Monetary Policy in Developing Countries

Abstract

This chapter discusses monetary policy in developing countries. From the long-run point of view, the problem of desirable monetary policy reduces primarily to the desirable rate and form of inflation. Two intermediate steps lead to this identification: the recognition that monetary policy is concerned primarily with the quantity of money, not with the terms and availability of credit, and that inflation is always and everywhere a result of a rapid rate of increase in the quantity of money. The chapter discusses these two intermediate steps before turning to the relation between inflation and development. The best way to foster an effective and diversified financial structure is to let financial institutions develop in response to market forces. Repressing prices of goods and of labor, while no less frequently attempted than repression of exchange rate and interest rates, generally does less economic harm. The reason is that they tend to be easier to evade. However, they do great social harm. Given price controls, black markets serve a socially useful purpose by preventing the distortions that would otherwise develop. The effect of price controls is, therefore, to make socially and individually beneficial action that is morally repugnant because it involves breaking the law. The conflict tends to undermine the moral capital of a nation. Good monetary policy cannot produce development. Economic development fundamentally depends on much more basic forces: the amount of capital, the methods of economic organization, the skills of people, the available knowledge, the willingness to work and to save, and the receptivity of the members of the community to change.