Monetary Policy in Selected Asian Countries
  • 1 0000000404811396 Monetary Fund

This study provides an overview of the role of money and monetary policy in selected Asian countries—Indonesia, Malaysia, Nepal, the Philippines, Singapore, Sri Lanka, and Thailand.1 The study analyzes the constraints imposed by underdeveloped financial markets on certain policy instruments, on the one hand, and the possible adverse effects of certain policies on long-term financial development, on the other. In all of these countries, central banks have been active in developing new institutions and strengthening existing ones. In the context of their economies, this is fully as important an aspect of monetary policies as demand management. However, the present study concentrates almost entirely on the latter topic. The paper focuses on a general cross-country analysis, rather than on the individual experiences of the countries, and does not deal in detail with the institutional aspects of monetary policy as such.


This study provides an overview of the role of money and monetary policy in selected Asian countries—Indonesia, Malaysia, Nepal, the Philippines, Singapore, Sri Lanka, and Thailand.1 The study analyzes the constraints imposed by underdeveloped financial markets on certain policy instruments, on the one hand, and the possible adverse effects of certain policies on long-term financial development, on the other. In all of these countries, central banks have been active in developing new institutions and strengthening existing ones. In the context of their economies, this is fully as important an aspect of monetary policies as demand management. However, the present study concentrates almost entirely on the latter topic. The paper focuses on a general cross-country analysis, rather than on the individual experiences of the countries, and does not deal in detail with the institutional aspects of monetary policy as such.

This study provides an overview of the role of money and monetary policy in selected Asian countries—Indonesia, Malaysia, Nepal, the Philippines, Singapore, Sri Lanka, and Thailand.1 The study analyzes the constraints imposed by underdeveloped financial markets on certain policy instruments, on the one hand, and the possible adverse effects of certain policies on long-term financial development, on the other. In all of these countries, central banks have been active in developing new institutions and strengthening existing ones. In the context of their economies, this is fully as important an aspect of monetary policies as demand management. However, the present study concentrates almost entirely on the latter topic. The paper focuses on a general cross-country analysis, rather than on the individual experiences of the countries, and does not deal in detail with the institutional aspects of monetary policy as such.

This study stresses one aspect of the structural and policy conjuncture in which monetary policy must operate. This aspect is the high degree of openness of the Asian countries in respect of both the freedom of movement of goods and capital and the importance of these movements relative to the size of the economies. Singapore is, of course, the best example, and Nepal is a good example as well, in relation to its neighbor, India. Indonesia, Malaysia, the Philippines, and Thailand, too, are highly open economies, and recent policy changes have also opened up the Sri Lanka economy. While they are highly open, these countries have followed exchange rate policies that, even if they have not involved formal fixed rate arrangements, have been much closer to that end of the spectrum of possible policies than to the other end—freely fluctuating rates. The combination of these two factors limits the scope for independent monetary policies, as it is well known that an open economy with a fixed exchange rate cannot have for long an inflation rate different from the world inflation rate.

Section I provides the theoretical underpinning for the discussion in subsequent sections and reviews briefly the role of money and the effectiveness of monetary policy. Particular attention is paid to the difference between short-term and long-term stabilization policies in developing countries. This section also discusses the interrelationship between monetary and exchange rate policies in open economies.

Section II analyzes the impact of changes in monetary variables on prices in the presence of constraints on monetary policy in the Asian countries. Our quantitative work examines the stability of the money demand functions in these economies; the public’s demand for real cash balances is seen to bear a stable relationship to real income and the yields on alternative assets. The stability of this relationship provides a basis for expecting monetary policy to have a predictable influence on the rate of inflation in these economies. Our work also shows a significant correlation between money supply variations and inflation. The section concludes with a discussion of the money supply process in these countries, concentrating both on the factors responsible for money supply changes and the countries’ experience with various instruments of monetary policy.

Section III presents the various considerations involved in the choice of the monetary aggregate that is best suited for use as a target—the relationship of various aggregates to the authorities’ ultimate objectives, and the controllability of the aggregates—and the considerations involved in the determination of the appropriate value of such a target. It is argued that, for a variety of theoretical and institutional reasons, monetary policy formulated in the framework of medium-term targets for monetary aggregates may be appropriate for developing countries. The results of our empirical work on these questions, as they relate specifically to Asian countries, are also discussed.

The concluding section of the paper, Section IV, brings together the principal results of the study and discusses their broader implications for the conduct of monetary policy in developing countries. It is hoped that the experience of Asian countries will provide some lessons that may be useful to other countries in similar stages of financial and economic development.

I. Analytic Aspects of Monetary Policy in Developing Countries

In this section, we provide the basic analytical framework for the discussion of monetary policy in developing economies. Over the last two decades, a great deal of research in monetary theory has concentrated on the role of monetary variables in the determination of output, prices, and the balance of payments, with the literature revolving around the arguments associated with the Keynesian-monetarist controversy. Most of this literature has been developed in the context of industrial countries, and little effort has been made to adapt it to developing economies. A comprehensive review of the literature and its application to developing economies is clearly outside the scope of this paper. In this section, we attempt only to summarize the major developments in those areas that are directly relevant to the performance of monetary policy in developing countries. First, we consider the impact of money on prices and output and the implications this impact has for short-term stabilization policy. Second, we extend the analysis to open economies. Finally, we outline the factors relevant to the choice of an exchange rate regime, placing particular emphasis on the close relationship between the appropriate exchange rate and monetary policies.

Scope for Stabilization Policy in Developing Economies

The question of effectiveness of stabilization policy has usually been raised in the context of the Keynesian-monetarist debate. The general tendency to identify with one or the other school has resulted in the magnification of differences, which are often more apparent than real. In fact, it can be argued that there is little disagreement over the major theoretical issues between the Keynesians and monetarists.2 The disagreement is basically over the evaluation of the existing empirical studies on the size of various key parameters and the implications for stabilization policy.

In the Keynesian view, the main source of instability in the economy is variations in aggregate demand. Changes in aggregate demand lead to changes in the rate of interest, which, in turn, given an interest-elastic demand for money, lead to an excess demand for, or an excess supply of, money. While a rise in aggregate demand leads to an excess supply of money and to higher prices, a fall in aggregate demand leads to an excess demand for liquidity that, given the key assumption of the downward rigidity of wages and prices, results in a fall in output and employment. As a result of periodic demand shocks, the economy oscillates between bursts of price inflation and unemployment. The sensitivity of the economy to an initial demand shock crucially depends on three conditions, namely: (1) the lower the marginal propensity to save, the higher the magnification of the initial demand shock through the “multiplier” process and the greater the degree of instability; (2) the lower the interest elasticity of investment, the lower the offsetting change in investment brought about by the initial change in the interest rate and the greater the degree of instability; and (3) the higher the interest elasticity of the demand for money, the higher the increase in excess liquidity brought about by the initial change in the interest rate and the greater the degree of instability. These three conditions, which tend to accentuate the impact of demand shocks, are also the conditions that render fiscal policy more effective than monetary policy. Based on the assumptions of a low marginal propensity to save, a low interest elasticity of investment, and a high interest elasticity of demand for money, Keynesians emphasize the relative effectiveness of fiscal policy in stabilizing the economy, although they do not rule out the use of monetary policy.

While the monetarists basically agree with this theoretical framework, they feel that the empirical evidence does not justify the Keynesian belief in the effectiveness of stabilization policies. Monetarists would argue that the marginal propensity to save and the interest elasticity of investment are, in fact, quite high, while the interest elasticity of the demand for money is quite low. Under these conditions, the impact of any demand shock is rapidly neutralized, because small changes in the interest rate lead to large changes in investment that offset the initial shock. Similarly, the impact of fiscal expansion would be only to “crowd out” private expenditure. The same conditions that render fiscal policy ineffective make monetary policy effective. Under the assumption of an interest-elastic demand for money, small changes in the money supply lead to large changes in the interest rate and, consequently, in investment. Moreover, in the monetarist framework, monetary balances directly affect aggregate expenditure through the wealth effect, a mechanism that strengthens the impact of monetary policy on the economy. However, far from advocating monetary policy to correct any demand shock—the effects of which would be expected to dissipate rapidly anyway—monetarists argue for a fixed-target monetary rule, because they view monetary variations as the major source of economic instability.

In the monetarist view, short-term stabilization policy is ineffective: in the long run, because the growth of output is determined by its “natural” full-employment rate and is independent of any policy measures; and, in the short run, because the actual growth of output can deviate from its natural rate only insofar as the public’s expectations of price inflation differ from actual price changes.3 Contrary to the Keynesian position, which perceives that there are many structural rigidities that result in a slow adjustment of the labor market, the monetarist position assumes that wages are perfectly flexible and that there is no involuntary unemployment. Because of long and variable lags, monetarists further believe that any attempts to stabilize the economy by using monetary policy will result in fluctuations in output and prices in the future. Under these circumstances, it would be best to utilize a fixed monetary target, which is aimed at stabilizing the price level, while allowing short-term fluctuations in output to be stabilized through the market mechanism.

In recent years, the gap between the two opposing positions has narrowed. Keynesians tend to concede that their original position regarding the destabilizing impact of demand shocks on the economy was perhaps overstated; the empirical evidence on the size of the relevant parameters accords more closely with the monetarist view. Nevertheless, they argue that demand shocks do contribute significantly to short-term fluctuations in output and that, despite the uncertainties associated with various adjustment lags, short-run stabilization policy can be effective.4

Although both Keynesians and monetarists can point to numerous econometric studies supporting their positions, the empirical evidence on the effectiveness of stabilization policies in the developed countries is still far from conclusive. It is even more difficult to draw any firm conclusions on this issue for the developing countries, because stabilization policy in these countries has received very little attention.5 Nevertheless, we can draw certain tentative conclusions by incorporating some of the existing empirical evidence on the size of various parameters, as well as the major institutional and structural factors peculiar to developing countries.

The marginal propensity to save in the developing countries is generally quite low, leading to a high arithmetic value for the multiplier. Prima facie, this indicates that demand shocks are a strong source of instability and that fiscal policy can be utilized effectively to offset these shocks, but the validity of this argument has been challenged on the basis of a number of factors. Agricultural production, which constitutes a large portion of total production in most developing countries, is supply-determined and quite insensitive to demand factors; manufacturing production in many developing countries is also insensitive to demand factors because of the lack of adequate capital, trained labor, and technical knowledge. Moreover, the rigidities in wages and prices that are present in the industrial countries are not present in many of the developing countries because of the surplus labor situation and the absence of powerful labor organizations. Consequently, unemployment in the developing countries is largely in the form of “disguised,” as opposed to “frictional,” unemployment. In this setting, supply factors become the major source of instability in output, and demand management policy becomes rather ineffective in stabilizing output.6

Estimates of the interest elasticity of investment are seldom available for the developing economies. As a result of fragmentation of financial markets, it is difficult to have a clear picture of the flow of funds and its sensitivity to changes in interest rates. The size of the unorganized market is relatively large, but there is little reliable data available covering it. While data on the organized market are more readily available, credit and interest rates in this market are often subject to various controls. As a result of these controls and the nature of the financial markets, availability of credit is often a more important element in the determination of private investment than the cost of credit.

Estimates of the interest elasticity of demand for money are more readily available owing to a large number of econometric studies in this area. Although interest rate series are unavailable for many countries, the rate of inflation can be viewed as a measure of the opportunity cost of holding money, and its coefficient as an indirect estimate of the interest elasticity of demand for money. The econometric estimates of this elasticity are generally significant in the statistical sense, but the estimated coefficients are relatively small for most countries (see Section II).

An analysis of the role of monetary and fiscal policy based on an examination of the size and importance of the key parameters—the marginal propensity to save, the interest elasticity of investment, and the interest elasticity of demand for money—in the developing countries would tend to lead to the conclusion that there is less scope for short-term stabilization policy in these economies than in developed countries.

More recently, the relevance of the basic monetary framework to the developing countries has been challenged on more fundamental grounds. The proponents of this view, notably McKinnon (1973) and Shaw (1973) argue that the fragmentation of capital and financial markets in the developing economies is the most important factor leading to retardation of growth and development. The major aim of monetary policy should, therefore, be to promote the development of capital and financial markets rather than to focus on short-term stabilization. McKinnon and Shaw challenge the traditional view that money and capital are substitutes, arguing instead that because of limited availability of alternative financial assets in the developing countries, money is the major vehicle for the debt-intermediation process arising from capital accumulation; consequently, money and capital are viewed as complements, and not as substitutes.7

A corollary to the McKinnon and Shaw argument is the necessity of providing high rates of interest on monetary assets, in order to shift the portfolio of private savings from nonproductive physical goods to monetary assets. In this view, the bottleneck in the process of capital formation is the inadequate flow of monetary savings to finance investment projects, rather than the lack of profitable investment opportunities (which would call for a reduction in interest rates). Thus, the major goal of the monetary authorities should be to promote the development of domestic capital markets, so that savings of rural and urban households are attracted into the financial system. This result can be best attained by providing alternative liquid assets with attractive real yields. In the McKinnon and Shaw framework, therefore, the overall role of short-term stabilization policy is rather limited, primarily because emphasis is put on the longer-term development of the financial sector; this is considered to be best achieved by providing a stable monetary situation conducive to the growth of capital markets.

In addition to the arguments put forward by McKinnon and Shaw, short-term stabilization policy may not be possible to implement, because the economic environment in which monetary and fiscal policies operate in developing countries is considerably different from that in developed countries. In developed countries, resources are utilized at close to full capacity, and the task of monetary and fiscal policy is to reduce the short-term fluctuations of output. In developing countries, the major problems facing the authorities are longer-term problems of growth and development. Because of the limited sources of government finance in many developing countries, monetary policy is closely linked to fiscal policy, restricting the authorities’ ability to engage two independent policy instruments for short-term stabilization purposes.8 In addition, the impact of these policies on output and prices is likely to be subject to longer lags and more uncertainties in the developing countries than in the industrial countries. It would, therefore, be more appropriate for the authorities to concentrate more on the medium-term goals of price stability and growth and to engage in short-term stabilization policy only when the shocks to the economy are severe and well identified.

Monetary Policy in an Open Economy

In this section, we turn to recent developments in monetary theory in the context of an open economy and their implications for the determination of the balance of payments. The major development has been a shift of emphasis from the traditional Keynesian, or elasticity, approach, which focused on the role of relative prices in the determination of trade flows, to what has become known as the “monetary approach to the balance of payments.”9 In the latter approach, the determination of the balance of payments, under a fixed regime, and the exchange rate, under a flexible regime, are regarded as essentially monetary phenomena—in the sense that excess demand for, and excess supply of, money are regarded as the major determinants of the changes in international reserves or exchange rates.

Despite the recent period of flexibility of the major currencies, the majority of developing countries continue to fix their rate, either explicitly or implicitly, to one currency or a basket of major currencies. Thus, the following discussion focuses on the relevant factors in the determination of the balance of payments under a fixed rate regime.10

The monetary approach to the balance of payments emphasizes the basic identity in which an excess demand for money is the counterpart of an excess supply of domestic goods and securities and is reflected in a surplus in the balance of payments. Although the balance of payments can be analyzed in terms of goods and capital accounts, it is convenient to use monetary accounts, because monetary data are generally more accessible and reliable. The crucial element in this approach is the stability of the demand-for-money function compared with other relationships, such as the expenditures function, which would be more relevant if one were analyzing the problem from the goods market side.

Under the stricter versions of the monetary approach, it is assumed that prices and interest rates are equalized internationally, while the level of output is determined exogenously. The increase in the demand for money is, therefore, determined exogenously by the increase in prices—which is, in turn, determined by world inflation—and in output. Any increase in domestic credit that is not matched by the increase in the demand for money is then reflected only in movements of international reserves. In practice, however, the above simplifying assumptions do not hold, at least in the short run. There are, in general, lags in the adjustment of prices, particularly in the nontraded goods sector. There are also a variety of capital controls and other obstacles to trade that impede the adjustment of capital and goods markets. Thus, in the short run, a portion of any excess supply of money is likely to be reflected in changes in domestic prices and output, in addition to the balance of payments.

The literature on the monetary approach to the balance of payments has been instrumental in bringing into focus the importance of monetary policy in an open economy. Insofar as the previous elasticities approach was a partial equilibrium framework, concentrating only on the impact of relative prices on trade flows, it did not allow monetary variables to play any role. In contrast, the basic conclusion of the monetary approach is that under a fixed exchange rate regime, credit policies are directly linked to the balance of payments situation and that, therefore, authorities will be constrained in their ability to pursue an independent monetary policy.11

Choice of an Exchange Rate Regime and its Implications for Monetary Policy12

Since the generalized floating of the major currencies in 1973, the developing countries have been faced with the problem of adopting an exchange rate regime that is most appropriate for their circumstances; most developing countries have been fixing their rate to one major currency or to a basket of major currencies. In this section, we first argue that a floating regime may not be suitable for most developing countries and that these countries are well advised to continue fixing their rate to one major currency or a basket of major currencies. Thereafter, we analyze the implications of adopting a pegged regime for the appropriate conduct of monetary policy.

Applicability of a floating regime to developing countries

A long-standing argument against the floating regime has been the instability in the foreign exchange markets that has been associated with this regime. The observed volatility of major currencies in foreign exchange markets has caused concern in developed countries. Contrary to earlier expectations, markets have not been stabilized in an orderly fashion by speculators, and fluctuations in exchange rates have been larger than could be explained either by variations in inflation rates or by perceived structural changes among industrial countries. For developing countries, there is even more likelihood of volatility in their foreign exchange markets, should the authorities allow the exchange rate to be determined purely by market forces. The market for the currencies of most developing countries is quite thin, which, in turn, discourages the development of the appropriate institutional framework.13 In the absence of a developed institutional framework—including trading mechanisms, forward markets, and the like—seasonal and random fluctuations, particularly in export earnings, can have a severe destabilizing effect on a freely floating rate.

An additional consequence of the thinness of markets for the currencies of most developing countries is that dealers in foreign exchange must look to world currency and capital markets for many monetary services. The cost of access to those markets depends crucially on the stability of the particular developing country’s exchange rate. The effective domain and, therefore, the usefulness of a small country’s currency becomes rather limited under a floating regime that allows large fluctuations in the exchange rate.14 Alternatively, by fixing to a major currency, holders of domestic currency gain access to all the services provided by the world markets for that currency, at low cost and limited risk. This access would spare traders the risk of fluctuations in foreign exchange by permitting them to purchase forward cover.

Floating exchange rates have sometimes been advocated on the grounds that they insulate a country from external shocks generated by world demand conditions. However, disturbances in the developing economies often originate on the domestic supply side, and floating rates are ineffective in eliminating their impact. In contrast, under fixed rates, reserve movements absorb part of the internal supply shock and reduce the impact on the domestic economy by allowing domestic absorption to exceed production in the short run. Also, a floating rate system cannot insulate most developing countries from the fluctuations in their external terms of trade, since in most cases major export and import prices are determined in world markets.

Floating exchange rates have also been recommended because they provide the authorities with direct control over the money supply. However, a fixed rate regime could bring a desirable element of discipline by providing additional leverage for economic policymakers to use in resisting political pressures for rapid monetary expansion. In the absence of that discipline, less distortion may result from the choice of a more flexible regime. It should be recognized that even under a floating system, monetary authorities would not have the freedom to expand the money supply indiscriminately unless they were willing to accept the political consequences of a continual depreciation of the currency.

Fixed exchange rates and appropriate monetary policy

In the previous section, it was argued that a freely floating exchange rate system is probably not suited to most developing countries. If the authorities choose to adopt a pegged rate system, they must decide between pegging the rate to a major currency or to a basket of major currencies. Fixing to a basket of currencies has the advantage of reducing the fluctuations in the effective exchange rate that result from movements in the value of the currency of any individual country. Fixing to a basket would therefore minimize the need for corrective measures associated with fixing to the “wrong” major currency. Moreover, a reduction in the average fluctuation would reduce the risk of accepting an open position in the foreign exchange market.

However, although fixing to a basket of currencies reduces the fluctuations in the nominal effective exchange rate, it will not necessarily reduce the fluctuations in the real exchange rate—that is, the effective exchange rate adjusted for relative price movements. Therefore, in deciding on its exchange rate regime, a country must take into account its own relative preference for price stability and the possibility of divergent price movements in the principal countries whose currencies are likely to dominate any basket.15

By adopting a fixed rate regime, the authorities are obliged to conduct their monetary policy in a way that is consistent with their exchange rate policy. As will be seen in the next section, the rate of inflation is linked, directly and in a stable fashion, to the rate of monetary growth. It is therefore important to set the rate of monetary expansion with a view to aligning the domestic inflation rate with that prevailing in those countries against whose currencies the exchange rate is fixed. In the absence of coordination between monetary and exchange rate policies, divergent price movements at home and abroad will result in cost-price distortions between traded goods, the prices of which are determined abroad, and nontraded goods, the prices of which are determined principally by domestic monetary developments. Divergence in price movements of traded and nontraded goods is not always a consequence of a monetary policy that is inconsistent with those abroad. There are a host of other factors that cause changes in the supply of, and the demand for, traded and nontraded goods, such as different rates of technological change and changing tastes. Nevertheless, these factors are unlikely to result in large changes in the relative prices in the short run; such large changes are almost invariably a result of inappropriate monetary policy and indicate a distortion in cost-price relationships. These cost-price distortions lead to misallocation of resources and cause imbalances in the external payments position, ultimately forcing the authorities to adjust the exchange rate. Thus, a persistent tendency to manage monetary policy without due regard to external developments leads to frequent adjustments in the exchange rate and abrogates the advantages associated with the stability of the exchange rate under a fixed regime.

II. Role of Money and Monetary Policy in Asian Countries

This section deals with three issues: first, the general importance of monetary variables in Asian countries within the framework of some simple empirical tests; second, recent monetary developments in these countries, with special attention being given to the question of the sources of monetary change; and third, recent experience with monetary policy and, in particular, the instruments of monetary control that have been utilized in the various countries.

Role of Money in Asian Countries

Financial variables, be they monetary aggregates, credit, or interest rates, are, of course, only intermediate objectives. The effectiveness of monetary policy has to be judged on the basis of its ability to influence the ultimate objectives of the authorities—principally prices, output, and the balance of payments.

A necessary condition for monetary policy to have a predictable effect on the ultimate economic objectives is that there must exist a well-defined and stable demand for money. In general terms, the demand for money can be functionally related to a scale variable, such as income, and the opportunity costs of holding money.16 Since individuals can substitute between money and goods, as well as between money and financial assets, the relevant opportunity costs would be the (expected) rate of inflation and the (expected) rate of interest on financial assets, respectively. In developing countries, however, the relatively thin markets for alternative financial assets make the substitution between money and goods (real assets) quantitatively more important than that between money and financial assets. In addition, interest rates on such assets as are available are often subject to control by the authorities. Since changes in these administered rates are made infrequently, it is difficult to detect any systematic empirical relationship between money and interest rates. For most developing countries, it would seem appropriate, therefore, to relate the demand for money only to a scale variable and the expected rate of inflation.17

Following the literature, the basic function can be specified in (semi) log-linear terms as:18


where md denotes the demand for real money balances (defined as nominal demand deflated by the price level P); y denotes the level of real income; and π denotes the expected rate of inflation.

Equation (1) is an equilibrium relationship, and one should allow for the possibility that real money balances adjust with delay to changes in income and expected inflation. One popular way of introducing lags into the specification is to specify a partial-adjustment mechanism for the change in real money balances. In this framework, the actual stock of real money balances adjusts proportionately to the difference between the demand in the same period and the actual stock in the previous period


where Δ denotes a first-difference operator, Δ log mt = log mt – logmt-1, and λ denotes the coefficient of adjustment. The lagged value of the inflation rate is used as a proxy for the expected rate of inflation, π.19

Substituting equation (1) into (2) results in the following equation for real money balances:


The short-run, or impact, effects are measured by the composite coefficients, λa1 and λa2. The corresponding long-run coefficients are obtained by dividing each of these by the estimate of λ yielded by the coefficient of the lagged dependent variable.20 The variable ut is a stochastic term added to the equation.

Equation (3) was estimated for Indonesia, Malaysia, the Philippines, Singapore, Sri Lanka, and Thailand,21 using narrow and broad money alternatively as the dependent variable.22 The estimation was done on a quarterly basis over the period for which the relevant data was available.23 The results for the two definitions of money are reported in Tables 1 and 2.

Table 1.

Six Asian Countries: Demand for Narrow Money1

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The figures in parentheses below coefficients are t-statistics.

Roman numerals denote calendar quarters.

Table 2.

Six Asian Countries: Demand for Broad Money1

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The figures in parentheses below coefficients are t-statistics.

Roman numerals denote calendar quarters.

Considering the results for narrow money balances (see Table 1) first, it can be observed that inflation has a negative effect on the holdings of these balances in all the countries in the sample. With the exception of Malaysia, this effect is statistically significant at the 1 per cent level. Singapore is the only country where the income coefficient is not significantly different from zero at the 5 per cent level. The long-run income elasticities for the six countries are shown in Table 3.

Table 3.

Six Asian Countries: Long-Run Income Elasticities of Real Money Balances

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In general, the long-run elasticities tend to be greater than unity, which is a fairly standard result in developing countries. For financially developed economies, one would expect a proportional relationship between real income and real money balances, but in developing countries the demand for money may well rise at a faster rate than income because of monetization, limited opportunities to economize on cash balances, and the paucity of other financial assets in which to hold savings.

The equations for narrow money are all fairly well specified, since the respective coefficients of determination are all high and there is no evidence of serial correlation in the errors.24

From the results for broad money (Table 2), we find that in all cases the coefficient of inflation has the expected negative sign and is significantly different from zero at the 5 per cent level. The effect of inflation on broad money holdings seems to be somewhat stronger than was observed in the narrow money equations. All short-run income elasticities have the expected sign and, with the exception of Singapore, are also significantly different from zero at the 5 per cent level. The hypothesis that the long-run response of broad money holdings to changes in real income should be greater than the corresponding response of narrow money is generally borne out by the values shown in Table 3. As in the case of the narrow money equations, the fits of the broad money equations are good and there is no apparent autocorrelation in the errors.

A further test was performed to determine the direct quantitative relationship between the supply of money and the rate of inflation. This test, which utilizes the procedure proposed by Granger (1969), is relatively more powerful in detecting the causal relationship between time series than is the standard regression analysis employed previously for the money demand model.25 The results, presented in the Appendix, show that prices and at least one definition of money are significantly correlated in almost all the countries in the sample.

Based on these empirical tests, it is apparent that two major requirements for the effectiveness of monetary policy—namely, the existence of a well-defined money demand function and a significant relationship between money and prices—are met for this group of Asian countries.

Factors Affecting the Money Supply

Table 4 presents some basic summary statistics describing the recent behavior of some of the main monetary variables in our sample of countries. As would be expected, in almost all countries, broad money grew faster than narrow money. The only exception is Singapore, where time and savings deposits grew more slowly than currency and demand deposits, a phenomenon that may be related to the availability of other financial assets in Singapore.

Table 4.

Seven Asian Countries: Growth Rates of Monetary Variables, 1974-77

(In per cent)

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Ratio of narrow money to reserve money.

Ratio of broad money to reserve money.

The supply of money, narrow or broad, is the product of reserve money (the liabilities of the central bank) and the money multiplier. The growth of money can thus be decomposed into the growth of reserve money and the money multiplier.26

If one considers narrow money, it can be seen that reserve money growth has been the prime determinant of the growth in money supply in these countries and that movements in the money multiplier have been relatively unimportant. The multiplier has had a more significant impact on broad money growth, but even here the overall effect has been small relative to that of reserve money.

Changes in reserve money are, by definition, equal to the total of changes in three items in a central bank’s balance sheet: net foreign assets (international reserves); net claims on the government; and net other assets, which would mainly include net claims on commercial banks. The relative importance of these three factors in changes in reserve money during 1974-77 is indicated in Table 5.

Table 5.

Seven Asian Countries: Factors Contributing to the Change in Reserve Money, 1974-77

(In millions of domestic currency units)

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Instruments of Monetary Control

Traditional instruments of monetary policy affect the supply of money through changing either the stock of reserve money or the money multiplier. Insofar as the components of reserve money are concerned, changes in foreign assets, which are a reflection of the authorities’ balance of payments objectives, cannot generally be considered as a policy instrument for changing the stock of reserve money.27 Nor can variations in credit from the central bank to the government be used by the central bank as an active instrument to adjust reserve money because this item is usually adjusted passively to the government’s budgetary position. Thus the authorities are basically left with one item, net claims on the private sector (i.e., principally the commercial banks), through which they can affect reserve money.

In order to change the money multiplier, the authorities would have to use instruments to change the public’s currency-to-deposits ratio and the banks’ reserves-to-deposits ratio.28

The instruments of monetary policy can be classified according to whether they operate on the supply side—that is, on reserve money—or on the demand side, by altering the public’s and banks’ preferences. Of course, certain instruments work through both channels. The main instruments of aggregate monetary policy in Asian countries are central bank credit to commercial banks, open market operations, reserve requirements, interest rate maxima and minima, margins imposed on bank borrowers, ceilings on bank credit, and moral suasion. The first two directly affect the stock of reserve money and, therefore, can be considered potentially the most potent in varying the supply of money and credit. Reserve requirement changes and interest rate regulations work on the components of the money multiplier. Margin requirements imposed on bank borrowers can curtail the demand for credit by raising the effective cost and thus work, in a sense, like interest rate changes. Ceilings on the supply of credit can be said to ignore both reserve money and the money multiplier by setting a limit directly on their product. Finally, moral suasion can affect the stock of reserve money, or the multiplier, or both. In effect, moral suasion substitutes for explicit regulatory action by the central bank.

In the remainder of this section, the characteristics of these instruments will be discussed along with a brief description of their use in individual countries.

Central bank credit to commercial banks

Refinancing of commercial banks has the basic advantage of affecting the stock of reserve money rapidly by directly affecting bank reserve positions. The disadvantages, however, of refinancing commercial banks arise from its implementation. Refinancing obviously cannot be initiated when the central bank wants to reduce the growth of money and bank credit. Moreover, the flexibility of this instrument is greatly reduced if access to refinancing is controlled by employing the rediscount rate as a cost factor or by announcing a refinancing quota for each bank. Once a rediscount rate is announced or quotas are specified, the central bank must stand behind them for some time before revising them.

The central bank may also find that it is impractical to diminish the amount of refinancing extended to commercial banks. For a reduction in refinancing to be effective in decreasing the growth of bank credit, banks must already be substantially indebted to the central bank. However, two problems arise. If there has been a subsidy element in the refinancing program, the commercial banks may be unable to sustain this loss. More important, if the refinancing scheme has been combined with regulations to allocate the resulting credit to priority sectors, the latter may well be deemed to require continued infusions of credit. For both of these reasons, the central bank may find that its refinancing of commercial banks cannot be reduced when this is required for macroeconomic reasons.

Table 6 shows the extent of refinancing in Asian countries, which is measured as a percentage of the total liabilities of commercial banks. It appears that banks and other financial institutions in Indonesia, the Philippines, and Sri Lanka have relied relatively more on central bank credit than the other four countries. Refinancing of commercial banks in Singapore and Thailand has recently increased but remains relatively insignificant. In Nepal, refinancing was very large at the end of 1975, but it has become very small since then. Refinancing has hardly been used in Malaysia.

Table 6.

Seven Asian Countries: Liabilities of Commercial Banks to Their Respective Central Banks as a Proportion of the Commercial Banks’ Total Liabilities, 1970-77

(In per cent)

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Sources: International Monetary Fund, Data Fund; Bank Indonesia, Indonesian Financial Statistics, various issues; Bank Negara Malaysia, Monthly Statistical Supplement, various issues; and Bank of Thailand, Monthly Bulletin, various issues.

As of the end of March of the following year—for example, the percentage reported for 1970 corresponds to March 1971.

In 1977, the Bank Negara Malaysia began a program of rediscounting export bills for goods manufactured in Malaysia.

Bank Indonesia has a detailed scheme for refinancing commercial banks that is intended principally to influence the allocation of bank credit to certain uses. At specified rates, Bank Indonesia is obliged to refinance all eligible credit up to the stated percentage as part of its selective credit policy. To the extent that refinancing has been employed to achieve aggregative targets, this has been accomplished by varying rediscount rates and the proportion of each loan that can be discounted. Occasionally, Bank Indonesia has introduced special programs—such as providing “emergency liquidity credits” to banks with deficient reserves in 1970-71 and refinancing up to 200 per cent of “healthy” national private and local development banks’ capital.

In the early 1970s, the Nepal Rastra Bank tried to expand commercial bank credit by offering each bank a quota of refinancing for the year. It turned out that initially the quotas were substantially underutilized, but by 1973–74 they were exceeded. Thereafter, the Nepal Rastra Bank did not publicize its quotas but resorted to controlling refinancing through variations in its rediscount rates and in the proportion of bank credit that could be refinanced. Undoubtedly, the higher rediscount rates charged to banks after April 1975 have played a part in reducing the amount of refinancing to commercial banks outstanding at the end of 1976 and 1977.

The Central Bank of the Philippines’ claims on commercial banks have varied considerably during the 1970s. Although there have been some major reductions in amounts outstanding, they have only mitigated the expansionary effects in other accounts of the Central Bank. In the early 1970s, the Central Bank of the Philippines tightened the criteria for access to its refinancing in order to encourage banks to improve their solvency; as a result, it reduced the volume of refinancing by disqualifying many banks. Rediscount rates have been low throughout the period and have been changed infrequently, and refinance has not been a major instrument of aggregate monetary policy.

In Sri Lanka, the Central Bank of Ceylon’s refinancing of commercial banks has also been more an instrument of selective credit policy than of aggregative monetary policy. Rediscount rates, which were unchanged from 1970 to 1977, have included concessionary rates for priority uses of credit. In the wake of the liberal use of the Central Bank of Ceylon’s refinancing facilities in 1974, quotas were formulated for individual banks at the beginning of 1975, and a penalty rate was imposed for rediscounts by a bank in excess of its quota. Table 6 shows the resulting decline in refinancing. However, the restrictiveness of this action was alleviated by reducing reserve requirements. In 1977, a new quota was introduced, and banks made greater use of the Central Bank’s refinancing facilities.

The Bank of Thailand has maintained low rediscount rates for priority uses of credit. These rates have remained constant in the 1970s, while the higher basic rate has been adjusted almost annually. Nevertheless, the Bank has relied on rediscount quotas for each bank to control access to refinancing, rather than on changes in its basic rediscount rate. Recently, each bank’s quota has been partly based on its liquidity position, so that the most liquid banks, which presumably have the least need for refinancing, have had the greatest access to it.

Open market operations

The fundamental advantage of open market operations, relative to the other monetary policy instruments, is their flexibility. The direction and strength of monetary policy can easily be shifted from day to day. However, the use of this policy has been tentative and experimental owing to the lack of sufficient suitable securities for the central banks to deal in and to the lack of depth in secondary financial markets.29 The one exception is the Philippines, where the Central Bank began issuing its own certificates of indebtedness in 1970 and later commenced trading in them in order to alter banks’ reserve positions. The Central Bank’s open market operations have been fairly successful and have now become the Bank’s major instrument of aggregate monetary policy.

Reserve requirements

Reserve requirements are a relatively inflexible instrument of monetary policy and cannot be changed as frequently as open market operations. Small changes in reserve requirements necessitate relatively large shifts among commercial bank assets, which require time to accomplish if they are not to be disruptive. Reserve requirements divert bank funds into assets that earn little or no interest, and this increases the cost of intermediation, which must be borne by bank borrowers (in the form of higher interest), by depositors (in the form of lower interest), or by bank shareholders (in the form of lower profits). If this cost is too onerous, reserve requirements will discourage the development of the banking system and will encourage the evolution of non-bank financial intermediaries, which are less amenable to control than the commercial banks.

In Indonesia, Malaysia, Nepal, and Singapore, commercial banks have been obliged to comply with liquid asset requirements in addition to cash reserve requirements. The apparent ease with which banks have complied with the liquid asset requirements in Indonesia, Malaysia, and Singapore suggests that these requirements should be viewed as regulations designed to reallocate bank assets rather than as tools designed to control the total amount of money and credit; certainly, the infrequency with which these regulations have been varied in Malaysia and Singapore indicates that they are considered to be the former by the authorities. However, Nepal may be an exception, in that in 1975, when the liquid asset requirement was initially imposed to slow down the expansion of money and credit, the banks were initially unable to satisfy the regulation, although they subsequently acquired substantial excess liquid assets.

In Nepal, the Philippines, Sri Lanka, and Thailand, the commercial banks’ basic cash reserve requirement has been changed periodically. In Sri Lanka, there was a large reduction in cash reserves for demand deposits in 1975, but this was intended to improve the banks’ profitability. For monetary policy purposes, this was offset by reducing the Central Bank of Ceylon’s refinancing of the banks and by eliminating vault cash as a reserve asset.

In the Philippines, there have been rather prolonged periods during which banks have had noticeable reserve deficiencies. The first period (1971-72) was ended when the Government raised the subscribed capital of its own Philippine National Bank by issuing special securities to it that qualified as reserves. The second period (beginning in the middle of 1974 and extending to the present) was begun by a liquidity crisis caused by the insolvency of one bank. For a time, the Central Bank allowed some of its certificates of indebtedness and some government securities to count as reserves. In this environment, changes in reserve requirements would have been an impractical monetary policy instrument.

In Indonesia, required reserves have been varied by changing the fraction of time deposits and savings deposits that count as liabilities against which reserves must be held, as well as by changing the reserve percentage itself.

In Malaysia and Singapore, reserve percentages have been changed directly as an aggregate monetary policy instrument. Nevertheless, changes have been infrequent, which supports the contention that this is a relatively inflexible instrument. In Malaysia, the cash reserve requirement was raised in 1972, not to contract money and credit but to expand them. It was assumed that, if more of the banks’ excess liquid assets were impounded in noninterest-bearing cash reserves, the banks would try to maintain their profitability by lending out their remaining excess liquid assets. In Singapore, special reserve deposits were briefly imposed in 1973 on net borrowing from foreign banks to stem the inflow of funds from abroad.

Bank reserve requirements have differed in Indonesia and Singapore, depending on whether the deposits were in domestic or foreign currency or whether they were from domestic or foreign sources. In Indonesia and Sri Lanka, reserve requirements also differ on demand deposits and time and savings deposits.

Interest rate regulations

To the extent that the financial system is responsive to interest rates, interest rate regulation bypasses the chain of responses that other instruments must work through to operate directly upon the demand for, and the supply of, money and bank credit.30 Central banks’ use of interest rates to influence economic aggregates differs considerably. For instance, the Monetary Authority of Singapore completely freed interest rates in July 1975, and since then it has only influenced them by working through market forces. The central banks of Indonesia, Malaysia, and Nepal have quite frequently changed interest rates by regulation, while the other central banks have left rates constant for several years at a time. Nevertheless, a majority of Asian central banks raised interest rates by regulation at least once in 1974 or 1975 to adjust them to the upsurge of inflation. Even then, real interest rates were negative for much of this period. As a result, several central banks undertook dramatic interest rate reforms to push nominal interest rates above, or closer to, the inflation rates. The freeing of interest rates from regulation in Singapore may be viewed as one such response. Bank Indonesia induced state banks to introduce new long-term fixed deposits with very high rates in April 1974, partly by awarding the banks a subsidy to cover some of their interest costs on these deposits. In Nepal, the whole bank interest rate structure was increased substantially in April 1975, which immediately turned real rates positive on some deposits. In September 1977, interest rates were raised in Sri Lanka, especially on longer-term fixed deposits and commercial bank loans.

There have been problems in enforcing interest rate maxima in most countries. First, in some countries, banks have offered additional incentives to depositors that have, in effect, pushed interest rates beyond their ceilings. In 1971, Bank Indonesia reached an understanding with the state banks, which are the largest in Indonesia, to cease paying premiums on time deposits. In the Philippines, restraining banks from offering additional incentives has been a continual problem, which has been exacerbated by the availability of deposit substitutes with higher interest rates. To reduce the yield disparities, in 1977 a higher withholding tax was imposed on deposit substitutes than on time and savings deposits; also, the Central Bank of the Philippines imposed interest rate ceilings on deposit substitutes. Second, banks have evaded ceilings on their lending rates by imposing service charges, withholding interest at the time that loans are disbursed, etc., to raise effective interest rates. Finally, the freedom of capital movement in several countries has meant that interest rate policies must be framed with prevailing or potential capital flows in mind. Very large capital inflows played a part in the Nepal Rastra Bank’s moderation of deposit interest rates in 1976 and 1977. Even after interest rates were freed in 1975, actual and anticipated capital flows kept interest rates in Singapore from diverging much from comparable foreign interest rates.

Margin requirements

Margins increase the effective cost of credit by requiring borrowers to finance part of their credit needs themselves and thus operate similarly to an increase in lending interest rates. These requirements have seldom been used as an active policy instrument—the Nepal Rastra Bank used margin regulation in the early 1970s but abandoned this policy a few years later. Similarly, the Central Bank of the Philippines discontinued margin requirements on letters of credit to finance imports in February 1970, but the banking association retained them.31 The association has occasionally changed these margins, apparently with the approval of the Central Bank, in order to restrict imports. Bank Indonesia continues a policy of maintaining high margin requirements.

Ceilings on bank credit

Ceilings on aggregate bank credit affect total liquidity directly, as opposed to affecting the product of the money multiplier or reserve money individually. Since ceilings may force banks to hold excess reserves, they could impinge directly on the multiplier. Overall credit controls can also result in some misallocation of credit when interest rates are set below market rates by regulation, as the banks may have to ration credit.

In response to the serious acceleration of inflation in 1973, the central banks of Indonesia, Malaysia, Singapore, and Sri Lanka resorted to credit ceilings on banks, and sometimes on other intermediaries, to reinforce the central banks’ customary monetary policy instruments. In Indonesia, ceilings on bank credit, which have been specified annually since 1974, have become Bank Indonesia’s major aggregate monetary policy instrument. In Malaysia and Singapore, credit ceilings were eliminated after 1974. In Nepal, the bank credit ceilings that were instituted in 1975 were rescinded almost immediately, and credit ceilings were not tried again until 1978. The Central Bank of Ceylon administered bank credit ceilings twice during the 1970s.

The growth rates of banks’ “net domestic assets” in Indonesia have remained well within the ceilings set, although ceilings have often been raised during the course of individual years. Because of the ceilings, banks’ and finance companies’ credit outstanding grew less rapidly in Malaysia and Singapore in 1974 than in any other year in the 1970s.

Apart from overall credit ceilings, central banks sometimes impose selective credit controls designed to channel funds to preferred sectors. Portfolio requirements that oblige banks to hold or extend certain percentages of their credit to priority sectors can be effective in the first instance. However, skeptics doubt whether the immediate borrowers may just switch their own funds from the priority activities for which they can obtain credit to low-priority undertakings for which credit is no longer available. Another question is whether the priority borrowers become intermediaries themselves, passing credit along to other borrowers. Effective portfolio requirements placed on banks necessarily leave some low-priority borrowers unsatisfied, consequently providing an incentive for nonbank intermediaries, which cater to their needs at higher interest rates, to evolve. If portfolio requirements are extended to the new intermediaries, artificial incentives are simply created for new varieties of intermediaries. Ultimately, if controls become all-pervasive, the financial system becomes distorted and repressed.

All central banks have some refinancing program for reallocating credit. In Singapore and Malaysia, there are only rediscount facilities for promoting exports. In the other countries, the programs are more detailed, with different rediscount rates and percentages that will be refinanced for different categories of credit. Bank Indonesia has even engaged in direct lending to increase the flow of credit to small-scale borrowers under the Permanent Working Capital Credit and Small Investment Credit schemes.

Portfolio requirements have been imposed on banks in most countries. State banks in Indonesia must extend at least 65 per cent of their own funds in specific categories of short-term credit. In addition, their outstanding medium-term loans must exceed 20 per cent of their time deposits with original maturities of more than six months. Malaysia’s provisions are much more specific, aiming credit at housing, food production, manufacturing, the Bumiputra community, and small-scale enterprises in general. Both Thailand and the Philippines have portfolio regulations designed to direct credit to agriculture. In Nepal, the portfolio regulations are intended to reallocate credit to small-scale enterprises, as well as to agriculture. Banks that are unable to meet the required percentages must place the deficiency in an interest-free account with the Nepal Rastra Bank.

Finally, it should be noted that most countries have specialized financial institutions to channel funds to priority sectors and that the central banks have played a role in establishing and fostering these institutions.

Moral suasion

In view of the number of monetary policy instruments available to Asian central banks and the frequency of their application, it would be surprising if moral suasion were a major tool of monetary policy. The way that moral suasion has been used most—in Malaysia, Singapore, and Sri Lanka, for example—has been to advise banks to reduce lending for share transactions and for speculative purchases to accumulate inventories. The Bank Negara Malaysia has recorded in its annual report frequent use of moral suasion to change bank practices—persuading banks to shift from overdraft lending to term loans, for example.

In 1972, the Bank Negara Malaysia advised banks to use their excess liquidity to expand credit, while in 1974, it counseled them to restrain the growth of credit. From the end of 1973 until the beginning of 1975, Bank Indonesia also applied moral suasion to reduce the growth of bank credit. Although their actions may not be judgments on the effectiveness of moral suasion in restraining bank credit growth, both the Bank Negara Malaysia and Bank Indonesia imposed formal bank credit ceilings in 1974.


Evidence provided in this section shows the importance of reserve money and its subcomponents—central banks’ net foreign assets and their credit to the government—in determining the money supply. However, neither central banks’ net foreign assets nor their loans to the government are usually amenable to active monetary policy. Consequently, the other instruments of monetary policy over which the central bank does have discretion often have to be used to offset the effect of one of the nondiscretionary determinants of reserve money. The effects of the discretionary instruments are not easy to discern; nevertheless, some generalizations can be made.

Table 7 shows which instrument has been the primary one in each country and which instruments have been regularly used for aggregate monetary policy purposes. Although refinancing for commercial banks and interest rate regulations have been instituted in most countries, they have been employed less as instruments of aggregate monetary policy than as tools of selective credit policy. The same can be said for secondary reserve requirements, which have been imposed in fewer countries. Although Sri Lanka and Thailand have relied on refinancing as the primary instrument of aggregate monetary policy, monetary policy in both countries also has strong selective credit aspects.

Table 7.

Seven Asian Countries: Primary and Secondary Monetary Policy Instruments1

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P denotes a primary instrument, and S denotes a secondary instrument.

The apparent success of open market operations in the Philippines suggests that central banks in other countries with equally well-developed financial systems should consider instituting them. The central bank could alter banks’ liquidity positions, either by dealing in outstanding government securities or, as in the Philippines, by issuing and repurchasing its own securities. However, such actions would have to be coordinated with rediscount policy, particularly when they were used to restrict the growth of money and credit, so that commercial banks’ rediscounts would not have the effect of financing their purchases of securities from the central bank. Finally, movements in the interest rates on securities being bought and sold by the central bank could put pressure on the authorities to review their interest rate regulations frequently, if not to free interest rates altogether.

Reserve requirements have been the primary instrument of aggregate monetary policy in Malaysia and Singapore. Nevertheless, changes in the requirements have been infrequent—only five changes in each country during the 1970s—and some changes have been quite large—one increase amounted to 4 percentage points in Singapore and another to 3.5 percentage points in Malaysia. The criticism of reserve requirements is not that they are ineffective but that, by their nature, they are blunt and inflexible.

Interest rate regulations have often been intended to offer borrowers low rates in order to stimulate investment. Continuously low interest rates in Indonesia, the Philippines, Sri Lanka, and Thailand seem to have interfered with contractionary monetary policy, as well as to have impeded intermediation by banks. In the Philippines, low interest rates on conventional deposits have been one cause of the emergence of deposit substitutes. In all countries, interest rate adjustments have been one step behind changes in the rate of inflation. Setting interest rates in open economies also requires that the rates be kept comparable to foreign interest rates, as well as domestic inflation rates.

Five countries have experimented with ceilings to restrain the growth of credit. In general, this policy was used in coordination with other, more traditional instruments; only in Indonesia have ceilings been used by themselves as the main instrument of monetary control. Credit ceilings have proved to be an effective, although not necessarily an efficient, instrument of macroeconomic policy.

III. Monetary Policy in the Framework of Aggregate Targets

In recent years, a number of industrial countries have endeavored to implement monetary policy by setting, and publicly announcing, quantitative targets for various monetary aggregates.32 This represents an important change in the actions of the central banks of these countries. It would be useful to examine the general issue of target-oriented policy in order to ascertain if it would provide some guidance to the formation and conduct of monetary policy in Asian countries. It should be recognized that a number of other countries have also imposed restrictions on monetary expansion at one time or another and, furthermore, that the Fund has emphasized this type of action in the context of stabilization programs.

The purpose of this section is to discuss briefly some of the main issues relevant to the adoption of target-type policies. The analysis is then applied to the Asian countries.

Theoretical and Practical Issues in Target-Oriented Monetary Policy

In the implementation of policy based on the concept of aggregate targets, two principal issues arise. First, the choice of the particular aggregate(s) for which the target value is defined, and second, the choice of the value itself. This section sets out some general criteria that should be used in selecting both the monetary aggregates and the target values.

Choice of monetary targets

Monetary targets are, by definition, only intermediate objectives—that is, they are means to an end rather than ends in themselves. It is no coincidence that the transition to monetary targeting occurred at a time when the overriding objective of most national monetary authorities was the achievement of greater price stability. The first objective of the authorities should be to choose as their proximate target a monetary aggregate that shows a close and systematic relationship to the inflation target. On the basis of empirical evidence for industrial countries, a broadly defined monetary aggregate is more closely related to the inflation rate.

A second objective should be to choose a particular aggregate as a proximate target that can be controlled more easily by the monetary authorities using the instruments at their disposal. Generally speaking, it is easier for the authorities to achieve a target rate of growth for a particular item in the central bank’s own balance sheet (e.g., high-powered or base money) than to control a broader definition of money. Thus, the main problem faced by a central bank in selecting an intermediate monetary target is its decision whether to use a more controllable narrower aggregate or a broader aggregate that is more closely related to the domestic inflation rate.

Another important aspect of the controllability question concerns the choice between targets for the total money supply and domestic credit expansion targets. In general, a small or medium-sized country with a fixed exchange rate has only limited influence over the money stock, and control can only be exercised over its domestic component.33 This is true because changes in the total domestic money supply can occur through monetary movements brought about by changes in international reserves. By definition, the domestic stock of money is equal to the stock of international reserves and the outstanding level of domestic credit of the banking system. Given the demand for money, the authorities can, by setting a particular domestic credit expansion target, also determine the change in international reserves that would allow the demand to be met.

In addition to the two general criteria listed above, a number of other considerations are also of importance in the choice of the particular monetary or credit aggregate as a target. In general, data on the target variable should be available to the monetary authorities on a regular and timely basis. Furthermore, since the authorities will generally have to use the earliest available estimates of a given aggregate when they decide how to adjust their policy instruments to keep within the announced range, the target aggregate should be one for which the preliminary data are accurate (in the sense that subsequent revisions are small).

The choice of the appropriate monetary variable to target is thus dependent on a number of factors, and consequently it varies among countries (and also over time within countries), depending on the prevailing circumstances.34

Choice of value for the monetary target

The value chosen for the monetary target depends essentially on the authorities’ preferences regarding the economy, subject, of course, to certain economic and institutional constraints. Thus, as was true of selecting the appropriate monetary aggregate, the target value will differ widely between countries and also over time. Basically, the authorities have to decide on their ultimate economic objectives—regarding prices, income, the balance of payments, etc.—and then choose a value for the monetary aggregate that is consistent with the ultimate targets.

The cornerstone of the derivation of a target value is the demand-for-money function. On the basis of a projection of what the desired stock of money balances would be during some period in the future, the monetary authorities can set a growth rate for the money supply that would be consistent with this. Essentially, the way to derive a target rate of expansion of the money stock would be to make a projection of the variables that affect money holdings—such as real income and prices—and then to calculate, on the basis of the parameters of the money demand function, the stock that would be required to satisfy demand. Such an exercise would yield a value for monetary growth that would be consistent with what the authorities view as the growth prospects of the economy, as well as with their preferences regarding the behavior of prices. Various refinements may, of course, be made—such as allowing for lags in the adjustment of money balances to changes in real income and prices, including other variables in the money demand function, considering the balance of payments effects—but the basic analysis would remain valid. The accuracy of the projection would depend upon, among other things, the accuracy of the projections of the variables determining the demand for money and the stability over time of the parameters of the function.

Two final points worth mentioning are: (1) the choice of the period for which the target is to be in effect and (2) whether the target value should be defined as a single value or as a range. Insofar as the monetary targets policy is essentially a medium-term policy, the time horizon it covers should be longer than that of short-run activist policy. The consensus in industrial countries is that the target should be set for 12 months, although differences in the choice of base period and in the definition of the target result in considerable variation among countries.35

Instead of focusing on a single target value, a range for the target variable could be considered. This would allow the authorities greater flexibility, since a single value may unnecessarily constrain the central bank’s actions. On the other hand, too broad a range may make the target less meaningful by creating an element of uncertainty, thus negating the main reasons for implementing a target-oriented policy, which are the reduction of uncertainty and the creation of a general climate of stability.

Target Policies for Asian Countries

Experience with target-oriented monetary policies has been gained over many years, and such experience has not been restricted to industrial countries; a number of other countries have experimented with such policies from time to time. Countries such as Indonesia, Nepal, the Philippines, and Sri Lanka have adopted quantitative ceilings on monetary aggregates as part of financial programs supported by the Fund. Other countries have also, on occasion, used quantitative restrictions on credit expansion as an additional instrument of monetary policy, along with the more traditional ones. Therefore, a move toward a target-type monetary policy would not represent a fundamental change in central bank operating behavior. If, however, the authorities should wish to publicly announce their targets for monetary expansion, in order to have a direct impact on private expectations, this would clearly represent a break with the past.36

Choice of monetary target

In the preceding theoretical discussion of the choice of a particular monetary aggregate as a target, we stressed, first, that it should be closely related to the authorities’ ultimate targets and that the relationship should be relatively stable and, second, that the aggregate should be the easiest one for the authorities to control.37

In order to examine the relationship between various monetary aggregates and prices (viewed as an ultimate target), we can utilize the estimation results for the demand for money (Tables 1 and 2) and the correlation tests between inflation and the growth of money that are presented in the Appendix. For the countries studied here, neither of the two types of tests yield an unambiguous conclusion. In the money demand results, the correlation coefficients are very similar in size for both narrow and broad definitions of money. This similarity could be due to the presence of real income in both specifications, and a stricter test would be the direct correlation test between the growth of money (defined alternatively as narrow and broad) and the rate of inflation. Here again, the results were not clear-cut, with both narrow and broad money apparently having a comparable statistical relationship with the rate of inflation. It is therefore difficult to choose on the basis of this criterion alone.

Turning briefly now to the controllability question, broad money is generally easier to control than narrow money because shifts between demand and time deposits will not affect the value of broad money, whereas narrowly defined money could change simply as a consequence of variations in the composition of money.

A more serious problem of control, however, arises owing to the relative openness of these economies. As was discussed previously for a typical open economy operating under a system of fixed exchange rates, the international monetarist analysis holds that domestic monetary policy cannot influence the total money supply, but only its composition between foreign and domestic components. Given the open nature of these economies and their exchange rate arrangements, domestic credit expansion would perhaps be the appropriate monetary aggregate. Targets, of course, can be formulated in terms of both the total money supply and its domestic component—namely, domestic credit.

Choice of value for monetary target

In order to set a target value for monetary expansion, a demand-for-money model based on the lines suggested in Section III could be used. Two particular features that emerged from the results are worth mentioning. First, since the parameter estimates differ across countries, and since projections of real income and expected inflation would also undoubtedly differ, each of the countries would naturally have a different target value for monetary growth. Second, since the income elasticity of broad money is generally larger than the corresponding narrow money elasticity, for a given growth in real income, the public would demand more broad money balances than narrow money balances. Also, because both sets of elasticities are greater than unity, imposing a simple one-to-one relationship between money and income to derive the target would result in serious underestimation of money holdings.38

As an example of how the money demand models can be used, assume that the authorities in each country expect real growth in the medium term to be 5 per cent and that they wish to have a rate of inflation exactly equal to the current rate (say, 5 per cent). The target rates of growth for narrow and broad money are given in Table 8. As expected, the target value for broad money growth is larger than the corresponding target for narrow money. This essentially reflects the differences in the relative sizes of the income elasticities.

Table 8.

Six Asian Countries: Hypothetical Target Rates of Growth of Monetary Aggregates

(In per cent)

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Finally, even if domestic credit expansion is the target variable, the money demand function is still very relevant. Since domestic credit is simply the difference betweeen the stock of (broad or reserve) money and foreign reserves, the domestic credit expansion target should be set consistent with the likely outcome of the balance of payments as well as the projected demand for money.

IV. Conclusion

The principal conclusion of this study is that the scope for short-term stabilization policies in Asian countries is somewhat limited. From the theoretical viewpoint, the effectiveness of stabilization policies depends essentially on differences in perception regarding the size of certain key parameters—the marginal propensity to save, the interest elasticity of investment, and the interest elasticity of demand for money. On the basis of a priori considerations and the available empirical evidence, the size of these parameters in developing countries appears to be such that the scope for short-term stabilization through frequent changes in monetary policies is not large. Note is also taken of another strand of recent thinking, which has been developed by McKinnon (1973) and Shaw (1973), that stresses the desirability of giving greater weight to the longer-term aspects of financial development.

While the economies of the Asian countries are characterized by a high degree of openness, the exchange rate arrangements of these countries are more akin to fixed than to freely fluctuating rates. This combination of factors limits the scope for independent monetary policies, since an open economy with a fixed exchange rate cannot have an inflation rate consistently different from the world inflation rate. It is necessary to stress that this does not imply that developing countries should adopt freely floating exchange rates in order to secure greater freedom in monetary policy. Indeed, one of the points made in the paper is that a floating exchange rate regime may not be particularly suited to the circumstances of these economies.

Certain institutional constraints on the flexibility of specific monetary instruments also suggest that fine tuning through frequent policy changes is unlikely to be successful in the Asian countries. Given the absence of well-developed money and capital markets, it is difficult to conduct open market operations; however, the Philippine experience with the Central Bank dealing in its own certificates of indebtedness may be worth studying further for more general application. Changes in reserve requirements are recognized to be too blunt an instrument and one that could have adverse effects on the long-term development of the banking system. Central bank refinancing policies—operating through the cost and/or availability of such finance—can be effective in restraining expansion but are sometimes constrained by the subsidization of particular sectors of the economy that is attempted through these policies. Direct portfolio ceilings on bank credit also cannot be changed too often if disruptive effects are to be avoided.

In addition to the previous arguments, there are two further reasons why fine tuning may be unsuited to many developing countries. First, the absence of well-developed information systems means that the “problem recognition” lag is longer in these economies. The regulation and rigidity of interest rates mean that variations in them are often not available as signals of changing credit conditions. Second, since developing economies are usually not fully integrated economies, effects of given policy changes spread through the economy only very gradually. These factors increase the likelihood that policy measures have their impact only after the problem to which they were addressed has disappeared. Therefore, the principal conclusion is that target-oriented monetary policies—as opposed to policies aimed at fine-tuning the economy—are better suited to the circumstances of the Asian countries. These countries appear to be carrying out annual financial programming exercises in the light of their price and balance of payments objectives and the likely output growth. It should be stressed that implementing a target-oriented policy does not preclude short-run policies that could be used both as events dictate and also, of course, to ensure that monetary variables stay on target. A question that deserves further consideration, and one which we have not dealt with explicitly, is the desirability or otherwise of publishing the monetary targets that the authorities now use as internal working guidelines.

APPENDIX: I. The Relationship Between Money and Prices

We present here the results obtained from applying the Granger (1969) procedure to determining directly the quantitative relationship between money and prices in our particular sample of countries. In the Granger framework, the absence of correlation between the current value of a variable (inflation) and the current value of another variable (the growth in money), once account has been taken of the effects of past values of inflation and the growth of money on their respective current values, implies the absence of a statistically significant relationship.39 Removing the effects of past values prior to conducting the correlation test greatly reduces the possibility of spurious correlation that could arise from, say, the variables in question following a common time trend.40 Specific econometric tests to apply the Granger methodology have been proposed by Sims (1972), Pierce (1977), and Pierce and Haugh (1977), and these tests have been implemented in a number of economic cases.41

Prior to proceeding with the actual correlation, it is necessary to undertake two preliminary steps. First, the series to be examined have to be made co-variance stationary; that is, their respective means and variances have to be constant over time. Generally speaking, for most economic time series it is possible to ensure stationary behavior by transforming the relevant series into rates of growth by taking logarithmic first differences. If Pt and Mt are the original (nonstationary) levels of prices and money, then transforming them into Δ log Pt (inflation) and Δ log Mt (money growth) will normally be adequate.

The second step involves the elimination of the effects of past values of each of the series on their respective current values. An efficient way of doing it is to apply the autoregressive integrated moving average (ARIMA) model approach of Box and Jenkins (1970). These ARIMA models are fitted to the data on inflation and money growth, and the estimated residuals—namely, v^p and v^M, respectively—are tested to see if they can be characterized as white noise. If they satisfy this assumption, the effect of past values on the current value can be said to be effectively eliminated, and we can proceed to apply the Pierce-Haugh test for mutual independence, which involves the calculation of the statistic


where N is the number of observations, q the number of lags considered, and rr^2pr^M(K) is the squared correlation coefficient between v^p and the kth lag of v^M. This statistic is distributed as ξ2 with (2 q+1) degrees of freedom, and if the calculated value of S* is greater than the critical X2 value, the null hypothesis of independence can be rejected at the previously selected significance level.

In our tests, we examined—for Sri Lanka, Indonesia, Malaysia, the Philippines, Singapore, and Thailand—the relationships between the consumer price index and two definitions of money—narrow and broad. The tests were based on quarterly data and covered the period for which the data were available for the particular country. Each of the three series was converted into a rate of growth, and then appropriate ARIMA models were identified and fitted to the data. The results of this exercise are given in Tables 9-11.

Table 9.

Six Asian Countries: Arima Models of Consumer Prices1

article image

The figures in parentheses below coefficients are t-statistics.

Roman numerals denote calendar quarters.

Degrees of freedom.

Sum of squared residuals.

Table 10.

Six Asian Countries: ARIMA Models of Narrow Money1

article image

The figures in parentheses below coefficients are t-statistics.

Roman numerals denote calendar quarters.

Degrees of freedom.

Sum of squared residuals.

Table 11.

Six Asian Countries: ARIMA Models of Broad Money1

article image

The figures in parentheses below coefficients are t-statistics.

Roman numerals denote calendar quarters.

Degrees of freedom.

Sum of squared residuals.

Each of the tables shows the period over which the model was estimated, the parameters of the models (the autoregressive and the moving-average), and the order of the lag polynomials corresponding to these parameters. Since the series are not seasonally adjusted, we also estimated seasonal autoregressive and moving-average parameters; and these are shown in conjunction with the number of quarters (4 or 8) for which these seasonal processes apply. Other information in the tables includes the mean of each series, the t-values of all estimated parameters, the sums of squared residuals (S.S.E), and the Q-statistic developed by Box and Jenkins (1970) to test for serial correlation in the errors.

It can be seen from the tables that the value of the Q-statistic allows us to accept the null hypothesis that the errors are independent at a reasonable confidence level. This allows us to treat the residuals as if they were effectively white noise. One point worth mentioning in this connection is that the results for narrow money and broad money in the case of Sri Lanka indicate that the rates of growth of these variables were themselves white noise, and consequently it was not necessary to estimate any filter.42

Using the residuals from the estimated ARIMA models, we conducted the cross-correlation tests of independence for two pairs of series—prices and narrow money and prices and broad money. The S*-statistic was calculated over 12, 16, and 24 quarters for Sri Lanka, Malaysia, the Philippines, and Thailand, and over 6 quarters for the remaining two countries—Indonesia and Singapore.43

The results of this test are shown in Table 12. For each pair of series, we have shown the calculated value of the S*-statistic and the corresponding significance level. The latter value indicates the confidence level at which one can reject the null hypothesis that the two series are independent, so that the higher the values, the more likely it is that the two series are correlated. Based on this type of reasoning, we find that prices and at least one definition of money are significantly correlated in all countries but Sri Lanka and Thailand. This test is, of course, much stricter than any simple correlation test, since the pre-whitening process has substantially reduced, if not entirely eliminated, the possibility of spurious correlation between series like prices and money that have pronounced trends in them.

Table 12.

Six Asian Countries: Cross-Correlation Test for Independence

article image

Roman numerals denote calendar quarters.

Significance level.

The results for Sri Lanka and Thailand are, to say the least, fairly puzzling, since they would indicate that, once they have been pre-filtered, changes in money have no effect on inflation. This may be a reflection of the test procedure used, and it can be argued that the removal of the effects of past values also sometimes eliminates useful economic information.44 The results for these two countries, therefore, should by no means be regarded as definitive.


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The SDR as a Basket of Currencies—J. J. Polak (pages 627-53)

The new provisions on the valuation of the special drawing right (SDR) in the Second Amendment to the Articles of Agreement; the new basket introduced on July 1, 1978; the increases in the SDR interest rate; and the introduction by the Bank for International Settlements and some commercial banks of SDR-denominated deposits call for a new analysis of the SDR as a basket of currencies.

While the “standard basket” for the valuation of the SDR was adopted in 1974 with considerable hesitation, it is in fact the only method that will permit the SDR to become a market asset; only that basket can have the properties of a currency, because it is the sum of fixed amounts of currency. Also, only the standard basket can include currencies with floating rates in a meaningful way. It is noted that in the European Monetary System, the European Currency Unit (ECU) includes all currencies of the European Community, including those that float.

The 1978 basket of currencies for the valuation of the SDR retained most of the characteristics of the initial (1974) basket: it is composed of the 16 currencies with the largest exports of goods and services; its weights are based on the value of these exports in the preceding five years; and it is designed to give a higher (33 per cent) weight to the U. S. dollar than would be indicated by the U. S. share of world exports. In the 1983 basket, however, weights of individual currencies will be determined by a formula based on exports and the extent of each currency’s reserve currency role. Most of the changes in the amounts of currencies included in the 1978 basket reflected not changes in trade shares but compensation for changes in exchange rates since 1974—reductions in the amounts of strong currencies and increases in the amounts of weak currencies.

The derivation of the SDR interest rate from a calculated average of interest rates on the five main currencies (which account for about 70 per cent of the total weight of the basket) was based on the assumption that this average presented a good approximation of the interest that could be earned on the basket as a whole. This proved to be not fully accurate. From 1974 to 1978, the approximation gave a downward bias to the calculated interest, to which, moreover, a discount was applied. When there is greater freedom to use SDRs and an emergence of market SDRs (Euro-SDRs), the SDR interest rate will need to be adjusted more closely to market interest rates.

Fixed and Flexible Exchange Rates: A Renewal of the Debate—Jacques R. Artus and John H. Young (pages 654-98)

This paper reviews the extent to which a decade of analysis and experience has altered the thinking on the choice of an exchange rate system. The advantages of flexible rates are viewed to have been exaggerated. They do not permit governments to have permanently higher rates of economic activity at the expense of higher inflation, as some had thought. Further, the slow speed of adjustment to relative price changes limits the contribution of flexible rates to external adjustment in the short run and the degree of insulation from external influences that they provide. Finally, flexible rates tend to be fluctuating rates, and, although there is little empirical evidence so far showing that the fluctuations have had adverse effects on trade and capital flows, the exchange rate instability more than any other factor has led to a certain disillusionment with the floating exchange rate system.

Notwithstanding the drawbacks of flexible rates, there will be a continuing need for exchange rate flexibility over the next few years, and some analysis is given of the problems of achieving greater stability under flexible rates or the requisite amount of flexibility under pegged rates.

Inflation and International Reserves: A Time-Series Analysis—Mohsin S. Khan (pages 699-724)

Several recent studies that have examined the empirical relationship between global inflation and the growth of international reserves during the period of fixed exchange rates reach the conclusion that the rise in international reserves was a principal cause of the worldwide inflation witnessed in the early 1970s. The purpose of this particular study is to reconsider the evidence on which this conclusion was based, utilizing statistical techniques that are more powerful than standard regression methods in determining both the degree of association and the direction of causation between two variables. These methods, generally referred to in the literature as tests of causality, have been applied in a number of studies and are designed essentially to identify more precisely leads and lags between time series. The results of the tests are then interpreted to imply causality of a particular kind.

Tests performed in this paper for three separate country groupings—the world, industrial countries, and developing countries—indicated that, when considering a period covering both the fixed and floating exchange rate regimes, inflation appeared to consistently lag behind the growth in international reserves in the cases of the world and industrial country groupings. In other words, it was the growth in reserves that “caused” inflation. For developing countries in this period, the relationship between the two variables was a contemporaneous one. Broadly, the results tend to support the quantity theory of money approach extended to the world economy.

To ascertain if the relationships changed with the advent of floating exchange rates, the tests were repeated for the subperiod 1973-77. The results of these tests indicated that, while reserve growth and inflation continued to be linked, the direction of causation became somewhat ambiguous. Generally speaking, however, because of data limitations the conclusions for the floating rate period should be viewed as fairly tentative.

The Role of Foreign Direct Investment in the External Adjustment Process—David J. Goldsbrough (pages 725-54)

This paper investigates the effect on foreign direct investment flows of changes in countries’ relative competitiveness and real levels of demand. Most previous models of foreign direct investment flows have simply adapted a version of the neoclassical investment function used to explain domestic investment expenditures, without considering the crucial question of what influences the multinational firm’s location decision. To remedy this, a simple model is developed to explain how such a firm locates its production facilities among different countries. This location model is then incorporated into a neoclassical investment function to explain the world-wide plant and equipment expenditures by the firm. For instance, it is shown that a fall in a country’s real exchange rate will lead to an increase in the output of a multinational firm’s affiliate located in that country, provided that the affiliate’s output is more of a “traded” good susceptible to international market pressures than are the inputs used to produce that good. The factors influencing the international distribution of financing for the firm’s world-wide capital expenditures are then discussed, and a model of direct investment flows is derived. The model is estimated empirically for direct investment inflows and outflows of the United States, the United Kingdom, Japan, and the Federal Republic of Germany using semiannual data to make it compatible with the Fund’s models of merchandise and invisible trade flows. The results show that, in general, foreign direct investment flows are strongly influenced by changes in both real levels of demand and countries’ relative competitiveness.

The Dynamics of Inflation: Forward Contracts and Money—Arturo Brillem-Bourg (pages 755-74)

Money demand theory within a rational expectations framework predicts discontinuous jumps in the price level and a serially uncorrelated inflation rate. Both of these predictions seem to be contradicted by observations of price level behavior. To reconcile theory with observation, this paper suggests that a general price index, such as the consumer price index, is a weighted average of spot and previously contracted prices. Applying a rational expectations framework to the demand for money, this paper shows that the spot price level jumps discontinuously, while the general price level tends to approach its long-run equilibrium slowly. The spot price will either jump to, or will overshoot, its long-run level, depending on whether the spot price level or the general price level, respectively, is the proper money demand deflator. The paper also suggests various applications of this theory to other issues, such as the relationship between the interest rate and the inflation rate, the empirical formulation of money demand, and the purchasing-power-parity theory.

Monetary Policy in Selected Asian Countries—Bijan B. Aghevli, Mohsin S. Khan, P. R. Narvekar, and Brock K. Short (pages 775-824)

This study evaluates the role of money, and assesses the conduct of recent monetary policy, in certain Asian countries (Indonesia, Malaysia, Nepal, the Philippines, Singapore, Sri Lanka, and Thailand). The paper focuses on a general comparison of the monetary experiences of these countries, without going into a detailed description of the financial structure of each one.

Empirical tests conducted for these countries indicate that monetary variables do have an important effect on the behavior of important macroeconomic variables, particularly the rate of inflation. However, the underdeveloped nature of domestic financial markets and the general openness of their economies impose some constraints on monetary policy in these countries; and these constraints tend to limit the effectiveness of monetary policy as a short-term stabilization device. The theoretical case made for this turns out to be supported by an examination of the specific monetary policy tools that are at the disposal of the authorities and the use that has been made of them recently. The principal conclusion of the study is that longer-term policies based on the concept of targets for monetary aggregates are better suited to the circumstances of these economies than short-term “fine-tuning.”


Le DTS—panier de monnaies—J. J. Polak (pages 627-53)

Etant donné l’adoption de nouvelles dispositions concernant l’évaluation du droit de tirage spécial (DTS) dans le deuxiéme amendement aux Statuts, la mise en place le 1er juillet 1978, d’un nouveau panier, la hausse du taux d’intérêt du DTS et la décision de la Banque des règlements internationaux et de certaines banques commerciales d’accepter des dèpôts libellés en DTS, il convient d’analyser à nouveau la méthode consistant à évaluer le DTS à partir d’un panier de monnaies.

Certes, en 1974, le “panier-type” a été adopté après beaucoup d’hésitations, mais c’est en fait la seule méthode qui permettra au DTS de devenir un instrument du marché; seul ce panier peut avoir les attributs d’une monnaie, puisqu’il correspond à la somme de montants fixes de monnaies. Et seul également le panier-type permet d’utiliser des monnaies dont le taux flotte. Par ailleurs, dans le Système monétaire européen, l’unité monétaire (Ecu) regroupe toutes les monnaies des pays de la Communauté européenne, y compris celles qui flottent.

Le panier de monnaies retenu en 1978 pour l’évaluation du DTS conserve la plupart des caractéristiques du panier de (1974): il se compose des monnaies des 16 pays les plus importants sur le plan des exportations de biens et de services; la pondération dont est assortie chaque monnaie est calculée en fonction de la valeur de ces exportations au cours des cinq années précédentes; celle du dollar E.U. (33 pour 100) étant néanmoins supérieure à la part des Etats-Unis dans les exportations mondiales. Dans le panier de 1983, cependant, la pondération de chaque monnaie sera calculée d’après une formule établie en fonction des exportations, d’une part, et du rôle de monnaie de réserve que joue la monnaie en question, d’autre part. Pour la plupart, les modifications apportées au montant des monnaies figurant dans le panier de 1978 (diminution des montants des monnaies fortes et augmentation des montants des monnaies faibles) ne reflètent pas de changements dans la structure des échanges, mais répondent au souci de corriger les effets des fluctuations des taux de change depuis 1974.

Si l’on a dérivé le taux d’intérêt du DTS de la moyenne pondérée des taux d’intérêt des cinq principales monnaies (qui représentent environ 70 pour 100 de la pondération totale du panier), c’est parce qu’on estimait pouvoir obtenir ainsi une bonne approximation de l’intérêt que pouvait rapporter le panier dans son ensemble. Or, cette hypothèse ne s’est pas révélée totalement exacte. De 1974 à 1978, cette approximation a donné une orientation en baisse au taux d’intérêt calculé, auquel on appliquait de surcroît une décote. Lorsqu’il sera possible d’utiliser plus librement les DTS et que les DTS apparaîtront sur le marché (euro-DTS), il faudra ajuster plus étroitement leur taux d’intérêt à ceux du marché.

Taux de change fixes et taux de change flexibles : reprise du débat—Jacques R. Artus et John H. Young (pages 654-98)

Les auteurs de la présente étude examinent dans quelle mesure l’analyse et l’expérience des dix derniéres années ont modifié l’opinion relative au choix d’un système de taux de change. D’une façon générale, les avantages des taux de change flexibles ont été surestimés. L’adoption de taux flexibles ne permet pas aux gouvernements de soutenir en permanence des taux d’activité éco-nomique plus élevés qu’en régime de taux fixes, au prix d’une inflation plus forte, comme certains le croyaient. En outre, la lenteur de l’ajustement en fonction des variations des prix relatifs limite la contribution des taux flexibles au processus d’ajustement externe à court terme, de même que le degré d’isolation qu’ils offrent contre les influences extérieures. Enfin, les taux flexibles tendent à fluctuer et, bien qu’il ait été difficile jusqu’ a present de prouver, sur le plan empirique, l’influence négative de leurs fluctuations sur les flux commerciaux et les mouvements de capitaux, l’instabilité des taux de change, plus que tout autre facteur, a suscité un certain désenchantement a l’égard du flottement des monnaies.

Malgré les inconvénients des taux de change flexibles, le besoin d’une certaine flexibilité des taux se fera encore sentir au cours des prochaines années. Les auteurs analysent les problèmes à résoudre pour obtenir une stabilité accrue en système de taux de change flexibles, ou le degré de flexibilité nécessaire en système de taux fixes mais ajustables.

Inflation et réserves internationales : analyse de séries chronologiques—Mohsin S. Khan (pages 699-724)

Plusieurs études récentes de la relation empirique existant entre l’inflation globale et la croissance des reserves internationales au cours de la période de taux de change fixes aboutissent à la conclusion que l’accroissement des réserves internationales a été l’une des causes principales de l’inflation mondiale observée au débutdes années 1970. L’auteur de la présente étude se propose de réexaminer les résultats sur lesquels se fonde cette conclusion en utilisant des techniques statistiques plus efficaces que les méthodes de regression types pour determiner à la fois le degré de relation et le sens du rapport de cause à effet entre deux variables. Ces méthodes, généralement appelées dans les ouvrages specialises tests de causalité, ont été appliquées à plusieurs études et ont été concues essentiellement pour montrer de façon plus précise les décalages temporels existant entre les séries chronologiques. Les résultats des tests sont ensuite interprétés dans un sens de causalité particulier.

Les tests effectués dans la présente étude pour trois groupes distincts de pays—le monde entier, les pays industrialisés et les pays en développement—indiquent que, lorsqu’on considère une période recouvrant à la fois le système des taux de change fixes et le systéme des taux de change flottants, il apparait que l’inflation a toujours enregistré un retard par rapport à la croissance des réserves internationales dans le cas du monde entier et des pays industrialisés. En d’autres termes, c’est la croissance des réserves qui a “causé” l’inflation. En ce qui concerne les pays en développement, au cours de cette période, la relation entre les deux variables était simultanée. En général, les résultats tendent à confirmer la théorie quantitative de Fapproche monétaire appliquée à Féconomie mondiale.

Pour savoir si les relations ont changé avec l’avénement des taux de change flottants, les tests ont été répétés pour la sous-période 1973–1977. Leurs résultats montrent que, tandis que croissance des réserves et inflation restent liées, le sens du rapport de causalité devient quelque peu ambigu. D’une façon générale, toutefois, en raison des limitations qu’imposent les données dont on dispose, les conclusions concernant la période de flottement des monnaies ne doivent pas être considérées comme définitives.

Le rôle de l’investissement direct étranger dans le processus d’ajustement externe—David J. Goldsbrough (pages 725-54)

Ce document présente une étude des effets exercés sur les flux d’investissements directs étrangers par les changements intervenus dans la compétitivité relative des pays et les niveaux réels de la demande. La plupart des modèles précédents de flux d’investissements directs étrangers sont une simple adaptation d’une version de la fonction d’investissement néo-classique utilisée pour expliquer les dépenses d’investissement intérieures; mais ils ne posent pas la question cruciale de savoir ce qui influence l’entreprise multinational dans le choix de son implantation. Pour combler cette lacune, l’auteur construit un modèle simple visant à expliquer comment les entreprises multinationales choisissent, parmi différents pays, celui où implanter leurs installations de production. Il introduit ensuite ce modele d’implantation dans une fonction d’investissement néo-classique pour expliquer les dépenses d’installation et d’équipement de l’entreprise à l’échelle mondiale. Par exemple, il est démontré qu’une baisse du taux de change réel de la monnaie d’une pays entraínera une augmentation de la production de la filiale d’un entreprise multinationale établie dans ce pays, à condition que les biens produits par la filiale soient des produits “commercialisés” plus sensibles aux pressions du marché international que les facteurs de production entrant dans la fabrication de ces biens. L’auteur analyse ensuite les facteurs influencant la répartition Internationale du financement des dépenses en capital de l’entreprise à l’échelle mondiale, et un modèle des flux d’investissements directs est alors établi. On estime le modele de façon empirique pour les entrées et sorties de capitaux au titre des investissements directs aux Etats-Unis, au Royaume-Uni, au Japon et en République fédérale d’Allemagne, en utilisant des données semestrielles pour que ce modàle soit compatible avec les modéles de flux d’échanges au titre des marchandises et des invisibles établis par le Fonds. Les résultats montrent que les flux d’investissements directs étrangers sont en général fortement influencés par les changements intervenus tant dans les niveaux réels de la demande que dans la compétitivité relative des pays.

Dynamique de l’inflation : les contrats à terme et la monnaie—Arturo Brillembourg (pages 755-74)

La théorie de la demande de monnaie considérée dans un contexte d’anticipations rationnelles suppose des mouvements discontinus du niveau des prix et un taux d’inflation sans correlation sérielle avec ceux-ci. L’une et l’autre de ces suppositions semblent être démenties par l’observation du com-portement du niveau des prix. Pour arriver à concilier la théorie avec l’observation de la réalité, cette étude prend pour hypothése qu’un indice général des prix—par exemple, l’indice des prix à la à consommation—est une moyenne pondérée des prix au comptant et des prix fixés dans des contrats antérieurs. Appliquant des bases d’anticipations rationnelles à la demande de monnaie, cette étude montre que le niveau des prix au comptant enregistre des variations discontinues tandis que le niveau général des prix évolue lentement vers sa position d’équilibre de longue période. Selon que le déflateur qu’il conviendra d’utiliser pour la demande de monnaie sera le niveau des prix au comptant ou le niveau général des prix, le prix au comptant atteindra son niveau de longue période dans le premier cas, ou le dépassera dans le second cas. Cette étude examine également quelques autres applications possibles de cette théorie à d’autres problèmes, notamment la relation entre le taux d’intérêt et le taux d’inflation, la formulation empirique de la demande de monnaie et la théorie de la parité des pouvoirs d’achat.

La politique monétaire dans certains pays d’Asie—Bijan B. Aghevli, Mohsin S. Khan, P.R. Narvekar et Brock K. Short (pages 775-824)

Les auteurs de la présente étude analysent le rôle de la monnaie et les orientations récentes de la politique monétaire dans certains pays d’Asie (Indonésie, Malaisie, Népal, Philippines, Singapour, Sri Lanka et Thaïlande). Ils effectuent une comparaison générale des expériences de ces pays en matière monétaire, sans décrire de façon détaillée la structure financière de chaque pays.

Les tests empiriques appliqués à ces pays montrent que les variables monétaires ont effectivement une grande incidence sur le comportement des variables macroéconomiques importantes, en particulier le taux d’inflation. Toutefois, le fait que les marchés financiers de ces pays soient peu développés et que leurs économies soient largement ouvertes sur l’extérieur impose aux dits pays certaines contraintes dans la conduite de leur politique monétaire, qui tendent à en limiter l’efficacité en tant qu’instrument de stabilisation à court terme. Cette hypothèse se trouve confirmée par l’analyse des instruments de politique monétaire spécifiques dont disposent les autorités et par l’utilisation qui en a été faite récemment. La principale conclusion de cette étude est que des politiques à long terme fondees sur le concept d’objectifs lies aux agrégats monétaires sont mieux adaptées à la situation de ces economies que les poli-tiques de “réglage précis” à court terme.


EI DEG, cesta de monedas—J. J. Polak (páginas 627-53)

Son varios los motivos que hacen necesario un nuevo análisis del derecho especial de giro (DEG) considerado como cesta de monedas: las disposiciones del Convenio Constitutivo enmendado sobre la valoración del DEG, la nueva cesta establecida el 1 de julio de 1978, los aumentos del tipo de interés del DEG y la decisión adoptada por Banco de Pagos Internacionales y otros bancos comerciales de aceptar depósitos denominados en DEG.

Si bien la “cesta tipo” para la valoración del DEG se adoptó en 1974 con cierto reparo, es en realidad el único método que permitirá convertir el DEG en un activo de mercado; únicamente esta cesta puede reunir las propiedades de una moneda, ya que consiste en la suma de cantidades fijas de diferentes monedas. Además, sólo la cesta tipo puede incorporar monedas con tipo de cambio flotante de manera significativa. Se señala que en el sistema monetario europeo la unidad monetaria europea (UME) reúne todas las monedas de la Comunidad Europea, incluidas las flotantes.

La cesta de monedas establecida en 1978 para la valoración del DEG conservó la mayor parte de las características de la cesta original (de 1974); se compone de las monedas de los 16 países que acusan los mayores niveles de exportación de bienes y servicios, sus ponderaciones se basan en el valor de dichas exportaciones en el quinquenio precedente, y atribuye una ponderación mayor (33 por ciento) al dólar de EE. UU. que la que le correspondería según su participación en las exportaciones mundiales. No obstante, en la cesta de 1983 la ponderación de cada moneda se determinará de acuerdo con una fórmula basada en las exportaciones y en la medida en que cada moneda se utilice como moneda de reserva. La mayoría de las modificaciones de los montos de las monedas que componen la cesta de 1978 no se debieron a fluctuaciones de las participaciones en el comercio sino que tuvieron la finalidad de compensar las fluctuaciones de los tipos de cambio ocurridas a partir de 1974, habiéndose reducido los montos de las monedas fuertes y aumentado los de las monedas débiles.

La obtención del tipo de interés del DEG a partir del promedio calculado de los tipos de interés de las cinco monedas principales (que representan alrededor del 70 por ciento de la ponderación total de la cesta) se basó en el supuesto de que dicho promedio se aproximaba en gran medida al interés que podría devengar la cesta en su totalidad, pero esto no resultó ser completamente exacto. De 1974 a 1978 la aproximación dio un sesgo a la baja al interés calculado, al cual se aplicó además un descuento. Cuando se liberalice aún más el uso del DEG y comiencen a utilizarse los DEG de mercado (Euro-DEG), el tipo de interés del DEG deberá reajustarse con mayor exactitud a los tipos de interés del mercado.

Tipos de cambio fijos y tipos de cambio flexibles: Reanudación del debate—Jacques R. Artus Y John H. Young (páginas 654-98)

En este trabajo se examina la medida en que, tras una década de análisis y experiencia, ha variado la manera de pensar en cuanto a la elección de un sistema de tipos de cambio. Se considera que se han exagerado las ventajas de los tipos flexibles. Contrariamente a lo que algunos habían pensado, dichos tipos no permiten que los gobiernos mantengan un ritmo de actividad económica que aumente permanentemente a costa de una mayor inflación. Además, la lentitud con que se produce el ajuste a las variaciones de los precios relativos en los mercados de bienes limita la influencia de los tipos de cambio flexibles desde el punto de vista tanto de su contribución al ajuste externo a corto plazo como del grado en que permiten que los países se aislen de las influencias externas. Finalmente, los tipos flexibles tienden a fluctuar y, pese a que hasta ahora hay pocas pruebas empíricas en el sentido de que las fluctuaciones hayan tenido efectos perjudiciales en el comercio y los movimientos de capital, la inestabilidad de los tipos de cambio—más que cualquier otro factor—ha causado cierta desilusión respecto del sistema de tipos de cambio flotantes.

Pese a las deficiencias de los tipos de cambio flexibles, durante los próximos años se seguirá necesitando la flexibilidad de los mismos y en este trabajo se analizan los problemas que se presentan al tratar de lograr una mayor estabilidad con tipos de cambio flexibles o la flexibilidad requerida con tipos de cambio vinculados.

Inflación y reservas internacionales: Un análisis de series cronológicas—Mohsin S. Khan (páginas 699-724)

En varios estudios recientes en que se ha examinado la relación empírica existente entre la inflación global y el crecimiento de las reservas internacionales durante el período de tipos de cambio fijos se llega a la conclusión de que el aumento de las reservas internacionales fue la causa principal de la inflación mundial experimentada a principios de la década de 1970. La finalidad concreta del presente estudio es considerar de nuevo los datos en que se basó esa conclusión, utilizando técnicas estadísticas de más peso que los métodos ordinarios de regresión, para determinar tanto el grado de relación como la dirección de causación entre las dos variables. Estos métodos, generalmente conocidos en la literatura como pruebas de causalidad, se han aplicado ya en una serie de estudios y han sido ideados esencialmente para identificar con mayor precisión los adelantos y atrasos entre series cronológicas. Se interpretan luego los resultados de las pruebas como indicación de causalidad en un sentido determinado.

Las pruebas efectuadas en este trabajo para tres conjuntos distintos de países—el mundo, países industriales y países en desarrollo—indicaron que, al estudiar un período que abarcaba tanto el régimen de tipos de cambio fijos como el de tipos de cambio flotantes, la inflación aparecía constantemente rezagada con respecto al crecimiento de las reservas internacionales, en el caso del mundo y de los países industriales. Es decir, el crecimiento de las reservas es el que “causó” la inflación. En el caso de los países en desarrollo, la evolución de las dos variables en ese período fue coetánea. En términos generales, los resultados tienden a corroborar la teoría cuantitativa del dinero en el ámbito de la economía mundial.

Se repitieron las pruebas para el subperíodo 1973-77, con el fin de averiguar si habían variado las relaciones mencionadas al implantar los tipos de cambio flotantes. Los resultados de estas pruebas indicaron que, si bien seguía existiendo un vínculo entre el crecimiento de las reservas y la inflación, la dirección de causación se hacía algo ambigua. No obstante, en general, y debido a las limitaciones de los datos, las conclusiones relativas al período de tipos de cambio flotantes deben considerarse bastante provisionales.

Importancia de la inversión exterior directa en el proceso de ajuste externo—David J. Goldsbrough (páginas 725-54)

En el presente trabajo se investiga el efecto que tienen en los flujos de inversión extranjera directa las variaciones de la capacidad relativa de competencia y del nivel real de la demanda de los países. La mayoría de los modelos anteriores de flujos de inversión extranjera directa se han limitado a adaptar una versión de la función neoclásica de inversión utilizada para explicar el gasto interno destinado a la inversión, sin tener en cuenta la cuestión crucial de cuáles son los factores que influyen en la elección de las distintas localizaciones por las empresas multinacionales. A fin de paliar esta deficiencia, se ha creado un modelo sencillo para explicar la forma en que dichas empresas deciden situar sus instalaciones fabriles en los distintos países. Se incorpora luego este modelo a una función neoclásica de inversión, para explicar la distribución mundial del gasto de la empresa en instalaciones y equipo. Por ejemplo, se demuestra que un descenso del tipo de cambio real de un país ocasionará un aumento en el producto de la filial de una empresa multinacional situada en ese país, siempre que el producto de dicha filial sea un bien “objeto de comercio” susceptible a las presiones del mercado internacional en mayor grado que los insumos utilizados para producir ese mismo bien. Se examinan después los factores que influyen en la distribución internacional del financia-miento de los gastos mundiales de capital de la empresa, y se formula un modelo de flujos de inversión directa. Se efectúa una estimación empírica del modelo con los flujos de entrada y salida de inversión directa de Estados Unidos, el Reino Unido, Japón y la República Federal de Alemania, utilizando datos semestrales para que sean compatibles con los modelos del Fondo sobre flujos de intercambio de mercancías y de invisibles. Los resultados indican que, en general, los flujos de inversión extranjera directa están muy influidos por las variaciones de los niveles reales de demanda y de la capacidad relativa de competencia de los países.

La dinámica de la inflación: Contratos a término y dinero—Arturo Brillem-Bourg (páginas 755-74)

La teoría de la demanda de dinero dentro de un marco de expectativas racionales permite predecir saltos discontinuos del nivel de precios y una tasa de inflación sin correlación en serie, predicciones a las que parece contradecir la observación del comportamiento del nivel de precios. Para poder conciliar la teoría con las observaciones, en este trabajo se establece que un índice de precios generales, como por ejemplo el índice de precios al consumidor, es el promedio ponderado de precio “spot” (de entrega inmediata) y de precios contratados con anterioridad. Aplicando un marco de expectativas racionales a la demanda de dinero, se demuestra en este trabajo que el nivel de precios “spot” varía en forma discontinua, en tanto que el nivel de precios generales tiende a aproximarse lentamente a su situación de equilibrio a largo plazo. El precio “spot” alcanzará su nivel a largo plazo de un salto o lo sobrepasará, según que el nivel de precios “spot” o el nivel de precios generales, respectivamente, sea el deflactor adecuado de la demanda de dinero. En este trabajo se indican además diversas aplicaciones de esta teoría a otras cuestiones, como por ejemplo la relación entre el tipo de interés y la tasa de inflación, la formulación empírica de la demanda de dinero y la teoría de la paridad del poder adquisitivo.

La política monetaria de algunos países asiáticos seleccionados—Bijan B. Aghevli, Mohsin S. Khan, P. R. Narvekar y Brock K. Short (páginas 775-824)

En este estudio se analiza la función que desempena el dinero y se evalúa la gestión de la política monetaria aplicada recientemente en ciertos países asiáticos (Filipinas, Indonesia, Malasia, Nepal, Singapur, Sri Lanka y Tailandia). El estudio se concentra en una comparación general de la experiencia monetaria de dichos países sin entrar en detalles sobre la estructura financiera de cada uno de ellos.

Las pruebas empíricas llevadas a cabo en relación con estos países indican que las variables monetarias ejercen de hecho un efecto importante en el comportamiento de las principales variables macroeconómicas, particularmente en el de la tasa de inflación. Sin embargo, el carácter poco avanzado de sus mercados financieros internos y el grado general de apertura de sus economías imponen ciertas limitaciones a la política monetaria que puedan adoptar; estas limitaciones tienden a reducir la eficacia de dicha política como instrumento de estabilización a corto plazo. El razonaminento teórico formulado al respecto resultó corroborado por un examen de los instrumentos de política monetaria concretos que las autoridades tienen a su disposición y de la aplicación que se ha hecho últimamante de estos instrumentos. La principal conclusión a que se llega en el estudio es que las políticas a largo plazo basadas en el concepto de metas fijadas para los agregados monetarios son más pertinentes a las circunstancias de estas economías que los frecuentes reajustes más precisos a corto plazo.

In statistical matter (except in the résumés and resúmenes) throughout this issue,

  • Dots (…) indicate that data are not available;

  • A dash (—) indicates that the figure is zero or less than half the final digit shown, or that the item does not exist;

  • A single dot (.) indicates decimals;

  • A comma (,) separates thousands and millions;

  • “Billion” means a thousand million;

  • A short dash (-) is used between years or months (e.g., 1975-78 or January-October) to indicate a total of the years or months inclusive of the beginning and ending years or months;

  • A stroke (/) is used between years (e.g., 1977/78) to indicate a fiscal year or a crop year;

  • Components of tables may not add to totals shown because of rounding.

International Monetary Fund, Washington, D.C. 20431 U.S.A.

Telephone number: 202 477 7000

Cable address: Interfund


(available free of charge)

No. 27. Financial Assistance by the International Monetary Fund: Law and Practice, by Joseph Gold. 1979.

This pamphlet deals with: (1) certain general features of the Fund’s financial assistance to its members, such as the origins of its resources, the techniques for making them available, and the objectives in making them available; (2) each of the Fund’s policies on the use of its resources; and (3) an actual and a potential impact of the Fund’s financial activities on the private legal practitioner.

No. 28. Thoughts on an International Monetary Fund Based Fully on the SDR, by J.J. Polak. 1979.

This pamphlet explores the possibility of a radical change in the Fund’s General Department, under which the special drawing right (SDR) would become the basis for all transactions of the Fund. It discusses the steps that would be necessary to bring about the proposed change, as well as the probable effects that such a change would have on the Fund.

No. 29. Macroeconomic Accounts: An Overview, by Poul Høst-Madsen. 1979.

This pamphlet is aimed at meeting the need for a short and relatively simple exposition of the principles underlying macroeconomic statistics, viewed as an integrated whole. The areas covered are the national income accounts; the balance of payments; monetary statistics; government finance statistics; and flow-of-funds accounts.

No. 30. Technical Assistance Services of the International Monetary Fund. 1979.

This pamphlet deals with a lesser-known aspect of the Fund’s work—the technical assistance provided by the Fund to its members. It concentrates on four of the major areas in which the Fund provides this assistance: central banking, fiscal affairs, legal matters, and statistics.

No. 31. Conditionaliy, by Joseph Gold. 1979.

This pamphlet discusses one aspect of the use of the Fund’s financial resources. It traces the development of the doctrine of conditionality and explains the new or clarified elements of conditionality arising from the new guidelines established by the Fund in March 1979.

All of the above pamphlets are currently available in English; French and Spanish editions of the pamphlets are in preparation.

For information and to request copies, write to:

The Secretary

Attention: Publications Section

International Monetary Fund

Washington, D.C. 20431 U.S.A.


Mr. Aghevli, Senior Economist in the Asian Department, is a graduate of Brown University.

Mr. Khan, Assistant Chief of the Financial Studies Division in the Research Department, is a graduate of Columbia University and the London School of Economics.

Mr. Narvekar, Deputy Director of the European Department, is a graduate of Bombay University and Columbia University.

Mr. Short, Senior Economist in the Central Banking Service, is a graduate of the University of Western Ontario and Cornell University.

This study was prepared at the request of the South-East Asian Central Banks (SEACEN) Research and Training Center. An earlier version of the paper was presented at the Fourteenth Conference of the Governors of SEACEN, which was held in Baguio City, Philippines on January 17–19, 1979.


Throughout this paper, the term “Asian countries” refers to this group of seven countries, all of which are members of the Association of South-East Asian Central Banks (SEACEN).


For lucid statements of the Keynesian and monetarist positions, see Friedman (1968) and Modigliani (1977).


A more recent branch of monetarism argues that, according to the so-called “rational expectations hypothesis,” even in the short run, errors in expectations are likely to be short-lived, as the public fully discounts any fiscal or monetary attempt to stabilize the economy. The strict assumptions of perfect foresight and information on the part of all agents, however, limit the usefulness of this approach for practical policymaking. See Lucas (1972), Sargent and Wallace (1975), Barro (1976), and Cuikerman (1979).


Important studies in this area are by Bottomley (1965) and Park (1973). See also the collection of papers contained in Coats and Khatkhate (1980).


The ineffectiveness of demand management policy in coping with supply shocks is evidenced by the severe impact of oil price increases on the industrial economies.


For some empirical tests of this proposition, see Fry (1978) and Galbis (1979 a).


Some of the recent papers in this area are collected in Frenkel and Johnson (1976) and International Monetary Fund (1977).


Under a flexible system, exchange rates are viewed as relative prices of different currencies and, as such, determined by the demand for, and the supply of, stocks of various currencies. This approach is basically relevant for those currencies that are held in large amounts internationally and whose rates of exchange are allowed to fluctuate rather freely, according to supply and demand factors.


As Mathieson (1979) shows, this conclusion holds even in the McKinnon-Shaw framework.


For more general discussions of some of the issues in this section, see Crockett and Nsouli (1977), Branson and Katseli-Papaefstratiou (1978) and Aghevli (1979).


This argument is an extension of the optimum currency position, which contends that if the domain of a currency is defined too narrowly, the usefulness of that currency, as a unit of account and a store of value, is minimized.


This formulation was proposed by Friedman (1956). For an extensive survey of theoretical and empirical studies on money demand, see Laidler (1977).


Examples of this function, which is almost uniformly applied for developing countries, are contained in Khan (1977), Aghevli and Khan (1978), and Galbis (1979 b).


Specifying the equation in logarithmic terms is convenient, since it yields directly the estimate of the income elasticity, a2.


Alternatively, the expected inflation rate variable could be constructed, as a weighted average of the lagged inflation rates, according to an “adaptive” or “error-learning” scheme. Previous empirical work indicates that the weight of the previous quarter’s inflation rate has the highest value (about 0.9) (see Aghevli and Khan (1978)). We have, therefore, simply used the lagged inflation rate as a proxy.


The long-run elasticities are obtained as a1=λa11(1λ)anda2=λa21(1λ), respectively.


Nepal was not considered in this instance because of problems with data availability.


Since there is no theoretical presumption in using one particular definition of money.


All the data were taken from International Monetary Fund, International Financial Statistics, various issues. The precise variables are narrow money (line 34), broad money (lines 34 and 35), and the consumer price index (line 64). Gross national product (GNP) in constant 1975 prices was utilized as the real income variable. Since this last variable is only available on an annual basis, it was converted to quarterly levels using an interpolation formula.


Since the Durbin-Watson statistic is biased in models with a lagged dependent variable, we also estimated the equations with the assumption that the errors ut followed a first-order autoregressive process

ut = ρut-1 + ϵt

where ρ denotes the coefficient of autocorrelation, | ρ | < 1, and ϵ is a random error term. Where necessary, the adjusted equations were used.


The test procedure is described in the Appendix.


Algebraically, this is defined as M = kRM, where M is the supply of money, k is the money multiplier, and RM is reserve money. From this identity, the percentage change in money is equal to the percentage changes in k and RM.


The Central Bank of the Philippines has engaged in foreign asset swaps with domestic commercial banks for monetary policy purposes. This has led to an increase in the reserves of these banks. However, this is only a temporary increase, since reserves fall when the swaps are reversed.


The multiplier can be expressed as: k=c+1c+r where c denotes the currency (outside banks)-to-deposits ratio and r denotes the banks’ reserves-to-deposits ratio.


The value of a secondary market in government securities is not just as a market in which open market operations can be undertaken but also as a means of generating liquidity for purchases of securities and thus increasing the demand.


Changing rates on deposits can also affect the money multiplier by altering the currency-to-deposits ratio.


This policy is designed for balance of payments reasons rather than for domestic monetary control.


For a description of the target variables used in industrial countries, see Organization for Economic Cooperation and Development (1979).


Against the potential benefit of, say, lowering the rate of inflation by lowering expectations, one should weigh the potential cost of exceeding the targets (i.e., the undesirable effects).


A further criterion we put forward had to do with the early availability of data. In general, however, data on relevant monetary aggregates within each country are available more or less simultaneously.


Such a relationship would result from the assumption that the income velocity of money was constant.


The Granger methodology is generally used to establish causality of a particular kind between time series. Here we are concerned only with detecting the relationship, rather than with its nature—causal or contemporaneous.


For a discussion of the problem of spurious correlation in econometrics, see Granger and Newbold (1974).


This implies that the movements of the stock of money can be viewed as a random walk.


The length of the time series for these two countries restricted us to 6-quarter leads and lags.


A similar result of independence of money and prices was also obtained for the United States by Feige and Pearce (1976).