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The views expressed in this paper are those of the author and should in no way be interpreted as reflecting those of the International Monetary Fund. The author is grateful to colleagues in the Fund for many valuable comments and suggestions.
Nominal GDP is a candidate, but may not be very helpful in situations of very high inflation, and where national accounts statistics are rudimentary at best.
The assumption that inflation is the final target for monetary policy does not, of course, preclude the authorities from having other macroeconomic objectives, such as growth and external balance. But it is usual to think of fiscal, structural and (depending on the regime) exchange rate policies as being the relevant “weapons” to tackle these problems, given the nominal anchor provided by monetary policy.
There have been cases in Fund programs where a budget surplus has been required to reconcile the underlying balance of payments position with a fixed exchange rate objective, and this possibility cannot be ruled out in FSU countries. The existence of quasi-fiscal deficits at the central bank may also have a bearing on the sustainability of an exchange rate peg (as well as on the control of inflation more generally).
The squeeze may be alleviated by starting out with a crawling peg arrangement, including regular pre-announced adjustments, that quickly converges to a fixed rate regime. However, the Latin American experience with crawling pegs (compare, for example, the successful Mexican version with the failure of the Argentinean “tablita”) demonstrates that they do not avoid the need for tight fiscal policy.
It will also generate a real income transfer from indebted enterprises to “surplus” enterprises, who are increasingly important holders of bank deposits.
Such a move would naturally have to be accompanied by a renewed commitment to stringent financial policies, to limit the potential loss of credibility.
A black, or parallel, market rate may suffice for this purpose, provided that it can be measured systematically and with a reasonable degree of confidence.
There is an extensive literature on these questions: see, for example, the papers in parts I and II of Connolly (1982).
Though they may not be, in which case the system could be left without a nominal anchor: see below.
The definitions of M1 and M3 are not always identical across countries: we use the terms here as shorthand for “narrow money” (cash plus demand deposits) and “broad money” (cash plus demand and time deposits), respectively.
Foreign currency deposits could become an increasingly important vehicle for saving too, in which case the demand for M3 is likely to be, more stable if defined to include such deposits (depending, to some extent, on the behavior of the exchange rate). The question of whether, and under what conditions, the FSU authorities should attempt to restrict the creation and use of foreign currency deposits is one that would warrant a separate study.
MO has the additional advantage that data for it tend to be available more quickly and at a higher frequency than is the case with M3.
It needs to be acknowledged that this is only partly a legal question; it depends to a large degree also on how laws are interpreted by parliaments and governments, and on the relative political strengths of the various players.
A bank in need of cash but without foreign currency can go to the monetary agency and borrow or draw on its deposits there. The monetary agency, in turn, either draws down its own domestic currency holdings or liquidates some of its foreign assets and buys domestic currency from the issuing authority. The separation of agencies ensures that, however large are banks’ borrowed reserves at the monetary agency, the foreign assets of the two agencies combined is never less than the amount of domestic currency in existence.
Safeguards may also be needed to prevent the government from coercing the commercial banks into a role of residual lender (Osband and Villanueva (1992)).
Two caveats should be acknowledged here: first, one could reasonably argue that the market rate would have been much lower (more appreciated) had a currency board or some other credible monetary policy been implemented; second, there was widely believed to be a cash shortage (for technical reasons) in Russia in the summer of 1992. On both counts, the reserve cost of backing the monetary base might be somewhat understated in these simple calculations.
Relatively stable interest rates would also be helpful in encouraging the growth of money markets in the FSU countries.
The amount should be determined by a conventional monetary programming exercise, and adjusted with a view to keeping central bank NDA and NFA within their program limits.
There is already a large volume of interbank lending in FSU countries which could develop, or be encouraged to develop, into a more formal money market.
“Adverse selection” because more creditworthy borrowers will tend to drop out as interest rates rise; “adverse incentive” because a given borrower will opt for riskier projects as rates rise (see Villanueva and Mirakhor (1990)).
The removal of inherited bad debts from banks’ balance sheets is also essential before deposit insurance schemes are introduced.
Equally, it is often the case that reserve requirements can safely be reduced only when accompanied by a tightening of fiscal policy.
Assuming that, in the aggregate, banks have no significant sources of funds other than central bank credit and reservable liabilities (deposits).
This seems a more relevant formulation in current circumstances than McKinnon’s (1991) proposal for the U.S.S.R., which was to exclude all “liberalized” enterprises (those free to set their own prices, market their own output etc.) from bank credit. Such enterprises would be required to be self-financing in McKinnon’s scheme. Only those remaining under strict state control would be eligible for credit, on the grounds that the state could then supposedly ensure that the credit was not frittered away in higher wages or on reckless investments.
It may be necessary to allow some specified increase for inflation—despite the dangers of indexation—if a squeeze on working capital is to be avoided.
The new commercial banks, which are more in the nature of credit cooperatives than deposit money banks, could be excluded from the moratorium, on the grounds, first, that they are not directly state-owned, and so should be allowed to take their own chances and, second, that enforcement on these banks would probably be extremely difficult.
These enterprises will probably not be able to borrow from the banks even after meeting the provision-of-information requirement, since their financial position is presumably dismal.
They should not, however, necessarily be liquidated, especially if the problem is mainly due to distorted relative prices. It may be that, on radical restructuring, or once the relative prices are rationalized, the firm can begin to produce profitably. But, in the interim, it would be better to have the workers paid to do nothing than to allow them to continue wasting valuable inputs.