Monetary Instruments and their Use During the Transition From a Centrally Planned to a Market Economy

IMF Working Papers, November 1, 1993

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Discusses different instruments of monetary policy, with emphasis on the choice between direct and indirect instruments.
Identifies main characteristics of a country’s financial system that should be considered when selecting monetary instruments.
Analyzes how these characteristics should influence instrument selection in countries transitioning from a state-controlled to a market economy.
Argues that characteristics of the financial system during the initial stage of the transition sometimes favor relatively direct instruments.
Proposes that market-based variants of direct instruments may both reduce monetary expansion and introduce/stimulate competition in financial markets.
Recommends a “belt and braces” approach: develop and test indirect instruments during the initial stage, which can later, as experience is gained, gradually replace more direct controls.

The initial stage of transition:
- May favor relatively direct monetary instruments due to the financial system’s characteristics.
- Market-based variants of direct instruments can combine effectiveness in reducing monetary expansion with stimulating competition.
Intermediate and later stages:
- Indirect instruments can be developed and tested alongside direct instruments.
- With experience, indirect instruments can gradually replace direct controls.

Consider the financial system’s specific characteristics when selecting monetary instruments rather than applying a one-size-fits-all approach.
Use market-based variants of direct instruments at the outset to achieve monetary control while promoting competition in financial markets.
Adopt a “belt and braces” strategy by concurrently developing and testing indirect instruments during the initial transition stage.
Transition toward greater reliance on indirect instruments as institutional capacity, market structure, and central bank experience deepen.

Subjects: Bank credit; Banking; Commercial banks; Credit; Credit ceilings; Credit controls; Financial institutions; Money
Keywords (verbatim as provided): bank, Bank credit, benchmark interest rate, central bank, central bank bank paper, central bank credit policy, commercial bank credit, Commercial banks, Credit, credit ceiling, Credit ceilings, Credit controls, credit demand, credit growth rate, credit plan, credit policy, credit supply, deposit base, Eastern Europe, market, market forces, selective credit control, WP