Domestic Credit Expansion Research Articles

Extremal analysis of currency crises in Taiwan

We employ extreme value theory to identify currency crises in Taiwan. The new approach is able to identify severe currency crises, and at the same time avoid the crisis-misclassification problem of Markov-switching models. Signal accounting indicates that currency crises in Taiwan are preceded by rapid expansion of domestic credit and other monetary aggregates, implying that financial excesses stressed by the third-generation crisis model are the main causes of these currency crises.

The Federal Democratic Republic of Ethiopia: 2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for the Federal Democratic Republic of Ethiopia

The Federal Democratic Republic of Ethiopia’s 2007 Article IV Consultation reports on the macroeconomic imbalances and on maintaining medium-term macroeconomic stability while fostering growth potential. Although agriculture continues to be the mainstay of the economy, the expansion has been broad-based, with manufacturing, construction, and services making significant contributions. Expansion of domestic credit has continued to be brisk, reflecting a pickup in private sector economic activity and increasingly negative real interest rates. A critical challenge for Ethiopia is to strike a judicious balance between demand-dampening measures and growth-enhancing structural reforms.

Monetary policy in developing countries: lessons from Kenya

We estimate and then simulate a model of Kenyan economic development from 1965 to 1997 with two objectives in mind. The first is to demonstrate the degree of volatility of cyclical shocks that developing countries experience and to calculate the domestic nominal adjustments required by these shocks under both irrevocably fixed and free exchange rates.A comparison of these counterfactual nominal adjustments identifies the short-run implications for an economy of the choice of exchange rate regime. The second objective is to provide an estimate of the consequences for the economic development of Kenya of the lack of a coherent monetary order (excessive domestic credit expansion and overvalued exchange rate) throughout most of the period since 1965.A neoclassical convergence growth model based on Barro and Sala-i-Martin (1992) is employed and calibrated to represent the long-run growth path of real GDP in Kenya. A short-run four-sector CGE model is constructed that allows for cyclical movements of real GDP about the convergence growth path. The cyclical model focuses on the adjustment of the relative price of non-traded goods that is required to ensure short-run equilibrium in the non-traded goods sector. Given that terms of trade shocks dominated the macro environment of Kenya over the sample period, we find that a free exchange rate regime would have insulated the economy to a greater degree than an irrevocably fixed regime. In the growth decomposition exercise, we estimate that the two largest (and negative) influences on Kenyan economic growth were the decline in the external terms of trade from 100 in 1965 to an average of 79.5 over the 32-year time period, and the overvalued Kenyan shilling represented by a premium on the parallel market for foreign exchange. Overall, we estimate that the overvalued exchange rate reduced economic growth by an average of 0.47 per cent per annum over the 32 years.

Collapsing Exchange Rate Regime Under Optimal Monetary Control

In this paper, we analyse the problem of optimal domestic credit expansion for a small open economy. We show that (i) the transition from the fixed to the flexible exchange rate regime proceeds smoothly with no speculative attack on the central bank's foreign reserves; (ii) once the exchange rate has floated, it will never be optimal to repeg it afterward; (iii) even under uncertainty, there will not be any speculative attack; however, the optimal rate of credit expansion jumps discontinuously at the date of complete depletion of the known stock of foreign reserves.

Collapsing exchange rate regimes: shocks and biases

Patterns in domestic credit creation stemming from inconsistent fiscal policies have received widespread attention for their role in aggrevating speculative attacks on central bank foreign exchange reserves and contributing to the collapse of exchange rate regimes. This paper acknowledges the importance of monetary and fiscal discipline, but also emphasizes the importance of other random shocks to the domestic money market, most notably shocks from external credit supplies and relative prices. Policies of the domestic fiscal authorities are only partial catalysts for speculative attacks on a currency. Expansion of domestic credit stemming from the monetization of fiscal imbalances may be dominated by involuntary domestic credit expansions which are necessitated by surprise shortages in supplies of external capital. Further, the unexpected availability of external capital translates into a lower net critical reserve floor, making the depletion of central bank reserves by a speculative attack more difficult to accomplish. Relative price shocks also randomize the demand for nominal money balances and therefore may also have a strong direct influence on the probability of an exchange regime collapse. Empirical studies of exchange rate crises that neglect these considerations will produce biased estimates of both expected collapse probabilities and anticipated post—collapse exchange rates.

The impact of credit policy on macro inventory behavior in the Hungarian economy

Stabilization programs usually contain Climitations endeavoring to keep the magnitude of domestic credit expansion consistent with the balance of payments, growth and price targets. In typical financial programs attention has been focused primarily on the aggregate demand effects of the financial variables and their implications for the balance of payments. In contrast, this paper is concerned with the analysis of the effects of credit policy on output, investment, consumption and how they relate to the development of the current account in the case of a planned economy like Hungary. The framework chosen for the analysis is one in which availability of financing is a direct and major determinant of current and future production. In particular, the paper addresses the following issues:

A Viable Gold Standard Requires Flexible Monetary and Fiscal Policy

national domestic credit expansion (dce) policies which offset the effect of money demand shocks on international gold reserves, the gold standard collapses with certainty in finite time through a speculative selling attack against one of the currencies. Various policies for postponing a collapse are considered. When a responsive dce policy eliminates the danger of a run on a country's reserves, the exogenous shocks disturbing the system which previously were reflected in reserve flows, now show up in the behaviour of the public debt. Unless the primary (non-interest) government deficit is permitted to respond to these shocks, the public debt is likely to rise (or fall) to unsustainable levels. For the idealized gold standard analysed in the paper, viability can be achieved only through the active and flexible use of monetary and fiscal policy.

The Balance of Payments of Trinidad and Tobago 1973–1983: A Monetary Phenomenon?

The monetary approach to the balance of payments accords a very important role to monetary variables in the determination of reserve flows; (see Johnson, 1977). It postulates that the reserve flows will increase (decrease) if the residents of a country desire to accumulate (deplete) money balances faster than the rate at which the money stock is growing (diminishing) as a consequence of purely domestic influences. In other words, reserve flows are the mechanism through which money demand and supply are brought into equilibrium, and the model predicts in particular that these flows are negatively related to the rate of domestic credit expansion. A most important policy implication of this approach is that the monetary authorities can influence the level of foreign reserves by acting upon the composition of the monetary base through deliberate and meaningful credit policies. Devaluation of the currency, on the other hand, will have little or no effect on the flow of these reserves; (see Frenkel and Johnson, 1976, Chapter 1).

Monetary Policy in Taiwan, China

This paper examines how Taiwan, China, has used monetary policy to deal with the impact of the two oil shocks since 1973, as well as with the recent problem of a very large rise in foreign exchange holdings. In dealing with the inflationary pressures brought on by the two oil shocks, the central bank relied primarily on changes in its rediscount rate to reduce inflationary pressures. However, the changes were initially too small and too late to prevent a large rise in consumer prices in 1974 and 1980. Since 1985, the large gains in foreign exchange reserves, due to a rising trade surplus and capital inflows have sharply expanded the money supply. The burden of containing this inflationary threat has fallen on monetary policy, and the government has not been able to offset the build-up in reserves by prepayment of external debt since the amount of outstanding debt is relatively small. In addition, use by the central bank of its rediscount policy or changes in reserve requirements has not been appropriate as domestic credit expansion has been low and not a basic cause of the large rise in liquidity. Instead, the central bank has relied almost exclusively on open market operations. It has engaged in a massive sterilization operation, selling primarily central bank certificates of deposit to neutralize the potentially inflationary impact from the large rise in the money supply. So far the central bank has been successful in holding the inflation rate to a low level, but it is not yet clear whether the present strategy will continue to be successful. Some suggestions of new basic measures for restoring a sustainable equilibrium between the external and domestic sectors are discussed.

Toward a Growth-Oriented Model of Financial Programming

This paper extends the basic monetary model that underlies the monetary approach to the balance of payments to allow for the endogenous determination of the short-run growth rate of the economy. In the extended model domestic credit expansion affects not only the balance of payments but also the output growth rate, which bears implications for the formulation of credit ceilings. Furthermore, the amount of external financing can influence both the output growth rate and the balance of payments outcome, unlike with the basic model. An integrated treatment of exchange rate adjustment involving both absorption and elasticity effects is provided.

External disturbances and the independence of monetary policy under the crawling peg in Colombia

This study examines the impact of external economic disturbances and the independence of monetary policy in Colombia. A five-equation econometric model is estimated. The results indicate that external occurrences have had a significant impact on Colombian prices and output. Contrary to the assumptions of the monetary approach to the balance of payments, a substantial portion of foreign reserve flows were sterilized, and the short-run balance of payments offset to domestic credit expansion was less than complete.

The Policy Implications of Internationally Mobile Capital under Fixed Exchange Rates

It is a well known prediction of the monetary approach to the balance of payments that a small country with a fixed exchange rate is precluded from pursuing an independent monetary policy. In the long run, it must inflate at the same rate as the rest of the world. Parkin (1974) demonstrated, however, that some degree of monetary independence is possible in the short run. Thus, if countries expand the domestic component of their money supplies at different rates, the existence of inflation differentials can be explained. The model used to derive this result was limited to the current account of the balance of payments. Moreover, there being no bond market, the only policy option available was a fiat money increase. It is the purpose of this paper to extend the Parkin model to incorporate the capital account of the balance of payments and to analyse the policy implications of internationally mobile portfolio capital for a small country faced by an increase in the world money supply. By re-specifying the model, it is also possible to widen the menu of policy options to include the sterilization of capital inflow to meet an interest rate target, targets for domestic credit expansion and complete capital controls. The dynamic stability properties of the model's response to an inflationary increase in the world money supply are examined. It is demonstrated that the long-run results of the monetary approach hold true provided capital is effectively immobile. If not, the model permits no stable solution. Its short-run properties are essentially similar to those obtained by Parkin.

Money, activity and prices: Some inter-country evidence

The paper explores the relationships between monetary variables and real economic activity and prices in the six largest industrialized economies. Univariate and multivariate time series forecasting models are used to break down monetary policy variables into anticipated and unanticipated components. Overall monetary policy variables, particularly domestic credit expansion, appear to be significant leading indicators for subsequent real economic activity and prices. Additionally, anticipated components of monetary policy are shown to have as much forecasting ability for subsequently realized economic variables as unanticipated components. This does not appear to be consistent with the implications of pure rational expectations models. It was also noted that results differed significantly according to the choice of monetary variable and across individual countries. In particular the results implied no contradiction with previous findings for the impact of unanticipated money supply in the U.S., though such contradictions would have appeared if DCE had been used as the monetary variable.

Domestic Credit Expansion, Confidence and the Foreign Exchange Market: Sterling in 1976

Abstract Domestic Credit Expansion, Confidence and the Foreign Exchange Market: Sterling in 1976 This paper examines in detail the reasons for the wide fluctuations in the sterling exchange rate during 1976, fluctuations which can be argued to have had lasting and significant effects on the course of the UK economy. Three possible explanations, emphasising movements in the current account, prior monetary growth rates and prior movements in relative price levels, are rejected as inaccurate and oversimple. The ‘established’ interpretation of the episode is then set out within the framework of the monetary approach to the balance of payments; this interpretation emphasises the importance and relative autonomy of fluctuations in confidence, in both the foreign exchange and the government securities markets, and implies ‘reverse causation’ from the balance of payments/exchange rate via confidence to domestic credit expansion (DCE). Some criticisms of this interpretation in the literature are discussed, and the thinking underlying the behaviour of the monetary authorities is examined in some detail: in particular the authorities are shown to have taken an essentially passive view of their own monetary policy, to have focussed on money supply growth rather than DCE and to have attached great importance to announcement effects and other factors affecting confidence. An alternative interpretation is then developed which regards confidence as determined, except in the very short run, by monetary policy (DCE) and which views causation as going primarily from DCE to the balance of payments/exchange rate. The difficulties involved in tests to discriminate between these two interpretations are discussed and it is argued that no definite conclusion can be drawn. However it is concluded that future sterling fluctuations can be prevented by the appropriate control of DCE, and that monetary policy should therefore focus on this aggregate rather than on the growth of the money supply. Finally the role of some political factors in the episode is considered in an Appendix

Definitions of Domestic Credit Expansion for the United Kingdom

Several different definitions of Domestic Credit Expansion (DCE) in the UK have been used either for official or for academic purposes, yet apart from an early paper by Art is and Nobay (1969) there has been little serious discussion of the issues involved. This expository note is intended to clarify the differences between the various definitions. Section I uses a table of assets and liabilities by sector to show the relationship between DCE, the change in money supply (ΔM) and the balance of payments/change in foreign reserves (ΔR)for a simple monetary system. Section II uses a more complex table to present three official definitions of DCE for the UK and three definitions that have been used in academic work. Section III considers the choice between the definitions in terms of the purposes for which the concept of DCE might be used. Section IV summarises the main conclusions.

Monetary Policy: Old Wisdom behind a New Facade

However imminent a change in British monetary practice may have been, few would have expected allegedly revolutionary reforms recently implemented. For although some three years ago Bank of England had expressed intentions (or some would say pursued a policy) of less concern with gilt-edged prices, actual behaviour echoed dilemma of seeking to control some monetary aggregate (be it money or Domestic Credit Expansion) while avoiding creation of conditions considered to be detrimental to health of gilt-edged market.2 Yet, contrary to what we were often led to believe, approach to this dilemma does not rest in deciding whether or not to sacrifice gilt-edged sacred cow of price stability on some Friedmanian altar. Indeed, some of our peers once approached a somewhat similar problem rather differently. After twenty years of almost uninterrupted fixity in Bank rate, disillusion with the use of public finance and direct controls as sole regulators of business activity resulted in 1952 witnessing initiation of a new monetary era-or so it was thought at time. Attention therefore turned to examination of questions of liquidity and ability to control credit. ability and readiness of banks [to extend credit to private sector] was greatly facilitated by two characteristics of contemporary situation. The first was that as a result of wartime cheap money policy and deficit finance banks held [comparatively too] large a proportion of short term low yielding liquid assets (chiefly Treasury Bills) .... The second was that in order to keep down cost of floating debt, Bank of England stood ready through its 'special buyer' to purchase Treasury Bills at pegged rate of 1 per cent. The banks were thus able to meet any increase in demand for advances by selling or running off Treasury Bills, without running any