Financial Sector Reforms and Monetary Policy

IMF Working Papers, December 1, 1991

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In recent years a number of countries have undertaken far-reaching reforms of their financial sectors.
Financial sector reforms aim at:
- achieving greater flexibility of interest rates,
- an enhanced role for market forces in credit allocation,
- increased independence for the central bank,
- a deepening of money and securities markets.
Such reforms, and the developments that follow, have important implications for the design and conduct of monetary policy.
This paper provides an overview of the linkages between financial sector reforms and the monetary policy framework, focusing in particular on the objectives, instruments, and operating procedures of monetary policy.

Reforms increase flexibility of interest rates and alter the interest rate structure and interest rate volatility.
Market forces play an enhanced role in credit allocation, affecting credit rationing and the transmission mechanism.
Deepening of money and securities markets influences money markets, the monetary base, excess reserves, and the money multiplier.
Changes affect demand for money and monetary management, with implications for monetary policy instruments and operating procedures.
Central bank independence is a core reform objective with links to credibility nexus and monetary policy effectiveness.

Monetary policy frameworks need to adapt objectives, instruments, and operating procedures in response to financial sector reforms.
Greater reliance on market-based instruments and deeper money and securities markets suggest shifts in monetary management practices.
Attention is required to the interaction between interest rate liberalization and monetary policy credibility.
Reforms call for monitoring of:
- bank interest and interest rate developments,
- money markets and monetary base dynamics,
- the effectiveness of monetary policy instruments in a liberalized environment.

Subject: Banking, Demand for money, Financial markets, Financial regulation and supervision, Financial sector reform, Monetary base, Monetary policy, Monetary policy instruments, Money, Money markets
Keywords: bank interest interest rate, credibility nexus, credit rationing, Demand for money, Eastern Europe, Europe, excess reserves, Financial sector reform, interest rate, interest rate liberalization, interest rate structure, interest rate volatility, liberalization, market, Monetary base, monetary management, monetary policy, Monetary policy instruments, Money markets, money multiplier, transmission mechanism, WP