IV, the sharp acceleration in the money supply during 1974 had some important implications for the adequacy of the old statutes of the BCEAO for the conduct of monetary policy. The following analysis, which isolated the different contributions made to money supply growth of components of the money multiplier and the money base, found that the sharply higher money supply growth was primarily due to higher liabilities.


The money supply consists of a money multiplier and a base (Frost, 1977). Although the latter can be defined in different ways, depending upon the degree of financial sophistication in a country, a simple definition—currency plus public and bank reserves—is appropriate in the case of the BCEAO countries. Between 1962 and 1974, the BCEAO did not prescribe any reserve requirements (which might have complicated the calculation of the reserve component of the base), and generally provided easy access to its rediscount facilities.

The money supply may then be seen as reflecting both the behavior of the monetary authorities (via the monetary base) and the behavior of the private sector, including banks (via the money multiplier). The monetary authorities affect liabilities by changing the assets of the central bank—through its credit to governments, and changes in foreign and other assets. Since changes in government credit as well as in foreign assets could be regarded as being outside the control of the BCEAO, the behavior of the monetary authority would then be reflected in the changes in the other assets in the Bank’s portfolio. Private behavior, on the other hand, could be analyzed in terms of the changes in factors affecting the money multiplier (defined as the ratio of currency to the money supply and the ratio of bank reserves to deposits). On the basis of these considerations, the money supply (A/) (the sum of currency with the public (C) and demand deposits (D)) is related to the monetary base, or monetary liabilities (L) (currency with the public plus central bank reserves (R)), by a multiplier, k (k = 1/(c + r(1 – c)), where c and r are the ratios of currency to the money supply and of reserves to demand deposits, respectively. Changes in the money supply over discrete intervals of time may then be described in terms of first differences:5


From Mt−1 = kt−1 · Lt−1 and substituting in (1),


The last term, representing the interaction of changes in k and L, will normally be insignificant for small variations.

Changes in the monetary liabilities of the central bank are caused by corresponding changes in its assets: these are net foreign assets (F), net credit to the government (DG), and the balance of asset changes (LP)—or total changes in assets less changes in F and DG The latter are deemed to be a potential policy variable. In the case of the BCEAO, this last change will generally be brought about by variations in total rediscounted bills issued by the commercial banks.

Changes in the money multiplier. Δk, may be decomposed into changes due to variations in the currency to money ratio, ΔKc, and to changes in the reserve to demand deposit ratio, Δkr. Thus,




and Δkr=(1c)(c+r(1c))2Δr(5)

Finally, equation (2) may be subdivided into the various components identified as affecting the money supply:


where the subscripts to M refer to the causal factors of the change—with the first term in parentheses on the right-hand side approximating the effects of the change in money multiplier and the second approximating the impact of the changes in monetary liabilities.

Following this analytical framework, changes in the money supply can be broken down into changes attributable to variations in the money multiplier and to the changes in the monetary liabilities of the BCEAO (Table 7 in the Statistical Appendix). Of these two determinants of the money supply, cumulative (yearly) changes in the money multiplier accounted for only 12 percent of the increase in the money supply in the group (although there were some individual years, particularly in the early 1960s, when the money multiplier had more impact). Monetary liabilities also had a greater impact on the money supply in individual countries, although this varied from accounting for 70 percent of changes in the money supply in Senegal to as much as 98 percent in Niger.

The relative importance of changes in monetary liabilities for variations in the money supply is not surprising, given that the habit of using banks and monetary institutions in these countries continued to expand between 1963 and 1974. On the other hand, the money multiplier is predominantly influenced by fluctuations in the currency ratio that are caused mainly by changes in commercial output and export prices, which tend to have “cyclical” or weather-influenced fluctuations. In a year with a good agricultural season, for instance, the consequent rise in farmers’ incomes leads to increased currency holdings (since banking habits are less developed in the rural areas). Over a period, however, these fluctuations tended to cancel each other out and the trend influence of the changes in the currency ratio on the money multiplier was small, as was, therefore, its relative influence on the money supply. The relatively high currency ratio also almost completely swamped the effects of the changes in the reserve ratio on the money multiplier.

The fluctuations in monetary liabilities also seem to have been the most important influence upon the changes in the money supply when the series is adjusted for trend. In Tables 8 and 9 in the Statistical Appendix, total changes in the money supply in the entire WAMU area and in Ivory Coast are divided between trend and cyclical changes, as are the influences of the changes in monetary liabilities and the money multiplier on those in the money supply. Ignoring algebraic signs, the changes caused by the money multiplier accounted for less than 20 percent of the total change in the money supply (uncorrected for trend), and for about 30 percent for the trend-corrected series as well as for the cyclical-corrected series. (A comparable analysis for other member countries yielded similar, though somewhat less pronounced, results.)

While the trend influence of the changes in the money multiplier tended to reinforce the trend influence of the changes in monetary liabilities on the money supply, their respective cyclical contribution was conflicting in all but two years in the BCEAO area as a whole and in all but three years in Ivory Coast. Thus, a cyclical increase in liabilities was accompanied by a dampening of the value of the money multiplier and vice versa. These opposing cyclical influences explain the relatively smaller influence of the cyclical changes on the money supply in comparison with the impact of trend changes. The offsetting cyclical behavior of liabilities and the money multiplier is perhaps not surprising. When base money increases abruptly, both the cash ratio and reserve ratio may be expected to rise in the short run until the public and the banks have had time to adjust their asset portfolio to the new circumstances.

Changes in the monetary liabilities of the BCEAO have been the predominant trend and cyclical influence on the changes in the money supply. In the BCEAO area, liability changes may be attributable to changes in net foreign assets and in net credit to governments (both of these create corresponding changes in domestic monetary liabilities), and, as a residual, in changes in the monetary liabilities corresponding to changes in other assets (Table 10 in the Statistical Appendix). At least theoretically, these residual effects could be considered as controllable by policy (through, for instance, the rediscount policy).

For the period considered, the influence of changes in credit to governments was minimal; such credit was rigorously limited by the statutes of the BCEAO which governed not only the amount, but also the duration of the credit. Of the remaining two components, the average impact of the changes in net foreign assets was slightly below half, and that of the potentially policy controllable liabilities slightly above half, of the total change in the money supply attributable to the change in monetary liabilities. Moreover, in all but three years, foreign assets and residual assets had an offsetting influence on the money supply in the area as a whole, indicating either an increased causal and negative relationship between them or an attempt by the BCEAO to use the policy controllable assets to dampen the effects of changes in foreign assets on the money supply. However, the latter seems unlikely; there is little other evidence of conscious attempts to regulate credit in the light of changes in foreign assets, and the negative relationship between the two types of asset is only consistently evident in two individual member countries. Furthermore, even in the case of Senegal, the cumulative negative impact of the changes in foreign assets was more than offset by the cumulative positive impact of the changes in potentially policy controllable variables, so neutralizing developments may have been fortuitous. This question of the passivity of credit policy is elaborated in the following section.

The results of an analysis into the impact of the components of the money multiplier shows that for the period as a whole the influence of the currency ratio was more crucial than that of the reserve ratio (Tables 11 and 12 in the Statistical Appendix), While the cumulative effect of the former was positive (and therefore expansionary), that of the latter was negative (and contractionary). Thus, the cumulative effect of the currency ratio change either matched or exceeded the cumulative change in the money supply in each member country of the area. The countervailing cumulative impact of the change in the reserve ratio was small (about 12 percent for the entire area); only in Niger was the negative impact of the reserve ratio at all significant. This is not surprising. Whereas the currency ratio tended to decline as banking habits spread, the reserve ratio fluctuated around a small average figure (Tables 3 and 4).

Table 3.

WAMU and Members: Ratio of Currency to Money of Commercial Banks, 1963–74

(Quarterly averages)

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Source: International Monetary Fund, International Financial Statistics (Washington: IMF).
Table 4.

WAMU and Members: Ratio of Reserves to Demand Deposits of Commercial Banks, 1963–74

(Quarterly averages)

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Source: International Monetary Fund, international Financial Statistics (Washington: IMF).

Small as the cumulative effect of the changes in the reserve ratio was relative to that of the currency ratio over the entire period, the former influence is more pronounced when the series is corrected for (rend changes and only the cyclical influences of the two ratios are compared. This is demonstrated for the WAMU area as a whole and for Ivory Coast separately in the last four columns of Tables 8 and 9 in the Statistical Appendix. The cyclical influence of the changes in the currency ratio is now more clearly brought out. In the case of the WAMU, it was negative in five years and positive in six. In the case of Ivory Coast, the cyclical influence of the changes in the currency ratio was negative in eight out of the eleven years.

In contrast to the uncorrected series, the cyclical influence of the changes in the currency and the reserve ratio was not offsetting in four out of the eleven years, both in the WAMU area, as well as in Ivory Coast. Furthermore, the cyclical influence (ignoring algebraic signs) of the changes in the currency ratio did not always exceed that of the reserve ratio; the latter was larger than the former in four years in the BCEAO area and in five years in Ivory Coast. This would suggest that from the point of view of monetary policy aimed at influencing yearly changes in the money supply, control of reserve behavior could be important.

Under the pre-1974 statutes of the BCEAO, however, the Central Bank only prescribed a liquidity ratio, and did not directly control the reserve ratio, allowing the commercial banks to influence the short-term behavior of the money supply. Moreover, as explained below, the BCEAO used the liquidity ratio to ensure bank solvency rather than to implement monetary policy, so it was changed infrequently.

In general, since an overwhelming part of the commercial banks’ assets historically consisted of rediscountable credit which the Central Bank stood ready to rediscount (subject to ceilings), the commercial banks felt little need to maintain large cash reserves and, indeed, often reduced them to very low levels to finance credit and other profit-yielding operations; as shown in Table 4, the aggregate reserve ratio remained around 6 percent, declining to only 2 percent in some years in some countries. Commercial banks appear to have maintained few precautionary cash reserves and to have invested their resources in revenue-yielding assets, a practice which would appear to have been encouraged by the BCEAO’s practice of standing ready to rediscount within generous limits.

Instruments of Monetary Policy

Rediscount Ceilings

The BCEAO’s monetary policy was implemented largely through rediscount ceilings. Quantitative ceilings (plafonds) were set on rediscounts of approved short-term and medium-term credit by commercial banks and other financial institutions with access to the BCEAO’s rediscount facility. Limits were also fixed on rediscounted credit to individual enterprises. These ceilings were fixed semiannually and were determined on the basis of the expected overall credit requirements of the economy in comparison with the resources likely to be available to banks, mainly through growth in their deposit liabilities. Ceilings were fixed separately for short-term and medium-term credit. Whereas the short-term ceilings were reviewed and fixed anew every six months, medium-term ceilings were cumulative—once the BCEAO had committed itself to rediscount a credit, that commitment could not be withdrawn. Still, the amount of medium-term credit, and particularly the magnitude of its changes, were relatively small compared with the amount of, and changes in, short-term credit.

The rediscount facility, in addition to being the principal means of implementing monetary policy, was also designed to be the main source of supplementary resources to banks. Unlike many other central banks, the BCEAO appears to have regarded itself as a cofinancier rather than a lender of last resort. Presumably, it was originally felt that, given the relatively low levels of monetization and income and the undeveloped use of the banking system in the member countries, the amount of resources likely to be available to commercial banks through the normal process of intermediation would not be sufficient to meet the needs for credit. A persistent resource shortage was, therefore, expected, which the Central Bank should be prepared to meet through its rediscount facilities to sustain growth. However, the validity of this assumption depends on whether (1) the growth in the banks’ own deposit resources was in fact less than that in rediscountable credit; and (2) the credit ceilings were instrumental in the determination of overall credit developments.

Taking the first of these questions, if the rediscount policy aims to satisfy the demand for rediscountable credit to avoid inhibiting income growth, increases in the ratio of bank deposits to income growth should be less than that of the demand for rediscountable credit to income growth. If, over time, demand is less than supply, the desirability of a mechanism to forestall excessive overall credit expansion is suggested. Furthermore, insofar as the behavior of the credit-income ratio and the deposit-income ratio may vary among member countries, and within any one country over time, a differentiated rediscount policy, tailored to developments in each of the member countries, may be required.

The relevant data were used to examine the above relationships empirically for the period through 1974 (Table 5). These data show that, for the Union as a whole, actual rediscounts remained below the ceilings in each of the years examined here.

Table 5.

WAMU: Basic Data, 1963–74

(Quarterly averages; in billions of CFA francs)

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Sources: International Monetary Fund, International Financial Statistics (Washington: IMF); and data provided by the BCEAO.

Regression equations were fitted between rediscountable credit (RD) and income (Y), and between total deposits (TD) and income (Y). The following results are for total short-term and medium-term credit, though the relative importance of the latter is rather small, as observed earlier. (Data in parentheses are t-statistics, R2 is the coefficient of determination, DW is the Durbin-Watson statistic, and SE is the standard error,)


(The annual monetary data were measured as averages of the data at the end of the four quarters.) These results indicate that the income elasticity of total deposits, at 1.9, is greater than the income elasticity of the demand for rediscountable credit, at 1.65. (On the assumption that central bank policy did not discourage commercial banks from granting credit for rediscountable purposes, the actual outstanding amount of such credit is taken to denote the demand for credit. This assumption is valid since, in general, the BCEAO’s rediscount ceilings tended to be only partially utilized.) Thus, over the period considered here, the inflow of deposits into the banking system was larger than the increase in the demand for rediscountable credit; accordingly, the Central Bank’s role as cofinancier should have gradually declined. Of course, to the extent that the authorities would have wished that a certain amount of this latter credit should also be financed, and the sum total of the two could have exceeded commercial banks’ own resources, a need would have arisen for the rediscount facilities. But in that case the distinction between rediscountable and nonrediscountable credit becomes irrelevant, as indeed was implicitly recognized after the 1974 reform of the statutes of the BCEAO.

The income elasticity of deposits was also greater than the demand for rediscounted credit in individual countries, except in Ivory Coast. These income elasticities, all statistically significant, are as follows:

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But in Ivory Coast, income growth was largely exportled, and a significant part of the demand for credit originated in the export sector, which was primarily dependent on bank credit for its financing. And even in the case of Ivory Coast, where the capacity to satisfy domestic demand showed a remarkable improvement, this pattern was more valid in the earlier than in the latter part of the period considered.

The relative growth in total deposits was particularly large after 1972, when the ratio of rediscountable credit to total deposits declined in each member country of the WAMU. Even in Ivory Coast, where the ratio had been relatively stable for several years, it declined by 17 percent in 1974 as the substantial increase in deposits was used to finance nonrediscountable credit. (Regression analysis was not made for the subtrends, in view of the brevity of the period covered.)

The acceleration in total deposits relative to the demand for rediscountable credit should have encouraged the monetary authorities to force commercial banks to rely increasingly on their own resources to finance their credit operations, and to reduce recourse to the rediscount facility of the Central Bank. However, the BCEAO did not appear to have followed this course. Had it done so, one would have expected the ratio of deposits to income to be positively correlated with the ratio of deposits to credit to the private sector, as the increase in the commercial banks’ own resources replaced central bank rediscounts for financing rediscountable rather than nonrediscountable credit. One would also have expected the ratio of deposits to income to move negatively with the ratio of rediscounts to bank credit to the private sector. The behavior of the three ratios, as shown in Table 6, belies this expectation. The movements in deposits to income do not appear to be positively related to those in deposits to private sector credit. Furthermore, while the changes in the deposit-income ratio and in the ratio of rediscounts to private sector credit were in the expected (that is, opposite) directions for seven of the eleven years considered here for the entire area, in four other years the ratios moved in the same direction, indicating that in their impact on total credit, changes in deposit resources were reinforced by similar changes in the use of central bank rediscounts. In the case of Ivory Coast, the largest member country in the area, such a mutual reinforcement is visible in six of the eleven years. It is particularly interesting that in 1974 this was the case in each of the member countries.

Table 6.

BCEAO and Members: Evolution of Basic Financial Ratios, 1963–74

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Source: International Monetary Fund. International Financial Statistics (Washington: IMF).

As regards the second question—whether rediscount ceilings determined overall credit developments—when it fixed these ceilings, the BCEAO took into account the credit requirements of growth in member countries, as well as the likely accrual of deposits to banks. In addition, the BCEAO was also probably concerned with maintaining adequate foreign exchange reserves, since its statutes obligated it to undertake corrective actions when the ratio of its foreign exchange holdings to short-term liabilities fell below a certain level.

A regression equation of ceilings (Qc) on total current external trade as a proxy for growth (exports, X, plus imports, M), total current deposits as a proxy for expected deposits (TD). The previous year’s ratio of the BCEACVs foreign exchange holdings to currency liabilities (Cov), and actual rediscounts (Rd) in the previous year yielded the following statistically significant results:


These results suggest that in fixing ceilings, the BCEAO tended to allow the banks almost half of their deposit reserves to finance nonrediscountable credit that was not subject to direct control by the BCEAO. This meant that a substantial proportion of the deposit resources of the commercial banks were largely outside the purview of the Central Bank.7 This conclusion is also supported by the peculiar definition of the liquidity ratio used within the Monetary Union. As will be discussed later, this ratio included in the numerator only short-term deposits, excluding time deposits, which, over the period 1963–74, accounted for nearly 40 percent of the increase in the deposit resources of the banks in the monetary area as a whole; this percentage varied from a low of 15 percent for Burkina Faso to a high of 59 percent for Niger.

The same functional relationship applied to individual country data yield statistically insignificant results. In these individual cases, the ceilings appeared to be influenced by the amount of rediscountable credit outstanding in the previous year, but the annual deviations of estimated ceilings from such regression equations were too large for them to be considered as an adequate explanation. Whether this means that the BCEAO paid more attention to fixing aggregate than individual ceilings, or that other factors determined them, is difficult to decide. A priori, however, the conclusion may be that the BCEAO, as a common central bank with a common pool of reserves, targeted its monetary policy on aggregate ceilings. (Aggregate rediscounted credit averaged about two thirds of the rediscount ceilings: in fact, this ratio could have been an implicit medium-term target of the authorities.)

Table 7 traces developments in short-term credit to the private sector, as well as those in rediscountable credit, credit rediscounted, and rediscount ceilings, for the BCEAO area and for each member country. These developments point toward the declining influence of rediscount ceilings in the determination of short-term credit to the private sector. As a percentage of short-term credit to the private sector, rediscount ceilings declined almost every year from 60 percent in 1963 to 38 percent in 1973, before rising to 44 percent in 1974. In the case of Senegal the ratio continued to fluctuate around a high level, while in Niger it underwent startling variations. While rediscount ceilings as a percentage of total credit declined, rediscounts as a percentage of rediscountable ceilings did not show such a trend and appear to have fluctuated within a 60 percent to 70 percent range.

Table 7.

BCEAO and Members: Short-Term Credit to the Private Sector and Rediscount Ceilings, 1963–74

(Quarterly averages: in billions of CFA francs and percent)

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Source: Data provided by the BCEAO.

As a result of these two tendencies, the ratio of rediscountable credit to total credit also declined, from an average of 64 percent during the period 1965–69 to 58 percent during 1970–74. A corollary of this development is the increasing importance of the nonrediscountable credit (from less than one third to over two fifths of total short-term credit) financed by the banks’ own, mainly deposit, resources. It may be argued that the decline in the importance of rediscounts as a source of financing credit was due to the BCEAO’s following a restrictive rediscount policy. However, the rediscount ceilings were not fully used, and there appears to be no evidence that an increasing proportion of these ceilings was used by the banks, which meant that the policy stance of the BCEAO was liberal. Alternatively, as the proportion of rediscountable credit in total credit declined, the rediscount ceilings may have gradually become less important as a monetary policy instrument. This is evident from the subsequent discussion.

Liquidity Ratio

In theory, a liquidity ratio serves a double function—to control the rate of increase in credit and to ensure bank solvency. The liquidity ratio can also be an instrument to influence the distribution of credit.

Under the pre-1974 statutes, the BCEAO was empowered to impose minimum liquidity ratios upon commercial banks and other financial institutions, but this role was modest and used primarily as a means to ensure that short-term liabilities were covered by short-term assets. By including in the denominator only liabilities of less than six months, the ratio excluded other liabilities, such as time deposits, of more than six months” maturity. Thus, on the one hand, it preempted a large part of demand deposits for the financing of rediscountable credit, but, on the other hand, it left out time deposits from the definition of the ratio, allowing the banks a considerable degree of margin to determine the distribution of credit between rediscountable and nonrediscountable credit.

Table 8 gives the average end-quarter liquidity ratios for the member countries. Note that the actual ratio for the area was above the requirement for every single year. Thus in practice the required liquidity ratio was not a serious constraint on the ability of banks to increase credit for nonrediscountable purposes. At the same time, since the rediscount ceilings also remained generally underutilized, banks could shift from rediscountable to nonrediscountable assets and vice versa. Therefore, the liquidity ratio was perhaps not even an effective means of influencing the broad distribution of credit between rediscountable and nonrediscountable credit.

Table 8.

BCEAO and Members: Liquidity Ratio, 1965–74

(Quarterly averages)

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Source: Data supplied by the BCEAO.

Could the liquidity ratio be regarded as a potential tool for influencing credit development? Of course, insofar as time deposits were not included in the definition of the ratio, it could control credit only partially. Apart from this limitation, the effect of varying the liquidity ratio may be illustrated as follows:


(where Q = liquidity ratio: R = cash reserves; RDC = rediscountable credit held in banks’ portfolios: RD = credit rediscounted at the central bank: and DD = demand deposits.) Thus an increase in Q can be achieved, given DD and the total level of rediscountable credit (RDC) by either increasing R or RDC (with a corresponding decrease in rediscounts with the central bank, RD). However, the increase in cash reserves, R, is akin to an increase in special deposits, an instrument which the BCEAO has not used. The increase in RDC would be possible if banks reduced their rediscounts with the BCEAO and correspondingly increased rediscountable assets in their portfolio. But this could only be done by banks’ calling in their nonrediscountable short-term credit (assuming that medium-term credit could not be immediately liquidated). Hence, an effective limit on any increase in Q was the amount of nonrediscountable credit extended by banks. During the period 1963–74, such credit averaged about CFAF 155 billion, while Q averaged about 84 percent, and DD + RD about CFAF 200 billion. In these circumstances, a I percentage point increase in Q would have involved eliminating nonrediscountable credit entirely—the BCEAO could not have increased Q by more than 1 percentage point.

It should be noted that an increase in Q cannot be achieved by simply increasing the level of total rediscountable credit or even by increasing the amount rediscounted at the Central Bank, because the latter enters into both the numerator and the denominator in the liquidity ratio. It can further be shown that:

R = Q (DD + RD) − RDCRD

This implies that the absolute level of required reserves, given total rediscountable credit and rediscounted credit, will increase by an amount equal to the percentage point increase in Q multiplied by the short-term liabilities of banks. Given that during the period Q averaged about 84 percent, while (DD + RD) averaged about CFAF 200 billion, a 1 percentage point increase in Q would have forced an increase in R of about CFAF 1.7 billion. Since R could be increased primarily by reducing nonrediscountable credit, and since the maximum increase in Q was I percentage point, the level of total credit could have fallen only by about 1.3 percent in all. However, in terms of the increase in reserves, the impact on individual banks could have been more traumatic, since banks in general kept only small cash reserves (because the holding of rediscountablc paper served the function of reserves).

Interest Rate Policy

Until 1973, the BCEAO followed a policy of relatively low and stable nominal interest rates. The BCEAO fixed its rediscount rate and correspondingly also set various interest rates (and commissions) charged by commercial banks on various categories of loans, as well as the deposit rates. These interest rates were applied uniformly throughout the Monetary Union, with only a few exceptions related to the deposits of certain public enterprises, interest charged by national treasuries on customs’ duty bills, interest on savings deposits with the savings banks (Caisses d’Epargne), and commissions on transfers abroad.

The structure of nominal interest rates remained unchanged from 1963 until the revision in January 1973 (Table 9). In all, the BCEAO fixed about two dozen lending and deposit rates: on the lending side, the BCEAO’s rediscount rate was fixed at 3.5 percent and the maximum commercial bank rate at 7.5 percent. On the deposit side, the interest rate was differentiated both according to the size of the deposit and its maturity. Thus, deposits up to CFAF 200.000 earned no interest while larger deposits earned interest ranging between 1 percent and 4.5 percent. This policy of low interest rates was subjected to repeated criticism, on two main grounds: that it neglected the supply of and demand for loanable funds, and that, given unrestricted inflows and outflows of funds between the WAMU and France, the growing divergence of interest rates between the two tended to encourage capital outflows. In particular, it was stressed that low interest rates discouraged savings, encouraged investment in low priority sectors, encouraged banks to finance less risky investments (such as the import trade), and constrained the Central Bank in its conduct of monetary policy.

Table 9.

BCEAO: Structure of Nominal Interest Rates, 1963–72

(In percent)

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Sources: BCEAO, Note d’Information, No, 203 (Paris), February 1973, pp. 20–21; and Banque de France, Bulletin Trimestriel, No. 51. June 1984.

Except for export paper with a maximum maturity of one month, for which the discount rate was 3.0 percent.

Relates to rediscount operations with promise to transfer the credit title back to the original lender and with a maximum maturity of six months, but with total rediscounts limited to 10 percent or less above the rediscount ceiling.

Obligations cautionnées.

In addition, the BCEAO charged an initial commission or between 0.25–0.50 percent, depending upon the maturity of the loan, except for those credits guaranteed by the state.

These rates apply only to rediscounted credits within the approved credit limits. For rediscountable credits beyond those limits, and for nonrediscountable credits above CFAF 5 million, the interest rate was fixed at 9 percent: for credits below CFAF 5 million, the interest rate varied between 6 and 8 percent.

These criticisms glossed over the distinction between nominal and real interest rates and the rationale behind the BCEAO’s policy. The general philosophy of the monetary authorities was, as mentioned earlier, that the BCEAO should be a cofinancier and not a lender of last resort, since interest rates could not perform their usual functions of promoting financial savings and allocating them in an efficient manner in member economies. The view was that, because of relatively low incomes, there was a tendency for a high propensity to consume at almost all income levels, with savings relatively elastic to rising incomes but practically inelastic with respect to interest rates. This view was supported by a perception that financial intermediation was unlikely to grow in the Union because the “technical expertise” to set up additional financial and nonfinancial intermediaries would have had to come from abroad, but the low volume of financial savings in the area, which, at best, would grow only very slowly, was hardly an inducement, particularly in the early years of the BCEAO.

Two other, practical, considerations could have justified the low interest rate policy. First, the governments in member countries played a crucial role in economic development, and had significant requirements for investment in economic and social infrastructure. Such public investment was interest inelastic, and the authorities would have been concerned to hold interest costs down. Second, in the private sector too, most of the demand for loanable funds was for seasonal (export) credit that was determined by the volume and value of agricultural crops and was also largely interest inelastic. In these circumstances, equality between the demand for and supply of loanable funds could be more easily brought about by setting credit ceilings than by allowing freedom for the interest rate mechanism to work.

One may lake this argument a little further. In its perceived role as a cofinancier, the BCEAO was concerned to stimulate demand for an appropriate amount of credit to meet the legitimate needs of member economies. By fixing low interest rates, it provided liberal credit ceilings, which were rarely fully utilized, implying that the level of credit was allowed to be determined by demand rather than supply. Since the BCEAO could not determine both the level of credit and that of the interest rate, it preferred to fix the latter whenever forced to choose between the two policies.

A policy of low nominal interest rates generally implies negative real rates. An examination of the relevant data for the BCEAO countries reveals, however, that even at the low nominal interest rates maintained by the monetary authorities, savers were rewarded with a positive real rate on their savings, at least until 1972. Thus, given the nominal savings deposit rate of between 3.25 percent and 4.50 percent, the average annual rate of increase in the consumer price index between 1963 and 1971 was 1.5 percent in Burkina Faso, 2.5 percent in Togo, 3.8 percent in ivory Coast, 4 percent in Senegal, and 4.4 percent in Niger. The rate of inflation began to pick up only in the 1970s: prior to 1970, the annual rate of inflation was generally below the average rates and more uniform among the members of the Union. The low nominal interest rate policy of the BCEAO did not, therefore, mean a negative real rate on fixed deposits.

How did the real interest rate in the BCEAO compare with that in other countries? Since comparable deposit rates are not easily available, rediscount rates and the average annual interest rates for the BCEAO countries are compared with those in some countries in Europe. Africa, and Asia (see Table 10). Although rediscount rates are not always a good proxy for other interest rates, at least in Africa, there tends to be a close correspondence between the rediscount rate and the major deposit and savings rates. It will be noted that, except for Thailand, the real rediscount rate (defined as the difference between the rediscount rate and the average annual rate of inflation) in the BCEAO countries compares favorably with the other countries in the sample. Paradoxically, the real rediscount rate in the Republic of Korea, often cited approvingly by proponents of high real interest rates, had a higher negative real rate than any of the live BCEAO countries.

Table 10.

Real Discount Rates, 1963–73

(In percent)

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Source: International Monetary Fund. International Financial Statistics (Washington: IMF).

It could still be argued, however, that savings are not interest inelastic, and that even though real rates were positive, the monetary authorities did not provide enough incentive to encourage savings, so that a policy of higher interest rates would have been more appropriate. To answer this question, various regressions were run for individual member countries of the Union relating the ratio of savings to GDP with the real interest rate (or the rediscount rate minus the rate of change in consumer prices). (As the nominal rate remained unchanged between 1963 and 1972, only the real rate varied.) In general, there was no significant response of the savings ratio either to the interest rate or to GDP. Thus, in the case of Ivory Coast, although the savings ratio was positively related to the interest rate and GDP in individual regressions, the results were not statistically significant. When the two explanatory variables were combined in a single equation, the coefficients were negative. In the case of Benin. Niger, and Togo, although the coefficients were positive in both single and joint equations, the relationship was statistically insignificant. In Benin, the addition of the discount rate to GDP as the explanatory variable did improve the relationship, but it was still statistically insignificant. In the case of Burkina Faso, however, the savings ratio was negatively correlated with GDP, but positively correlated with the discount rate. But again the equations were statistically insignificant.

The results thus do not suggest a definite relationship between the savings ratio and the interest rate (or, for that matter, between the savings ratio and GDP), giving no support to the advocacy of a high interest rate policy. The most that could be concluded is that in some countries there was a positive association. The argument for high interest rates would have to depend essentially upon the theoretical presumption that a higher reward should provide higher savings. Even this presumption only suggests a policy prescription that the monetary authorities should provide a positive real rate of return, without quantifying how large it should be.

Although total savings may not be interest elastic, it can be argued that financial savings, or those savings invested in financial assets, may be positively related to interest rates. Higher interest rates would induce savers to keep their savings in financial assets, thereby increasing the scope of financial intermediation in the economy. Since the growth of financial intermediation is supposed to assist development, a policy of high interest rates becomes desirable, even though total savings may not be interest elastic.

In the BCEAO countries, financial savings are represented mainly by currency and bank deposits. To test the responsiveness of financial savings to real interest rates, the ratio of the increment in financial savings to total savings was regressed on real interest rates (the discount rate deflated by consumer prices) and GDP for individual countries. Since financial savings in the form of currency holdings bear no interest, the ratio of deposits to currency plus deposits was regressed on the real rediscount rate and GDP. The ratio of financial savings appeared to be positively related both to GDP and the real discount rate in Burkina Faso, Ivory Coast, and Niger, However, while the coefficients were significant in the case of Ivory Coast, they were not for both Burkina Faso and Niger. In Benin and Togo, however, the coefficients were negative and statistically insignificant. As regards the ratio of deposits to currency plus deposits, only in the case of Niger was it both positively and significantly related to the real discount rate. In Benin, Burkina Faso. Ivory Coast, and Togo, it was negatively related to the real rediscount rate and the results were insignificant. In all these countries. GDP was a significant explanatory variable for changes in the deposit ratio.

Thus, the evidence about the responsiveness of financial savings to the interest rate is contradictory—both for individual countries and for categories of financial savings. But compared with the results for total savings, this result does not conclusively mean that some beneficial effects on financial savings could not arise from a policy of positive, or even high, real rates of return.

Hence, the criticism of the relatively low interest rate policy in the BCEAO’s first decade of operation may well have been overstated. Notwithstanding low nominal rates, real returns on deposits were positive in most member countries throughout the 1960s and early 1970s. The policy of low interest rates was also a logical complement of the Bank’s perceived role as a cofinancier—a supplier of funds. Finally, an examination of the data on savings, financial savings, and interest rates for the period 1963–73 did not reveal sufficiently conclusive evidence on the responsiveness of savings to the interest rate to justify a critique of the low interest rate policy. The case for higher interest rates, however, may be more persuasive for the 1970s when the rate of inflation in these countries had accelerated and the financial markets and savings habits had become more sophisticated.

Credit to Governments

Under its statutes, the BCEAO is authorized to grant credit to a member country’s treasury, at the current rediscount rate, in the form of “ways and means” (or short-term) advances for a period not exceeding 240 days, consecutive or not, in any calendar year. (Under the 1966 amendment of Article 15, the BCEAO was authorized to waive the 240-day limit in the case of special difficulties.) In addition, the BCEAO could also accept member countries’ treasury bills with maturities of less than sixthe indebtedness of the treasury months for rediscounting, for temporary advances (prises en pension), or as collateral for advances within certain limits fixed by the BCEAO. It could also accept such bills from commercial banks without their endorsement, provided that the banks were not acting as intermediaries for the treasuries, and provided that the total amount of such intervention by the BCEAO for each bank did not exceed 10 percent of the average amount of deposits with the banks concerned during the preceding 12 months. Excluded from this calculation were the deposits placed with a bank by a treasury and the Postal Checking System corresponding to the deposits of individuals or private corporate bodies with these two institutions.

The statutes prescribed a legal limit on all such credit to governments. Until the statutes were amended, the total amount of credit granted to governments by the BCEAO, including loans provided via treasury bills, could not exceed 10 percent of fiscal receipts in the preceding budgetary year. The amendment raised this limit to 1? percent of fiscal receipts, with the proviso that advances might be granted up to this limit only after the BCEAO had reviewed developments in currency issue and evaluated the effect of the requested advance on domestic liquidity. The limit on the BCEAO’s credit to a treasury was adjusted by the amount of the indebtedness of the treasury vis-à-vis banks availing themselves of the BCEAO’s rediscount facilities. Since all banks used these facilities, in practice the statutory limits on credit by the BCEAO became limits on total bank credit to governments.

Various unique features may be noted in the provisions relating to credit to governments. Unlike credit to the private sector, it was statutorily limited within a narrow ceiling. However, until the 1968 amendment, the BCEAO could not refuse credit to a member government, notwithstanding domestic and external balance considerations, up to the statutory ceiling: after the credit limit was raised, only the additional 5 percent margin was made subject to the discretion of the Central Bank, which was enjoined to take into consideration the domestic liquidity effects of such credit. (In practice, however, in no case did the BCEAO refuse credit under this provision.) Furthermore, credit policy vis-à-vis the private sector continued to be determined independently of credit to governments, which could not be, and was not, predicted at the lime private credit ceilings were fixed. Thus, fiscal policy was not integrated with monetary policy, except indirectly via the effects of fiscal operations on the flow of deposit resources to the commercial banks, since these determined the individual bank’s rediscount ceiling with the BCEAO.

The BCEAO accepted only short-term treasury obligations and, even within the prescribed limits, provided no medium-term credit to governments. This injunction implied that the role of the BCEAO should not include development financing by the public sector, even though it provided medium-term financing to the private sector (via medium-term rediscount ceilings).

As mentioned earlier, the Central Banks’ statutory ceiling was modified by the amount of credit given by the commercial banks. The BCEAO also accepted only those obligations of a treasury which had outstanding maturities of up to a maximum of six months. This, in effect, discouraged the development of bond markets outside the banking system, which found little incentive to hold longer-term government obligations that could not be readily sold or rediscounted. The governments also presumably found no particular attraction in floating treasury bills or other government instruments, since if such assets were sold to banks, they would probably be subject to the BCEAO’s statutory credit ceilings.

Data on the BCEAO’s statutory ceilings on credit to governments and their utilization are given in Table 11. The use of ceilings averaged around 22 percent: member governments made only moderate use of the Bank’s credit facilities. However, the average for the entire area (which in Table 11 includes member countries in each year, and not only the present ones) is low because the two major member countries. Ivory Coast and Senegal, made relatively little use (in comparison to the statutory maximum) of the BCEAO’s credit facilities during the period (Table 12). Benin and Niger, on the other hand, made more intensive use of the facilities. Indeed, it may be said that it was because of the latters’ severe fiscal problems, and their intensive recourse to bank financing, that the limit was raised in 1968.

Table 11.

BCEAO: Use of and Ceilings on Credit to Governments, 1963–73

In millions of CFA francs and percent)

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Source: BCEAO. Statistiques Monétaires (Paris). May 1975.

End of year: relates to all member countries in year indicated.

Maximum use during the year by all member countries.

Table 12.

BCEAO Members: Credit to Governments, 1963–73

(In millions of CFA francs)

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Source: international Monetary Fund, International Financial Statistics Yearbook (Washington: IMF, 1980).

The relatively low use of the BCEAO’s credit ceilings by governments such as Senegal does not indicate that the ceilings were appropriate or more than met the needs of the treasuries of member countries. Indeed, as the case of Senegal illustrates, member governments did experience chronic and severe fiscal problems, and had to seek means other than borrowing from the Central Bank to finance treasury deficits. They appear to have regarded central bank borrowing as truly short term and not suitable to finance annual treasury requirements. In the circumstances, governments tended to resort to external borrowing, especially in the Eurodollar markets, and, in some cases, they built up domestic payments arrears.

The intentions of the statutory limitations on bank credit to governments were easily bypassed by this reliance on external financing. If the limit was intended to control the expansion of domestic demand, it was ineffective. Some indirect domestic bank financing was also probably involved in bypassing these limits, in that domestic suppliers to whom the governments owed payments tended to seek commercial bank financing to continue operations. (The extent to which this occurred is hard to quantify, but commercial banks frequently voiced this reasoning when requesting higher credit ceilings.) Two undesirable consequences followed from this. By encouraging external borrowing rather than borrowing from the domestic banking system, the statutory limits on domestic credit resulted in increasing the external debt-servicing burden for the entire Union (which, however, was not out of proportion to the WAMU’s overall balance of payments needs or to its overall debt-servicing capacity). Second, domestic payments arrears tended to be less visible in government operations and, therefore, probably masked the fiscal pressures and the urgent need to undertake corrective fiscal actions.

Governments also, intentionally or unintentionally, used other means to finance some of the expenditures which could be properly classified as budgetary. Thus, in many instances in the BCEAO countries, state enterprises were made responsible for some such expenditures; for example, subsidies on goods sold to the public were made the charge of agricultural marketing boards, which financed these operations either by using profits from their export transactions or from domestic bank borrowing. The BCEAO’s statutory limits did not apply to credit extended to state enterprises; this was governed by the policy regarding credit to the private sector. Thus, in the case of Senegal, the Office Nationale de Coopération et d’Assistance pour le Développement (ONCAD) and the Caisse de Péréquation were formally responsible for providing consumer subsidies. The ONCAD incurred substantial “deficits” on those operations and financed them by borrowing from the banking system, (In theory, the BCEAO did not allow credit to finance the deficits. In the case of the ONCAD, bank credit was extended as seasonal crop financing.)

In short, the statutory limit on credit to governments suffered from several drawbacks and could not be considered as an effective instrument to moderate demand pressures. The authorities of the WAMU appear not to have recognized the inadequacy. Instead, under pressure from member governments, they periodically raised the limit on such credit, first to 15 percent in 1968 and (hen to 20 percent under the new statutes. But this liberalization may be characterized as misplaced at best, and, as a result, the necessary coordination of monetary, fiscal, and external borrowing policies was unlikely to have been achieved by statutory limits on government borrowing from the domestic banking system.