Monetary Base Management and BOP Movements: The ASEAN countries

Abstract

In recent years, the world has experienced signifi cant economic instability as manifested by the wide fluctuation of key macro-economic variables. Most instabilities in less developed countries (LDCs) have been attributed to external factors, particularly since 1973, a year which saw the breakdown of the Bretton Woods system and a drastic increase in oil prices. In many cases domestic instability has augmented external stabilization issues, particularly those related to the international transmission of disturbances. Two important transmission mechanisms are prices and balance of payments (BOP). This paper focuses on the BOP and, specifically, how it affects domestic monetary conditions. It is basically a study of sterilization policies. With the advent of generalized floating regimes, mon etary authorities have gained an additional tool for monetary management?the exchange rate. Under this system, the exchange rate can also serve as an instrument for sterilizing the effects of BOP flows on money supply. Given the BOP situation, the monetary authorities can intervene in the exchange market, and intervention changes domestic high-powered money accord ingly. This mechanism is explained further in subsequent sections. This paper considers both types of sterilization policies: exchange rate intervention and the traditional tools of monetary management. Another factor which is taken into account in examining sterilization policies is offsetting pay ments flows. Other studies assume exchange rates to be fixed and hence consider only tiny effects. The concepts of offsetting flows, exchange rate intervention, and the traditional tools of monetary management are important not only in relation to sterilization but also as indepen dent factors which influence the stability of the domestic financial system. To study these concepts and interrelationships, a model incor porating (i) reaction functions of the monetary authorities and (ii) the monetary approach to BOP and exchange rate determination, is developed. The next section discusses the theoretical framework for analyzing the effects of BOP changes on the monetary base. An econometric representation of the framework is presented in the following section, and the results of the estimation of the various models are then ana lyzed with regard to the ASEAN countries. The final section presents a summary and the conclusions.