Public Information Notice No. 05/15

Public Information Notice: IMF Executive Board Discussed Staff Paper on Monetary Policy Implementation

February 7, 2005

On November 17, 2004, the Executive Board of the International Monetary Fund (IMF) considered an IMF staff paper, Monetary Policy Implementation at Different Stages of Market Development, which looks at issues relating to the implementation of monetary policy, based on a survey of practices in countries at different stages of money market development.

Background

Central banks in emerging market economies and developing countries have been moving toward greater reliance on money market operations for the implementation of monetary policy. The move toward use of open market operations following the trend seen in industrial countries in the 1970s, and complements broader reforms aimed at improving the capacity of financial institutions to mobilize domestic savings, and strengthening the role of market forces in the allocation of financial resources. The Fund has encouraged the process and technical assistance was provided to help countries make the transition.

The experience of emerging market economies and developing countries with market-based monetary-policy operations has been mixed. Limited competition in financial markets has complicated use of money market operations in some smaller countries in particular. In larger countries, some have moved successfully to the use of open market operations, while others, despite lengthy periods of adjustment, still cannot fully rely on money market operations for liquidity management.

This aim of the paper is to identify guidelines for developing strong frameworks for monetary policy operations, drawing on the experience of a dozen countries or groupings of countries. It includes small countries with limited scope for developing diversified markets, some of which have been able to set up effective monetary policy frameworks, and larger countries which, at some point, had not yet managed to establish a strong market infrastructure due to weaknesses in policy implementation. The country cases (Eastern Caribbean Currency Union, Democratic Republic of the Congo, Egypt, Kyrgyz Republic, Malta, The Gambia, Tonga, Tunisia, Uganda, Ukraine, Vanuatu, and Zambia) are presented in a Supplement.

The country experiences show that adoption of money market operations for the conduct of monetary policy has been most effective in the context of a stable macroeconomic environment and sound fiscal policies, a sound and competitive financial system and adequate supervisory framework, and a significant degree of institutional autonomy and operational capacity at the central bank. The paper also shows that the development of money market operations needs to be tailored to each country's particular circumstances. The conclusions of the paper support the close integration of the work of the Fund's area departments (surveillance or use of resources) with the Fund's technical assistance in monetary policy design and implementation. This integration is particularly relevant for countries in transition to market-based frameworks for the implementation of monetary policy.

The paper can be regarded as work in progress. Going forward, the next steps involve developing a menu of options for the implementation of monetary policy that takes into account the underlying impediments to market development.

Executive Board Assessment

Directors looked forward to enhanced cooperation between the Monetary and Financial Systems Department (MFD) and area departments to ensure that a country's monetary framework and its instruments are consistent with the level of development of its money market. This could be done in the context of a country's FSAP, or a follow-up to it. The staff might also consider extending this approach, on a voluntary basis, beyond countries that have completed FSAPs, to include post-conflict countries and those at an early stage of financial intermediation development.

Directors generally supported the staff's recommendations for future work in this area. They saw as useful the development of a menu of options for the implementation of monetary policy that takes into account potential impediments to market development,including the extent of dollarization, the size of the country, government financing needs, structural excess liquidity, implementation capacity at the central bank, and the strength of the banking system. They encouraged follow-up work to further refine the Fund's policy advice to countries developing their money markets, which should draw on the experience of countries that have successfully shifted to money market instruments, as well as those making the transition, while taking into account the problems identified in countries that are still in the early stages of financial development. Directors welcomed the staff's intention to engage in close dialogue and outreach with member countries as a preparatory step for this work.