The appropriate intermediate target for monetary policy in less developed countries: Empirical evidence

Abstract

It is argued in this paper that recent financial innovations and deregulation in less developed countries may have established a case for an intermediate target strategy for monetary policy. The question of which financial aggregate to target is not, however, a trivial one. Three criteria have to be met for a financial aggregate to serve as an appropriate target for monetary policy. Using time series data from a sample of six less developed countries, these three criteria are empirically tested to determine whether narrow money, broad money or domestic credit is the most appropriate target for monetary policy in less developed countries. The results indicate that it is difficult to generalize and that until monetary policy can be independent of fiscal policy in these countries, none of the tested financial aggregates would be appropriate as an intermediate target.

Notes

The author is indebted to Lionel Demery from the World Bank and the University of Warwick, Andrew McKay from the University of Warwick and to two anonymous referees for helpful comments and insights made on an earlier draft of this paper.

Department of Economics, Potchefstroom University, Potchefstroom.