- Tomás Baliño, Charles Enoch, and William Alexander
- Published Date:
- July 1995
In the late 1970s, industrial countries began phasing out the direct instruments some of them used to operate monetary policy—including credit controls, interest rate ceilings, and sometimes directed credits—and began moving toward full reliance on indirect instruments, such as open market operations, rediscount facilities, and reserve requirements. In more recent years, there has been also an increasing tendency for the developing countries and the economies in transition to adopt such instruments.
The greater use of indirect monetary instruments can be seen as the counterpart in the monetary area to the widespread movement toward enhancing the role of price signals in the economy more generally. Both have the same objective of improving market efficiency. Perhaps even more critically, moves to indirect instruments are taking place in an increasingly more open economic environment, with widespread adoption of current account convertibility and progress in moving to full convertibility. In such an environment, direct instruments have become increasingly ineffective, leading to inefficiencies and disintermediation. In the absence of indirect instruments of monetary policy, the authorities would, therefore, be unable to counter any problems of excess liquidity, which would impede their efforts to stabilize the economy.
With the IMF’s increasing involvement in structural reforms—including those in the financial and monetary spheres—progress toward the adoption of these instruments has been an element in a number of IMF-supported programs. In addition, the Monetary and Exchange Affairs Department (MAE) of the IMF has provided considerable technical assistance in this area. The IMF’s involvement reflects the recognition of the fact that the mere setting of monetary targets cannot guarantee their achievement, however great the commitment of the authorities, if capacity is lacking and the appropriate institutional infrastructure is not in place.
This paper examines the experience of implementing indirect instruments of monetary policy. The experiences of the countries under review illustrate the variety of circumstances under which indirect instruments of monetary policy have been introduced. It also indicates that, to be effective, the adoption of such instruments generally requires prior and parallel reform in the banking and financial sectors as well as a number of concomitant actions regarding the pace and sequencing of the adoption of indirect monetary instruments. By implication, then, the countries’ experiences would caution against premature introduction of such instruments in situations where the required supporting institutional reform is lacking and the necessary concomitant policy measures are not likely in the near future. Moreover, once the process of introducing indirect instruments has begun, pragmatism and the principle of evolution should guide the speed of transition.
Section II describes the characteristics of direct and indirect instruments and explains the reasons for moving from the former to the latter. Section III addresses issues in the reform of monetary policy instruments. Section IV examines a number of countries that have adopted indirect instruments and reviews both how they did it and the results. Since the effective implementation of indirect monetary instruments typically requires many parallel and sometimes prior reforms in central banking and the broader financial sector, the paper also identifies a number of frequent concomitant measures and discusses how important these were to the success of the reform strategy as a whole (Section V). Section VI discusses the design of IMF-supported stabilization programs and the need for technical assistance. Finally, Section VII summarizes the principal conclusions. (The case studies that serve as background for Sections IV and V are contained in Part II.)