THE KEIZAI BUNSEKI - ESRITHE KEIZAI BUNSEKI (THE ECONOMIC ANALYSIS) No. 145 March 1996 Macroeconomic Stabilization and Monetary Policy of Four Asian Countries Japan, Korea, Indonesia,

THE

KEIZAI BUNSEKI (THE ECONOMIC ANALYSIS)

No. 145 March 1996

Macroeconomic Stabilization and Monetary Policy of Four Asian Countries

Japan, Korea, Indonesia, and the Philippines

- Targets, Effectiveness and Results -

Masaaki Kuroyanagi

Junji Yano

Yasuo Nakanishi

Masaaki Komatsu

Hidehiko Futamura

Tsuyoshi Mihira

Economic Research Institute Economic Planning Agency

Tokyo, Japan

The Keizai Bunseki (The Economic Analysis) is a series of studies issued by the Economic Research Institute of the Economic Planning Agency and contains results of research works by the staff members of the Institute.

The purpose of the publication is to develop the understanding of the general public about current research works and ideas in the Institute and to ask for any comment on the results in order to enhance a quality of the research activities in the Institute while the works are still not completed. Thus, the views expressed are those of the authors and do not necessarily reflect those of the Institute.

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THE ECONOMIC ANALYSIS No. 145

March 1996 Economic Research Institute

Economic Planning Agency Tokyo, Japan

Macroeconomic Stabilization and Monetary Policy of Four Asian Countries

Japan, Korea, Indonesia, and the Philippines - Targets, Effectiveness and Results -

Contents

Introduction...............................................................................................................................................9

Chapter 1. Macroeconomic and Financial Developments of Japan, Korea, Indonesia

and the Philippines ...................................................................................................15

Chapter 2. On the Objectives of Monetary Policy.................................................................................44

Chapter 3. The Money Demand Function .............................................................................................82

Chapter 4. Results of the Monetary Policies of Four Asian Countries-VAR Analysis ......................115

Conclusion .............................................................................................................................................153

References .............................................................................................................................................161

Appendix 1. Error Correction Models..................................................................................................180

Appendix 2. ..........................................................................................................................................197

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Macroeconomic Stabilization and Monetary Policy of Four Asian Countries Japan, Korea, Indonesia, and the Philippines

- Targets, Effectiveness and Results -

Masaaki Kuroyanagi

Junji Yano

Yasuo Nakanishi

Masaaki Komatsu

Hidehiko Futamura

Tsuyoshi Mihira

*) Masaaki Kuroyanagi (Project Director: Senior Economist, The Export-Import Bank of

Japan), Junji Yano (Associate Professor, Hiroshima University), Yasuo Nakanishi

(Associate Professor, Tezukayama University), Masaaki Komatsu (Financial Advisor,

Lehman Brothers and Bank Indonesia), Hidehiko Futamura (Cabinet Official, Cabinet

Councilors, Office on External Affairs), Tsuyoshi Mihira (Officer, Social Policy Bureau,

EPA)

**) This paper is the final report of the research project on “Macroeconomic Stabilization

and Monetary Policy,” which started in December 1990. Since then, invaluable supports

and advices have been given to the project by numerous experts. Takanori Arima (City of

Kitakyushu; Former Researcher), contributed in the early stage and Tsutomu Matsuo

(Researcher, Department of Research Cooperation, Economic Research Institute,

Economic Planning Agency) contributed in the final stage of this project.

We would like to thank various experts for their insightful comments on in the

various stages of our study in the following occasions: Juro Teranishi and Akira Goto

(Professors of Hitotsubashi University), Kyoji Fukao (Associate Professor of

Hitotsubashi University) and Shinichi Fukuda (Associate Professor of Hitotsubashi

University, currently Associate Professor of Tokyo University) at the seminar held at

Economic Research Institute, Hitotsubashi University on March 8, 1993; Hidenobu

Okuda (Associate Professor of Hitotsubashi University), Jiro Nemoto (Associate

Professor of Nagoya University), and Kazuhisa Ito (Senior Research Officer of

Development Study Department, Institute of Developing Economies) in the workshop

held at EPA on March 29, 1993; Hidenobu Okuda (Associate Professor of Hitotsubashi

University), Raiji Inamura (Senior Economist of the Export-Import Bank of Japan), and

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Takako Ide (Associate Professor of Seikei University) in the workshop held at EPA on

March 27, 1995. We also like to express our thanks to Robert E. Lucas Jr. (Professor of

the University of Chicago), professors Jisoon Lee (Seoul National University, currently

with the World Bank), Yong Jim Kim (Dongduck Women’s University), and Ha-Hyum Jo

(Yonsei University) for their insightful comments; Edita A. Tan (Professor of the

Philippine University) and Charito D. Arriora (Chief Economic Development Specialist,

Macroeconomic Division, NEDA) for providing written comments on the earlier

manuscript of the report in March 1993. We also thank staff of EPA for their support on

this study; Atsushi Yoshikawa (Vice-Minister for International Economic Affairs, EPA),

Isoroku Sawada (Director-General, Research Bureau, EPA), Shoichi Kojima (Director-

General, ERI, EPA), Akira Sadahiro (Director, First Domestic Research Division,

Research Bureau, EPA), Yoichi Nakamura (Senior Economist, Japan Economic Research

Center), Nobuki Sugita (Director, Public Information Office, Minister’s Secretariat, EPA),

and Noriki Hirose (Director, DRC, ERI, EPA), who gave deep understanding and useful

comments to the research project. We also like to thank Pamela S. Palmer who gave a

careful reading to the manuscript, which improved the paper very much; and Tazuko

Ishikawa, Kayoko Hirakawa, and Rei Munakata (the Export-Import Bank of Japan) for

the excellent word processing in finalizing the paper. Our final thank goes to Hiroko

Kojima (Price Inspection Section, Price Bureau, EPA) for her continuing kind and patient

support; without her support, we would have been unable to complete the research

project. Opinions and possible errors are strictly ours and by no means reflect the policy

position of any institution.

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Introduction

The rapid, stable economic development of Asian countries has been an

important topic of empirical study in recent years. The remarkable results of this steady

economic development have been called a “miracle” in the recent literature of

development economics. This cross-country study attempts to investigate the roots of the

rapid, sustained economic growth of East Asian countries. In “The East Asian Miracle”

(The World Bank, 1993), rapid growth of human capital, productivity improvement and

high investment levels were pointed out as the primary factors contributing to the rapid

economic growth of so called High Performing Asian Economies (HPAEs).1 On top of

these supply-side factors, favorable and stable economic management and

macroeconomic performance provided an important framework for private investment.

The macroeconomic stability was based on fiscal discipline and prudent financing. The

low inflationary pressures contributed to keep real interest rates positive, and maintain

real value of financial assets, of which helped increase domestic savings.

In the course of economic development, the importance of the long term

development strategy and structural policies have been widely pointed out. The best-

known proponents of this argument would be McKinnon (1973) and Shaw (1973). They

forcefully argue that fragmentation of financial markets in developing economies causes

retardation of economic growth. Thus, the central role of monetary policy should be to

develop matured financial markets rather that to induce short-run stabilities. However,

we cannot ignore the stability of macroeconomic conditions as one of the key elements

contributing to stable economic growth. A series of the studies has come out recently

citing the importance of macroeconomic stability on the economic growth.

Fischer (1991) attempts a straightforward econometric study examining the

relationship between macroeconomic performance and long run economic growth. In this

study, Fischer picks up inflation rate, external debt outstanding and fiscal deficit as

indicators measuring the macroeconomic performance and executes cross-section

regressions on 73 developing countries during the period of 1972 to 1985. The results of

this study clearly indicate that high economic growth has a negative relationship to the

inflation rate, fiscal deficit and external debt outstanding. An important finding of

1 High performing Asian economies: Indonesia, Hong Kong, Japan, Malaysia, the

Republic of Korea, Taiwan Province of China, and Thailand.

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this study is that there exist a significant relationship between investment and long-run

economic growth.

In the World Development Report (1991), the importance of the macroeconomic

foundation of the adjustment process is emphasized. In this report, the problem of the

inflation is cited as the discouraging factor on savings and investments, which are

essential elements of long run economic growth. Khan (1990) reviews the macroeconomic

adjustment program supported by the International Monetary Fund (IMF). In this study,

macroeconomic stabilization represented by different indicators such as inflation rate or

current account balance, have a positive association with the growth performance.

Earlier study by Sakurai et. al.(1986) shows the relation between

macroeconomic policy and economic performance of 18 developing countries, for the

period of 1970 to 1984. By choosing monetary policy, fiscal policy, and exchange rate

policy as a policy instrument, they evaluate the policy, in a rather illustrative way, to

determine whether counter-cyclical policies were employed. They found the followings.

All high-inflationary countries (with yearly inflation rates of over 30%) experienced debt

crisis, while all low-inflationary countries (with yearly inflation rates lower than 15%)

avoided debt crisis. As for evaluating economic performance by the criteria of whether

the country fell into debt crisis or not: to avoid falling into debt crisis, two out of the three

macroeconomic policy tools mentioned above must be applied counter-cyclically. Although

this study does not provide results of significance econometric analysis, it provides us

with a general idea of policy tools and macroeconomic performance.

Recently, influenced by the new growth theories of Lucas (1988) and Romer

(1986), development economics is attracting attention.2 Empirically, study of Asian

countries is becoming a major topic in development economics due to their favorable

economic performance. Formerly, an interesting perspective on the macroeconomic

situation in this area was Sachs (1985), which makes a comparative study of Asian

countries and Latin American countries. This study focuses on the difference between

these two regions on the structural issue, and concludes that difference between these

2 However, the new growth theory and associated empirical work have focused on more

structural factors, such as accumulation of human capital, external effects of the

government expenditure, or growth of export. The influence of macroeconomic policies on

economic growth was not emphasized.

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groups of the countries is the export performance and the development strategy of

promoting exports.

The relationship between macroeconomic stabilization and economic growth is

often mentioned through the mechanism of financial intermediation and financial

deepening. Representative studies on this topics are Goldsmith (1969), McKinnon (1973),

and Gurley and Shaw (1955). Goldsmith (1969) focuses on the share of financial assets to

total assets, and found a positive relation between this ratio and economic growth.

McKinnon (1973) points out that imperfect capital market results in misallocation of

factors of production. If financial market reform is enforced in a way to strengthen

financial intermediation, this will encourage savings and capital accumulation. The

argument of Gurley and Shaw (1973) shows a close relationship between economic

growth and development of financial intermediation measured by financial deepening.3

However, the results of these studies illustrate the difficulty of applying these results in

actual policy, due to prevailing obstacles to manipulation of financial variables and the

evaluation of the direction of causality between variables.

Gelb (1989) offers an interesting study of economic growth in relation to the

developments in the financial sector and efficiency measured by Incremental Capital

Output Ratio (ICOR). In this study, the stabilization of macroeconomic condition is an

important element of economic growth, and without the stabilization, intervention in the

financial markets or introduction of financial liberalization should not be started. Also,

this study stresses that the development of the financial sector is an important factor in

economic growth. But since inflation has a negative impact on the development of the

financial sector, the sequencing of the economic policy should first focus on containing

inflation to accomplish economic growth.

Even though the development of the Asian countries has attracted much

attention, not many studies in the past have focused on the monetary policy of

developing economies. Recently, however, monetary policies of developing countries are

attracting attention; several new studies have been published in this area. In 1993,

Page, did a comprehensive study of monetary policy, an interesting suggestion of which

is that, it is inappropriate to assume that authorities know the proper tools and

application of monetary policy. Therefore, many of these studies attempt to identify and

remove the obstacles. The main question of Page’s study is why many countries have

found monetary policies difficult to implement, and the main conclusion is that a highly

3 See Kuroyanagi and Hamada (1993) for a survey of these studies.

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functional formal financial system may improve the efficiency of an economy. Follow up

studies have come out recently from the staff of the IMF, such as Tseng and Corker

(1991) and Hamann (1993). As is indicated in Page (1993), the monetary policy of

developing countries, particularly low-income developing countries, has not been paid

attention to for a long time because the importance of real sector developments made

development of the financial sector or the monetary policy take second place in the

concern of the policy-makers and scholars, so monetary policy was being ignored.

In view of the growing importance of macroeconomic management, we have

attempted to investigate monetary policy, which is an essential element of

macroeconomic policy. In this paper, we focused on the monetary policy of four Asian

countries, Japan, Korea, Indonesia, and the Philippines, to examine the targets,

effectiveness and the results of their monetary policies. Due to the lack of the quarterly

economic statistics, we were not able to pick up fast-growing countries such as Thailand

and Malaysia. In addition, Taiwan remains an interesting candidate for our future study.

The periods we have chosen are different for each country, due basically to the

availability of the time series data.

The countries we have studies represent the varieties of Asian nations. Japan,

of course, a developed country in the region which lacks natural resources, is positioned

as a benchmark of the study. Korea is representative of fast-growing NIEs, which lacks

natural resources and has been developed by high growth of exports with heavy

government intervention. Indonesia, on the other hand, is a representative case of a

developing country which depends heavily on oil production but is attempting to free

itself from the heavy dependence on oil production. The Philippines, which is typical of

developing countries which are basically agricultural with the endowment of several

mineral products, has a development strategy of industrialization by “import

substitution.” Also, the Philippines is the only country in East Asia which fell into debt

crisis.

In this study, we will focus on the targets, effectiveness and the results of the

monetary policy of Japan, Korea, Indonesia and the Philippines in the light of

macroeconomic policy, basically in the period of 1970’s and 1980’s.

Regarding the financial conditions, all the countries we studied changed in the

1980’s. Financial and banking sectors of all four countries, including Japan, were

strongly regulated by the authorities until that time. Strong rationing of subsidized

credits existed in Korea, Indonesia and the Philippines until the late 1970’s. Entering

into the 1980’s, all countries initiated deregulation and liberalization in the financial

markets and the banking sectors.

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This study attempts to clarify the following questions on monetary policy. What

are the targets of the monetary policy? Is there a base of for the monetary policy to

function effectively? Did the monetary policy have a real effect on the macroeconomic

conditions?4

One interesting topic of studying monetary policy is to find common factors

affecting real economic performance and to derive policy implications. However, it is

extremely difficult to connect monetary policy with actual economic performance. A

recent detailed study by Tseng and Corker (1991) on the financial liberalization and

monetary policies of Asian countries also faced the same problem. In our study, we have

tried to explore the effectiveness of monetary policy and its relationship to

macroeconomic performance.

We also are interested in the differences among the countries we have chosen for

our study. Are there features of monetary policy common to all these countries or are they

significantly different? To tackle these questions, this study estimated reaction function,

money demand function, and applied VAR model.

In Chapter 1, we overview macroeconomic developments and financial

developments of the four countries.

In Chapter 2, the analysis by reaction function indicates the target of monetary

policy. It must be noted that this analysis strongly assumes that the tools we have chosen,

discount rate and money supply, are econometrically exogenous variables which

monetary authorities were able to control. Another strong assumption of this analysis is

that monetary authorities are able to observe contemporaneous macroeconomic variables

and that their responses can be made within one period. Under these two assumptions,

we are able to observe targets of the monetary policy in a simple way.

Chapter 3 examines money demand function as the background of the

effectiveness of the monetary policy. In formulating monetary policy, stability of

relationship between money demand, interest rate and income is the crucial factor. If the

money demand function does not perform properly, monetary policy may be ineffective.

Also, a study of unit root and error correction model on money demand function has been

attempted in Appendix 1.

Chapter 4, VAR analysis is applied to examine whether money in an

4 Earlier study by Connoly and Taylor (1976) reached a conclusion that developing

countries, in general, do not appear to pursue any systematic monetary policy.

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exogenous variable or not, and to determine the results of the monetary policy. The four

variables used are growth of money supply, real economic growth rate, rate of inflation,

and interest rate. If one variable can be identified as an exogenous variable from the

variance decomposition based on Cholesky decomposition, we defined this variable as

operational, which is a policy variable. Application of this analysis enable us to picture

the causality between economic variables, and if these policy variables have some-kind of

effect on other macroeconomic variables, we interpreted that “fine tuning” type of

macroeconomic policy were implemented. Summary and findings of the study are

mentioned in the final chapter.

In Appendix 2, we tried an individual study of foreign exchange rate policy, with

an alternative data set, by applying response function and VAR analysis.

Although analyses attempted in each chapter do not have direct relationships

between them, and they are under different assumptions; we will attempt to evaluate the

monetary policy of four countries, from the conclusions of each study.5

5 Obviously, the alternative approach to answer the questions we are interested in would

be to estimate a macroeconomic model for each country and execute a policy simulation.

For such an analysis of fiscal and monetary policy for the Korean economy using optimal

control framework, see Hahm and Choi (1988). For simulation analysis focusing on

financial market of Korean economy, see Hong (1991). For simulation analysis using

macroeconomic model for Indonesia, see Ahmed and Kapur (1990) and Kosuge (1991).

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Chapter 1. Macroeconomic and Financial Developments of Japan, Korea, Indonesia and the Philippines

1.1 International economic environment in the 1970’s and the 1980’s1

The global economy grew rapidly in the 1960’s, and Asian counties benefited from

the favorable international economic environment. Rapid growth was the result of the free

trade under the IMF and GATT regime, and the U.S. economy provided strong demand for

exports. Also, Asian NIEs and ASEAN were affected positively by the special procurement

boom of the Vietnam War in the middle of 1960’s to early 1970’s. Accordingly, the 1960’s was

an era of high growth.

In the 1970’s, the framework of international economy was changed drastically by

the collapse of the Bretton Woods regime in 1973, and the adoption of a flexible exchange rate

system by the major industrial countries. The change of the exchange rate regime also

influenced economic management of the Asian countries.

Another factor which had significant impact on the world economy was the two oil

shocks during the 1970’s. The upswing of oil prices negatively affected oil importing countries

such as Japan, Korea and the Philippines, who faced deterioration of balance of payments,

high inflationary pressure, and strong negative effects on economic growth. Indonesia, as an

oil exporting country, benefited from the rise of oil prices.

However, the after-effects of the two oil shocks on the global economy were different.

Soon after the first oil shock, major industrial countries adopted expansive economic policies

to cope with the recession caused by the oil shock and the global economy recovered.

Furthermore, the increased prices of the primary commodities benefited exporters of such

products and many non-oil exporting developing countries recovered very quickly from the

negative effects of the oil shock.

Remarkably, after the first oil shock, “recycling of oil money” proceeded smoothly

through the Euro-market, which eased the balance of payment difficulties of many developed

countries as well as developing countries. However, the easy funding from the Euro-market

enabled developing countries to choose expansive rather than stringent economic policies. In

Asia, Indonesia, Korea, Malaysia and the Philippines borrowed heavily from the commercial

banks through the Euro-market. Latin American countries in particular pursued this policy.

However, after the second oil shock, the economic policies of the major industrial

1 For a survey of the financial liberalization and its effect on the implementation of the

monetary policy for the Asian countries, see Tseng and Corker (1991).

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countries were different from those adopted after the first oil shock. Instead of avoiding

recession, economic policies of the major industrial countries took stringent fiscal and tight

monetary measures to avoid inflation. With the results of high international interest rates

and a global recession which negatively affected developing economies, particularly those of

heavily indebted countries. Latin American and Asian countries struggled to make their

external payments, and many countries, particularly Latin American countries, fell into debt

crisis.

For many developing countries, the first half of the 1980’s was a difficult period. The

Philippines was in the process of adjustment to the economic crisis which occurred in the

early 1980’s, but it fell into debt crisis in 1983. After the balance of payments crisis, Korea

faced low growth and was in a period of adjustment process in the early 1980’s. However,

after 1985, Korea benefited from the depreciation of the US dollar, low oil prices and the low

international interest rates. Korean economic growth recovered as the exports grew rapidly,

and accomplished high growth, finally turning its current account into surplus in 1986.

Indonesia was also in difficulty in the early 1980’s from the decline of oil prices and high

interest rates, but overcame this problem. Macroeconomic policies were important

components of the adjustment policies in this recovery process, particularly monetary policy.

Indonesia, heavily depending on oil exports and indebted by external borrowing, also had

difficulty and took measures to avoid debt crisis.

With the international economic environment, we will outline the economic

development and the financial systems of the four countries in this chapter. We will also

summarize the characteristics of financial systems of Japan, Korea, Indonesia and the

Philippines to provide a background for our study of the monetary policy of these countries.

The basic economic indicators of Japan, Korea, Indonesia and the Philippines are shown in

Table 1-1 and Table 1-2. Trends of the main macro-economic variables are based on the

quarterly data shown in Figures 1-9 through 1-20 at the end of this chapter.

1.2 JAPAN

(1) Macroeconomic development of the Japanese economy2

The Japanese economy grew rapidly throughout the 1960’s to the 1980’s, as we can

see in Figures 1-9, even through the growth rate declined in the 1970’s to an average of 4%.

The inflation rate was rather high in the 1970’s, but relatively stabilized in the 1980’s. The

2 See, for example, Hamada and Hayashi (1983) and Ito (1992) for a review of the

macroeconomic performance and its economic policy for the post war Japanese economy.

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current account balance was in surplus, except during the period of the two oil shocks of the

1970’s.

This study divides the period into two parts. The first period is from 1962 to the first

quarter of 1973, and second period is from the second quarter of 1973 until 1990, a division

made because of the change in the exchange rate system. The first period is the fixed

exchange rate system and second is the flexible exchange rate period.3

Several large external shocks struck the Japanese economy in the early 1970’s. The

first was the end of Bretton Woods system in the summer of 1971: after the struggle to

maintain the fixed exchange rate system by the Smithsonian Accord, the Yen rate floated

from early 1973.4 Another major external shock was the first oil shock in the late 1973, which

quadrupled petroleum prices.

The early 1970’s was a difficult period for the Japanese economy. Internally, in

1970’s Japan was in a recession which was triggered by the decline of fixed and inventory

investments in the late 1960’s. On top of these domestic difficulties, appreciation of the Yen

hit the Japanese economy. Attempts to sustain the exchange rate level agreed by the

Smithsonian Accord of 308 yen per US dollar, and the government policy to stimulate the

economy resulted in an extremely relaxed monetary policy. The growth of the money supply

were extremely high in the early 1970’s. When Japan was suffering from these difficulties

and responding by stimulating the domestic economy, the first oil shock occurred. The rise of

oil prices and the negative effects on the supply side produced stagflation of the economy.

With an already expanded domestic money supply, Japan faced coexistence of inflation and

stagnation of the economic growth and its economic performance of this period was the worst

among OECD countries.

The Japanese economy was stabilized in the mid-1970’s, and economic growth

recovered gradually, but then the second oil shock hit in 1978. The global economy again

suffered from the rise of oil prices and the after-effect of stagnation, although Japanese

3 The division of the period can be viewed in another way. The latter part of our first period is

the so-called “High growth era”, 1955 through 1970, when the average real GNP growth

exceeded 10% (Yoshikawa 1992), but after this period economic growth rate declined

substantially.

4 The Yen rate was determined at $1=Yen 360 since 1949. After the collapse of the Bretton

Woods system in 1971, the yen rate was fixed at $1=Yen 308, for a short period, before

adopting the floating rate in 1973.

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economic performance was better than that of other countries. The characteristics of the

Japanese economy in the first half of the 1980’s were moderate growth, the undervalued yen

rate causing accumulation of the trade surplus, and a low rate of inflation. In this period,

serious bilateral trade friction developed between Japan and other developed countries. The

trade imbalance between the industrial countries on one side, and the increasing current

account surplus on the other, led to appreciation of the Yen in 1985 after the Plaza Accord.

The economic situation of Japan in the late 1980’s did not come out as had been

forecasted in 1985. Just after the Plaza Accord, the yen rate appreciated substantially and

anxiety about possible recession was strong among Japanese the public and policy makers.

The economic policy of this period can be characterized as a mixture of stringent fiscal policy

and lax monetary policy. Due to the strong pressure to undertake fiscal reform, an expansive

fiscal policy by the government was forestalled. Stimulation of domestic demand relied on the

lax monetary policy of lowering the interest rate. Accompanied by this low rate of interest,

inflation of asset prices, such as stocks and real estate stimulated rapid economic growth

pulled by fixed investment and increasing consumption. In spite of anxiety about the prospect

of a serious depression caused by the appreciation of the currency, the Japanese economy

accomplished high economic growth from 1987 to 1990.

(2) Characteristics of the Japanese Financial System

In this section, we will summarize the characteristics of the Japanese financial

system. First, the financial system during the high-growth period will be described, and then

financial liberalization and internationalization of the Japanese financial market will be

examined.

Due to the difficult and severe constraints on the Japanese economy after World War

II, reconstruction and economic growth were given first priority. Accordingly, the authorities

imposed a wide range of restrictions on financial institutions and transactions. The financial

sector of Japan, until the beginning of 1980’s, was characterized by the predominance of

indirect financing, over-lending, over-borrowing, mal-distribution of funds, interest rate

regulation and strong segmentation of financial institutions.

In Japan, as in most developing countries, indirect finance, financing through the

intermediation of banks, ruled throughout the high growth period. During the 1970’s, the

share of supply of funds by the banking sector accounted for more than 90%. Throughout

this period, the banking sector relied excessively on borrowing from the Bank of Japan. This

phenomenon, known as “Over-Loan,” is quite unique among the financial sectors of

developed countries. In turn, the corporate sector depended heavily on borrowing from the

banking sector. Two issues are associated with this state of affairs: the share of outside

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funding was rather large; and due to the underdeveloped open capital market, the shares of

security and bond financing remained relatively small.

In the interbank market, the city banks were constant borrowers, with the regional

banks and other financial institutions being consistent lenders. Close ties between city banks

and export-oriented corporations resulted in the concentration of loan demand on city banks.

Under these circumstances, the inter-bank market rate, the call rate, was categorized as the

market-determined interest rate in Japan during the high-growth era. Other interest rates,

such as long-term and short-term lending rates and deposit rates, were in essence regulated

interest rates. Moreover, the yields on public bonds were severely restrained.

There was ample segmentation among private banks. Most notably, financial

institutions specializing in long-term finance were created to meet the need to finance capital

investment in the high economic growth era. When Japan accepted IMF article VIII in 1964,

limitations of foreign exchange transactions on current transactions were removed. However,

the domestic financial market was strictly separated from the foreign financial market

throughout the 1960’s and 1970’s. The domestic financial market was protected from external

disturbances and competitions among financial institutions were inhibited. Heavy loan

demands by export-oriented corporations were met mainly by city banks who were constant

borrowers in the interbank market. However, this highly regulated financial system may

deserve some credit for maintaining a very stable and sound financial system which

facilitated industrialization and financed high export-led economic growth.

(3) Financial Liberalization

Rather than sequentially tracing the process of the financial liberalization in details,

we will highlight two central issues of this process: large-scale floatation of government bonds

and internationalization of the financial markets.

Among several inducements to financial liberalization in Japan, the worldwide

financial liberalization in the 1970’s and 1980’s affected Japanese financial markets. The

emergence of substantial fiscal deficits played a decisive role in stimulating the development

of an open capital market in the Japanese financial system. Another important factor in this

process was undoubtedly the internationalization of Japanese financial markets.

The budget deficit of the central government grew rapidly after the early 1970’s,

because of the stagnation on of tax revenues on the one hand, and adoption of an

expansionary fiscal policy to offset the slower economic growth after the first oil shock on the

other. As a result, a considerable volume of government bonds were issued.

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Figure 1-1 Ratio of M1/GNP (%) : Japan

Figure 1-2 Ratio of M2/GNP (%) : Japan

(Note) Ratio of end year monetary aggregates to the nominal GNP at the end of each year

(Data Source) IMF IFS

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The Bank of Japan kept purchasing a significant portion of the outstanding

government bonds held by private banks. And therefore succeeded at persuading private

banks to abstain from selling bonds in the secondary market. However, this ample float of

government bonds stymied such policy, and consequently the capital market developed

significantly, which naturally encouraged intense competition among financial institutions,

thereby realizing succeeding financial innovations with essentially free market interest rates.

The innovations were the newly introduced instruments of medium-term government bond

funds, introduction of Certificate of the Deposits, introduction of MMCs and large-scale time

deposits with free interest rates. The introduction of new financial instruments also affected

the deregulation of the segmentation among financial institutions.

With the remarkably stable growth of the Japanese economy and the adaptation of

the flexible exchange rate system, the Japanese financial markets became much more closely

integrated with foreign markets, which made it difficult to sustain severe regulations on

domestic financial markets. Hence in December 1980, New Foreign Exchange and Foreign

Trade Control Law were enacted, permitting international capital transactions. Another

important step was the announcement of the report of Yen-Dollar Ad-Hoc Committee, jointly

established by the Japanese Ministry of Finance and the US Treasury, which further

accelerated internationalization of the Japanese financial market.

As a result of these developments, many of the traditional characteristics of the

Japanese financial system were diminished or at least considerably weakened. For example,

the complete liberalization of interest rates has been accomplished and significant measures

for deregulation of segmentation of the financial institutions have been taken. Although

substantial unsettled problems remain, further financial reforms will be unavoidable as well

as irreversible.

In the course of Japanese financial development since the 1960’s, the Ml/GNP ratio

fluctuated around 30%, but the M2/GNP ratio increased from 67% in 1962, to 90% in 1972.

Since the beginning of 1970, the M2/GNP ratio did not grow very fast and we had to wait

until 1986 for this ratio to exceed 100%. This slowdown of the M2/GNP is suggesting the

development of alternative financial assets, however, it is high compared to other countries in

our study, and indicates Japan’s developed financial sector (Figure 1-1, Figure 1-2).5

5 For an overview of financial market and monetary policy in Japan, see, for example,

Shigehara (1990), (1991), Ito (1992, Chapter 5).

- 22 -

1.3 Korea (1) Macroeconomic development of the Korean economy6

The rapid economic growth of Korea since 1960’s was one of the most remarkable

results of post World War II economic development. After the Korean war, recovery in the

1950’s from the devastation of the war was rather modest. The Korean economy accomplished

rapid economic growth led by a rapid export growth in the 1960’s, but faced a difficult

situation in the early 1970’s. The fast economic growth in the 1960’s induced a rise in real

wages, and as a result, Korean exporters were losing competitiveness in labor-intensive

sectors. In response, the Korean government initiated promotion of heavy industries. The

promotion was strongly supported by the government using preferential credit through

governmental financial institutions and direct subsidies, a strategy called “the Big Push.”7

Just after the Korean government started “the Big Push,” Korea faced the first oil

shock in 1973. Higher oil prices and the following recession negatively affected the Korean

economy. Low growth of exports caused by the worldwide recession slowed the economic

growth, and the rise of oil and other import prices made a major contribution to the

deterioration of the balance of payments. The acceleration of the inflation in this period had

various causes, among them, a domestic inflationary pressure due to increased wages for

skilled labor in the early 1970’s, and imported inflation due to rise of oil prices. Korean

authorities undertook to contain inflation by fixing a nominal exchange rate from December

1974. Due to the high domestic inflation, the real exchange rate appreciated, which retarded

exports. Despite these difficulties, government maintained “the Big Push” strategy which

was enabled by the external financing.

This “Growth cum debt” policy succeeded during the 1970’s due to the fast recovery

of the world economy in mid-decade. Increase of export receipts and workers’ remittances

from the Middle East improved the balance of payments, and in 1977, the current account

balance turned into surplus.

Credit can be given to the consistent government commitment to economic growth

as one factor of the success of Korean economic development. In contrast to the growth

under these favorable conditions in the mid-1970’s, the Korean economy faced a difficult

situation late in the decade. During the rapid economic growth throughout the 1960’s and

1970’s, Korean economy accumulated internal structural problems. Rapid change of the

industrial structure toward heavy industry induced heavy demand for imported capital goods

6 For an overview on macroeconomic performance of the Korean economy and various

economic policies, see, for instance, Collins and Park (1989).

7 This policy, which promoted capital-intensive industries was strongly criticized by the

World Bank as ignoring the competitive advantages of Korea. Actually, a request to finance a

steel complex project was rejected by the World Bank.

- 23 -

financed by heavy external borrowing, which accumulated of external debt. Also heavy

governmental intervention in trade, finance, and pricing impeded flexibility and

competitiveness of the economy. The need for structural adjustment was recognized among

the authorities, but it was difficult to implement during the period of faith in high growth (II

Sakong 1993). The inaction resulted in excess capacity among the main industries, which

made the Korean economy difficult to adjust in the 1980’s.

After the second oil shock, the Korean economy faced extreme difficulties in 1979

and 1980, triggered by the assassination of President Park and the decline of agriculture

production. The underlying problems were, heavy accumulation of external debt, and balance

of payments problems caused by high oil prices and slow growth of exports. To cope with the

deterioration of the current account balance, Korean government initiated stabilization and

structural adjustment policies in April 1979, and accelerated them after the crisis due to the

assassination. The economic reform program started in 1980 first focused on restoring the

current account imbalance. This stabilization program can be evaluated as a very strong

program. According to Dailami (1992), deterioration of current account balance by exogenous

shock, including rise of oil price was 9.4% of GDP. However, the stabilization efforts recovered

7.3% of GDP, of which 4.2% was achieved by restricting the volume of imports. Devaluation of

the Won rate by 17% in 1980, and changing to the managed floating exchange rate system

contributed to restore the balance of payments, and these adjustments which prevented

further deterioration of the economy.

The important feature of the macroeconomic policy in this period was the effort to

contain inflation. Also, the policy mix was the stringent fiscal policy and rather easy

monetary policy. After the devaluation in 1980, the exchange rate was kept overvalued to

keep the inflationary pressure low.

The Korean economy started to recover in 1986, when the real GDP growth rate

exceeded 12%. Favorable external conditions of low dollar exchange rate, low prices or dollar,

and low levels of interest rates contributed the recovery, as well as the fast growth of the U.S.

economy in the late 1980’s. The most outstanding characteristics of the Korean economic

development in the late 1980’s, was conversion of the current account into a surplus in 1986,

which continued until 1989. Furthermore, we should note that this fast economic growth was

accompanied low inflation.

(2) Characteristics of the Korean Financial Structure

The Korean financial structure has four segments; (1) official commercial banking

institutions, (2) non-bank financial institutions, (3) unorganized financial institutions, and

(4) governmental financial institutions, the relative dominance of which changed from time

- 24 -

to time.

Before the 1980’s, financial policy was an important component of industrial policy,

and monetary policy was merely the tool of macroeconomic policy. In the 1960’s, the Korean

government nationalized all commercial banks and initiated direct control of the financial

system to accomplish this policy objective. The basic structure of the system was formulated

in the 1970’s to provide funds for investment in heavy industries whose the growth the

government was promoting. To maintain consistency with the industrial policy, the budget

and financial sectors were under the sole administration of the Ministry of Finance. An

interesting aspect is that whenever the government launched a new economic plan in the

1960’s and 1970’s, new governmental financial institutions were established and others were

remodeled. Also financial markets were developed by the initiative of the authorities to

contribute to economic growth. Therefore, strong government intervention and control, and

the existence of unofficial financial markets were the basic characteristics of the Korean

financial system.

Governmental intervention to keep the lending interest rates low affected the

funding activities of banks. Accordingly, interest rates on the deposits had to be kept at low

levels, and commercial banks consequently were not able to collect sufficient funds to meet

the heavy demands. The repression of this financial system stimulated the development of an

unofficial financial market, and commercial banks had to depend heavily on the credits

provided by the Bank of Korea, the central bank.

The official banking sector was under strict control of the government. One unique

aspect of the Korean system was that determination of the interest rates was not in the

hands of the Bank of Korea, but was determined by the Ministry of Finance. This control

generally kept lending rate under the market rate, creating excess demand for funds in the

banking sector, and the government allocated the credits to the preferred sectors.

In the 1960’s, the availability of funds from official sources was limited, and funds

from unofficial financial market were an essential source for investment. In the mid-1960’s,

the government started to attract bank deposits by raising real interest rates, stimulating

significant increase of time deposits in the late 1960’s. But the government reversed the

policy and again strengthened direct control accompanied by the low interest deposit rate in

the 1970’s. As a result, unofficial financial institutions proliferated again and the growth of

the banking sector slowed down. Not until 1982 do we see financial liberalization and the real

development of the commercial banking sector.

The restrictions on the official banking sector channeled funds to the unofficial

financial market, attracted by its high interest rates. To the cope with heavy inflationary

pressure, authorities tried to abolish the curb market and initiated control of the unofficial

- 25 -

financial markets. After the freeze of the curb market, a large share of the funds collected in

the unofficial market shifted to non-banking institutions in the official market. But over-

investment in heavy industries and inflationary pressures made it difficult for authorities to

control unofficial financial markets completely. In the 1980’s, the development of non-banks

was promoted, and while unofficial financial markets shrank quickly as a result of a financial

scandal in 1982, non-banks grew very rapidly. Regulations imposed on non-banks were not as

strict as those on banks, which created a loophole in the monetary policy.

Another important characteristic of the Korean financial structure is the dominance

of governmental financial institutions such as the Korean Development Bank. It has been

pointed out that 70% of the total financial funds were under the control of the Ministry of

Finance. This dominance of governmental financial institutions also hindered the functioning

of the monetary policy.

(3) Financial liberalization in 1980’s8

In the late 1970’s, growth of the non-banking financial institutions was so rapid that

the funds provided from these institutions exceeded the funds provided from the banking

sector (Ito, K. 1991). Since non-banking financial institutions were under the legislation of

the Ministry of Finance, not the Bank of Korea, the effectiveness of the monetary policy

declined significantly in Korea.

Until the 1980’s, Korean commercial banks were obliged to provide low interest

finance to targeted industries. On the other hand, the Bank of Korea set ceilings on the

interest rate for deposits in private banks (Euh and Amsden 1990), a typical example of

financial repression. In 1982, the government officially abolished all preferential credits,

although they persisted until 1988.

A basic feature of the Korean financial policy was control of the unofficial financial

markets with simultaneous intervention in the official financial sector. Using this stratagem,

the government was able to provide low interest rate credit to preferential sectors by credit

rationing. Scarcity of funds in the banking system caused heavy dependence by firms on the

curb market to procure sufficient funds for fixed investment requirements. Therefore, the

basic objective of the regulation by the Korean authorities shifted to control the curb market.

In 1972, when authorities froze the curb market and attempted to develop the corporate bond

market, numerous investment companies were established and an attempt to regulate the

8 For the review on financial reform in Korea, see Euh and Amsden (1990), Cole and Park

(1983), Bank of Korea (1993).

- 26 -

Figure 1-3 Ratio of M1/GNP (%) : Korea

Figure 1-4 Ratio of M2/GNP (%) : Korea

- 27 -

unofficial market was initiated.

In the early 1980’s, financial liberalization was initiated, an undertaking which

finally achieved its goal in the late 1980’s to early 1990’s. One important point of the financial

liberalization, was that it was part of the comprehensive adjustment policy of the Korean

government to create money market instruments. In the 1970’s, over investment caused

inflationary pressure and tight monetary policy led to stringent bank credits. Heavy credit

demand and shortage of bank credit stimulated development of the unofficial curb market.

The Bank of Korea was not able to control the monetary aggregates because of the

underdeveloped securities and money market, and only policy that monetary authority could

implement to cope with the inflationary pressure was direct guidance of commercial bank

lending. This reform introduced reestablishment of the commercial paper (CP) market and

other short-term instruments. Following this liberalization, in 1984, the interest rates of

bank deposits were liberalized. In 1989, the money market interest rates were basically

liberalized (Sudo 1991).

When we look at the development of the financial sector by quantitative

measurement, M1/GNP held steady at a level close to 10% during the 1970’s and 1980’s,

which might indicated that monetary policy was tight (Figure 1-3). The ratio of M2/GNP grew

very fast from the mid-1970’s. After slight decline in the early 1980’s, it reached the level of

40% at the beginning of the 1990’s. This rather low level of the M2/GNP ratio was the product

of the policy of the Korean authorities which encouraged the development of non-bank

financial institutions as we have explained before (Figure 1-4).9

1.4 INDONESIA

(1) Macroeconomic developments of the Indonesian economy10

After the hike of oil prices in 1973, Indonesia adopted a high-growth policy

supported by the favorable international economic environment. The real economic growth

rate in the 1970’s was almost 8%, nearly double the growth rate in of the 1960’s. Although

Indonesia benefited from another rise in oil prices during the second oil shock, the country’s

heavy dependence on the oil industry caused difficulties during the plummet of oil prices in

the early 1980’s. Anxiety about the possible exhaustion of oil resources was another concern

9 For the review of the financial reform and monetary policy for Korea, see, Park (1982) and

Layman (1988).

10 For the review of the Indonesian economy, see, for instance, Woo and Nasution (1989).

- 28 -

of the government.11

The Indonesian government initiated “import substitution” industrialization

depending on imported capital goods and intermediate goods, financed by oil revenues and

external borrowing. These industries were heavily protected from foreign competition.

Foreign direct investment did not play an essential role in the industrialization process as in

Thailand or Malaysia until late 1980’s.

Macroeconomic management of Indonesia during the 1970’s and 1980’s can be

evaluated as prudent. This can be considered an inheritance from two important episodes in

the past, the first being the experience of high inflation at the end of the Sukarno

administration caused by the large fiscal deficit, which prompted the government to adopt

the “balanced budget principle.” A political commitment which prohibits total expenditures

form exceeding total revenue, this rule limits capital expenditures within the surplus of the

current budget and external assistance.12 Second was the management of external debt

which the Indonesian government learned from mismanagement of PERTAMINA in 1975,

which may have triggered to the country’s debt crisis.

After the first oil shock, the boom caused by the rise of oil prices overheated the

economy. The average rate of consumer price inflation was 17.6% in the 1970’s, the highest

among the four countries that we are studying, so containment of inflation became the major

concern of the Indonesian government. However, real GNP accomplished a growth rate of

almost 8%, double the level of the rate of growth in the 1960’s.

Since 1978, production and export of oil has declined, and anxiety about the

exhaustion of oil and becoming a net importer have concerned the Indonesian government.

11 Share of the mining sector, of which the major part is the oil industry, was 11% of GDP in

1972, and this ratio peaked at a level of 25% in 1980, but gradually declined to 14% in 1989.

On the fiscal side, the share of the oil-related revenues was 26% in fiscal year (FY) 1969/70

(April 1969 to March 1970). This ratio increased to 71% in FY 1981/82 and gradually declined

below 40% by the end of 1980’s. The share of oil and oil products of total export earnings was

40% at the beginning of 1970’s. This ratio increased dramatically to 70% in 1975, and stayed

over 50% until 1983, gradually declining to below 30% at the end of 1980’s. The oil industry

was solely controlled by the state monopoly called PERTAMINA, and earned huge revenues

for the government

12 “Balance budget principle” was congressional decision made every five years, and recently

it is given a legal status.

- 29 -

The Indonesian government maintained a fixed exchange rate since 1971 to block the effects

of international inflation on domestic inflation. Accompanied by domestic inflation, the real

exchange rate was substantially overvalued and competitiveness was declining. Indonesia

was able to maintain this policy because of increasing oil export earnings. The government

decided to devalue the exchange rate in 1978 to promote non-oil exports, even during the rise

of oil prices. Despite these efforts, after-effects of the second oil shock seriously impaired the

Indonesian economy. At the beginning of the 1980’s, the current account deficit expanded, it

peaked at nearly 7% of GNP in 1982, and the real GNP growth rate declined to 2.2%, the

lowest level since 1962.

To cope with the difficulties of this period, the Indonesian government introduced a

comprehensive adjustment package comprised of fiscal and monetary measures, and a

devaluation of the exchange rate. Tax reform was introduced to restore the decline of oil

revenues, deregulation in the financial sector was initiated and the exchange rate was

devalued by 33% in 1983. However, an oil glut and decline of oil prices starting in 1986 moved

the Indonesian government to undertake further adjustment. These adjustment packages

introduced: (1) devaluation of local currency by 45% in September 1986 to further promote

non-oil exports; (2) deregulation and liberalization of foreign direct investment; (3) reduction

of budget expenditures to correct the budget deficit.

We can characterize the Indonesian economy in the late 1980’s as one of the most

successful cases of structural adjustment. The country’s adjustment policies during 1983 to

1986 were reduction of imports by quantitative restrictions, redefinition of priorities, and

control of re-phasing investment projects.13 The export of non-oil products boosted by an

annual growth rate exceeding 20% in the period after 1986.14 Even with these adjustments,

the current account remained in deficit and external debt continued to grow rapidly.

Indonesia was able to manage the debt service due to continuous commitment of concession

13 To contain domestic demand during the overheating of the economy, the Indonesian

government took measures such as limiting the external borrowing of the state enterprises or

delaying approval. These measures were called “re-phasing.” Two packages undertaken in

1988 and 1991 are both called “Sumarulin shocks,” named after the Minister of Finance.

14 It is difficult to relate the growth of non-oil exports to the adjustment measures and the

devaluation of the Rupia in 1983 and 1986 analytically. But it is a common understanding

among analysts and policy makers that policy measures contributed to the rapid increase of

non-oil exports.

- 30 -

aid and increasing capital flow in the form of direct investment and portfolio investment.15

The economic growth rate from 1986 to 1990 exceeded 6%, and even with some difficulties of

macroeconomic management, the overall economic performance was positive.16

(2) Financial System of Indonesia

Strong control of Bank Indonesia (the central bank), in the form of credit rationing

and interest rate control, was the most notable specialty of the finance and banking sector

policy in Indonesia. Until the mid-1980’s, Bank Indonesia not only acted as a monetary

authority, but also as the largest lending institution. In 1982, Bank Indonesia’s total assets

exceeded the total assets of the five state commercial banks combined, and dominated

financial activities in Indonesia. Even after rapid development of the banking sector due to

liberalization in the late 1980’s, Bank Indonesia played a significant role as a lender.

Until the liberalization in 1983, the major policy instrument of the Indonesian

monetary authority was to impose a credit ceiling on lending activities of state-owned

commercial banks. On the funding side, state enterprises were obliged since 1967 to deposit

their funds to the state-owned commercial banks, and these deposits were guaranteed by the

government. In addition, liquidity credits with preferential interest rates were provided by

Bank Indonesia to state enterprises.

In 1974, Bank Indonesia introduced a “credit ceiling” on the lending activities of

commercial banks, an important policy through the 1970’s and the 1980’s, was to control

domestic credit. Before its adoption, direct lending from Bank Indonesia was an essential

tool of the funding of the commercial banks, public enterprises and private firms. The

selective credit ceiling imposed by Bank Indonesia disabled rediscount facility as a tool of

monetary policy for macroeconomic adjustment. The target of this policy was to allocate

15 The concessional assistance was from the Inter-Governmental Group on Indonesia (IGGI),

a group of donor countries formed to insure medium-term assistance after the Sukarno crisis.

IGGI was chaired by the Netherlands, but recently transformed into Concessional Group on

Indonesia chaired by the World Bank.

16 Indonesia seemed to have macroeconomic policy difficulties due to free capital movement

and the “balanced budget principle,” and the adjustment policy’s tendency to rely on direct

and abrupt control. The policies implemented during the period of 1983 to 1985, and the

famous Sumarlin Shock in 1992 were the reflections of these difficulties. See Komatsu (1992).

- 31 -

funds to the specific sectors which the government selected as targeted industries, which

were rice and oil. Imposing credit ceilings on the lending activities might have been effective

at containing increase of the money supply, however, credit rationing retarded the

development of the financial market.

As of December 1982, the share of eight state banks including five state commercial

banks exceeded 80% of the total assets of the entire banking sector comprised of 99 banks. As

a result, private financial institutions remained very small. In 1982, total assets of private

banks were only one eighth of that of Bank Indonesia. In addition, the government strictly

prohibited new entry by of private institutions into the financial market.

(3) Financial Liberalization in the 1980’s

Financial liberalization in the 1980’s came in two segments. First, the deregulation

of interest rates was initiated in June 1983, enabling a policy change from direct control by

the central bank to indirect control through the financial markets. The second segment,

announced in 1988, was the liberalization of establishment of new banks and the opening of

new branches by foreign banks.

The background of this financial liberalization was change of the economic structure

of the Indonesian economy. Due to the decline of oil prices and the increase of domestic

consumption of petroleum products, the government was no longer able to depend on oil

export revenues as the major source of economic development. The mobilization of domestic

savings was a requisite for collecting funds to meet increasing investment demand. The

government attempted to mobilize domestic capital by promotion of competition among

financial institutions, and the resultant increase of domestic savings.

The financial reform of 1983 was one part of a comprehensive economic policy

comprised of devaluation of the exchange rate, tax reform and budgetary reform. The reform

moved to liberalize deposit and lending rates of state commercial banks; abolish the credit

ceiling for commercial banks; and abolish subsidized lending of the state banks. As a result,

the deposit rate in state commercial banks rose to the level of private banks, and the real

interest rate turned from negative to positive. Because the interest rate on 24 months’

maturity time deposits was not liberalized, most of the increase of time deposits was in short-

term which made it difficult for financial institutions to collect long-term funds. The increase

of funds was so rapid, and investment opportunities were lacking, so excess funds

accumulated in the banking sector. Bank Indonesia faced difficulties absorbing the funds

collected in the banking sector due to the lack of financial instruments.

In 1988, the second stage of financial liberalization was initiated, with the aim of

introducing the principle of competition among financial institutions. The important policies

- 32 -

Figure 1-5 Ratio of M1/GNP (%) : Indonesia

Figure 1-6 Ratio of M2/GNP (%) : Indonesia

- 33 -

of this reform were deregulation of establishment of domestic banks and opening of new

branches which have been restricted since 1971. The liberalization enabled foreign banks to

enter the market by opening new branches or establishing new joint-ventures. Foreign

investors were allowed to hold up to 85% of the share capital of joint-ventures.

Changes in allocation of deposits were another feature of this liberalization.

Formerly, state enterprises had been obliged to deposit their funds in state commercial banks,

but after the liberalization, they were also allowed to deposit their funds in private banks.

The liberalization limited the maximum amounts which public enterprises could deposit in

state commercial banks to 50% of their total deposits. At the same time, the reserve

requirement ratio of financial institutions was reduced from 15% to 2%. To absorb excess

liquidity caused by the reduction of reserve requirements, Bank Indonesia issued Central

Bank Bills (SBIs), and was able to absorb the liquidity equivalent to 80% of the reduced

reserve requirements.

A remarkable effect of the financial liberalization was the increase of time deposits

in financial institutions. Particularly, time deposits in private commercial banks increased

rapidly, while the share of state banks declined. At the same time, M2/GNP increased

remarkably, which further concentrated domestic funds for investment in the official banking

system. Although, it is difficult to explain how the growth of M2 led directly to the increase of

national or domestic savings and investments, in spite of the decline of oil exports, national

investment did increase after the financial reform, which supported the further growth of

Indonesia (Figure 1-5, Figure 1-6).

It has been pointed out that important objectives of the monetary and banking policy

in Indonesia are long-term economic development and the maintenance of external balances

(Sundarajan and Molho 1988). Since 1971, foreign exchange transactions have been were

basically free from any restrictions and Indonesian monetary authorities have focused on

avoiding capital flight. To accomplish these two objectives simultaneously, Indonesia’s

monetary policy has been different from that of other countries, which has made

interpretation of the objectives and tools of that policy difficult.17

1.5 Philippines

17 For an overview of financial reform and monetary policy in Indonesia, see, for instance,

Binhadi and Meek (1989), Sundarajun and Molho (1988), Lane, Cole, and Slade (1993) and

Komatsu (1992).

- 34 -

(1) Macroeconomic developments of the Philippine economy18

The overall economic performance of the Philippines is one of the rare cases in East

Asia which can be considered a failure; it is notable that World Bank’s East Asian Miracles

Studies did not include the experience of the Philippines (The World Bank 1993).

Throughout 1970’s and 1980’s, the Philippine economy repeatedly exhibited rapid

growth, debt crisis and adjustment. In the early 1970’s, the Philippines rescheduled the

external debt which had resulted from its expansion of investments during the Marcos

administration. As a result of the adjustment program, which consisted of tight monetary

policy, devaluation of foreign exchange rate, and stringent fiscal policy, the current accounts

balance turned into a surplus while the rate of inflation declined.

However, the adjustment program did not solve any of the structural or fundamental

problems of the Philippine economy. In spite of this experience with debt crisis, the Philippine

government again adopted an expansive policy from 1972. The total investment share of GDP

grew from 21.6% in 1972 to 31.0% in 1979, while governmental fixed investment grew from

2.1% to 7.3% (Dohner and Intal 1989). Confronting the first oil shock in 1973, the Philippine

government continued and accelerated its expansive policy to avoid recession, possibly

because of increases of export revenue from primary products, prices of which rose

significantly, and because of heavy external lending. As a result, economic growth in the same

period averaged 6.5% but the current account deficit persisted, at 5% of GNP. If the expansion

policy had succeeded, the Philippines economic growth would have been a typical case of

growth-cum-debt. Due to the cautious debt management and favorable international

environment which allowed further external lending, the Philippines avoided facing the debt

crisis for the remainder of the 1970’s.

Adverse external effects in the 1970’s were another cause of the deterioration of the

Philippine economy, which in terms of trade registered a loss of 6.9% of GNP from 1979 to

1982. Furthermore, increase of the real interest rate caused an additional 3.5% loss of GNP

(Dohner and Intal 1989). The external balance was negatively affected, notably by external

environment, but by the inadequate trade and foreign exchange rate policy as well.

Nevertheless, the real GNP growth rate in the 1970’s reached 6.2%. On the other

hand, the inflation rate was 14% and current account deficits were consistently over 5% of

GNP during the same period, contributing heavily to the accumulation of a huge amount of

external debt. The Philippines failed to shift its resources to tradable sectors due to the

18 For an overview of the Philippines economy, see, Dohner and Intal (1989), and Yap

(1991).

- 35 -

misalignment of the exchange rate and adoption of protectionist policy. With these structural

problems, financial crisis in 1981 and the assassination of opposition leader Benigno Aquino,

which caused an outflow of short-term capital, triggered the debt crisis.

After the crisis, the Philippine government initiated an adjustment which seriously

hampered economic output. The real GDP growth rate declined severely in 1982 and 1983

and turned negative in 1984 and 1985. Fixed investment declined from over 30% of GNP in

early 1980’s to 14% in 1986, but current account recovered and turned to surplus in 1986.

It should be noted that this macroeconomic mismanagement seems to be the result

of the “Crony Capitalism” practiced by the Marcos government. The economy of the

Philippines had traditionally been ruled by a small number of wealthy families and resulted

in an concentration of the wealth and political power. The Marcos government, which rose

outside of the traditional power structure, tried to create countervailing power to support the

government and President Marcos himself. The “Marcos cronies” were rewarded by using

public investment projects on the one hand, and finance from governmental banks on the

other, thereby creating a new ruling economic and political force.

The late 1980’s was a period of economic recovery, the growth rate started to recover

and the inflation rate came down from the peak level of 1984 and 1985, but the current

account balance turned to deficit. This economic growth, which was based on the export

growth depending on imported goods, and domestic consumption seems not to have been

sustainable. Krugman et. al. (1992) called this “unsustainable growth of import-led recovery”

and even at the beginning of the 1990’s, the Philippines had to request rescheduling of its

external debt from international creditors.

(2) Characteristic of the financial system19

The financial system of the Philippines was strongly influenced by the US system,

but at the same time, strong government intervention is apparent. Coexistence of rather a

developed stock market and various financial instruments, with the existence of large

governmental banks was the character of the Philippines.

The financial sector of the Philippines is composed of commercial banks, rural

banks, savings banks, development banks, finance companies, investment companies and

many other officials and unofficial financial institutions. The Philippine stock market,

established in 1934, is one of the oldest in Asia. It played an important role in the early

19 For a survey on the financial market and its reform for the Philippine economy, see Okuda

(1990), and Suleik (1992).

- 36 -

period of economic development; but in recent years, its role has been became marginal.

Throughout the 1970’s and 1980’s, banking dominated the financial sector with a consistent

share of over 70% of total assets. Particularly, share of the governmental banks’ was over 30%

until 1985, reflecting their important and crucial role in economic development. However, the

management of these governmental financial institutions, such as the Development Bank of

the Philippines (DBP) and Philippine National Bank (PNB), is considered to be one of the

underlying causes of the debt crisis. Also, preferential low credits were widely provided by the

banking sector. The share of governmental banks peaked in 1982 at 17% of total assets of the

banking sector, but during the process of the liquidation of non-performing loans of the state

enterprises and government-related enterprises (Marcos Cronies), the share declined to 2.8%

of the total banking system.

(3) Financial liberalization

When we look at how the financial system was regulated and liberalized, it is useful

to follow the classification in Yap et. al. (1989). First period is 1956 to 1973, when the interest

rate was controlled by the Central Bank and low interest rate credits were provided from the

governmental banks. However, this policy obstructed financial intermediation by the formal

financial sector, thereby encouraging development of the informal financial sector. The shift

of the funds from the formal sector to the informal financial sector hampered real capital

formation.

The Banking Act was modified in 1972, and the new system determined the

character of the second period from 1974 to 1981. The aim of the change was to put larger

amounts of funds under control of monetary authorities by regulating the money market

which had been developing since the late 1960’s. The basic stance of the policy was to regulate

the informal sector but not to deregulate the formal sector.

The third period began after 1981, when full-scale deregulation of the financial

system was adopted, as a result of the two crises of the early 1980’s, namely the financial

scandal in 1981 and the debt crisis in 1983. The objective of the deregulation was to

rationalize the financial market and strengthen risk management of the banking sector to

restore confidence in the system. The main components of the reform were; (i) deregulation of

the interest rate, (ii) authorization of universal banking activities, (iii) increases of reserve

requirements, and introduction of new taxes. The reform undertaken in this period focused

on emphasizing domestic saving to mobilize long-term capital.

(4) Developments of the financial sector and liberalization

The developments of the financial sector can be briefly explained by the ratio of

- 37 -

monetary aggregates to GNP. In 1970, the M1/GNP ratio was 10%, but declined to remain at

6% to 8% throughout the 1980’s (Figure 1-7). On the other hand, since the 1970’s, the ratio of

M2 to GNP was close to 20% which is not high compared with the other countries. This ratio

was eroded by the economic turmoil in the early 1980’s. We can see a wide range of financial

disintermediation triggered by the economic turmoil. Due to the recovery of the economy and

the effects of the financial liberalization, this ratio rose by over 30% at the end of 1980’s

(Figure 1-8).

In the case of the Philippines, the movement of M3/GNP is an important feature to

follow. M3 is the sum of M2, deposit substitutes and marginal deposits (non-interest deposits

for issuing letter of credits). Deposit substitutes are certificates issued by banks based on the

repurchase agreements of treasury and corporate bonds, and were actually in the form of the

short-term financial instruments traded in the money market. The interest rate on deposit

substitutes was not regulated by monetary authorities, and they grew rapidly through the

1970’s with the development of finance companies. The economic crisis in the early 1980’s

caused the widespread bankruptcies among finance companies, and the issuance of large

amounts of treasury bills, and abolition of tax exemptions on the transactions of deposit

substitutes the shrank the market. In the late 1980’s, monetary authorities gradually

abolished deposit substitutes and the volume of M2 and M3 nearly equalized.

Rapid increase of M2/GNP ratio in the late 1980’s can be considered to be a result of

the financial liberalization started in 1983. But when we observe that the savings rate is not

rising, the subsequent financial deepening can be considered to be the result of the shift of

funds to the formal sector.

Starting from this reform, we can interpret that the central bank was able to use the

monetary policy for macroeconomic management. We can also point out that financial

liberalization was executed to interrupt the vicious cycle of high inflation, negative interest

rates, financial disintermediation and to cope with the debt crisis.

We can summarize that the banking sector of the Philippines has been a source of

the economic problem and debt crisis, because of government involvement in governmental

financial institutions that was used as the fiscal purpose and distorted the monetary policy.

Rescue finance of insolvent governmental enterprises and so-called “Marcos Cronies” that

were heavily indebted in the 1980’s, and expansion of the monetary aggregates resulted from

of this operation. Despite the adjustment measures, the basic features and structure of the

Philippine economy has not changed and is on a difficult road to recovery.20

20 For the review of monetary policy in the Philippines, see, for instance, Rosario (1989),

Ygrubay (1990), and Zialcita and Gonzalez (1991).

- 38 -

Figure 1-7 Ratio of M1/GNP (%) : Philippines

Figure 1-8 Ratio of M2/GNP (%) : Philippines

- 39 -

Chart 1-9 Real GNP Growth Rate (%) : JAPAN

Chart 1-10 Consumer Price Inflation Rate (%) : JAPAN

Chart 1-11 Current Account Balance (%) : JAPAN

(Note) Real GNP Growth Rate and Inflation Rate are Percentage change from the previous Period

- 40 -

Chart 1-12 Real GNP Growth Rate (%) : KOREA

Chart 1-13 Consumer Price Inflation Rate (%) : KOREA

Chart 1-14 Current Account Balance (%) : KOREA

- 41 -

Chart 1-15 Real GNP Growth Rate (%) : INDONESIA

Chart 1-16 Consumer Price Inflation Rate (%) : INDONESIA

Chart 1-17 Current Account Balance (%) : INDONESIA

- 42 -

Chart 1-18 Real GNP Growth Rate (%) : PHILIPPINES

Chart 1-19 Consumer Price Inflation Rate (%) : PHILIPPINES

Chart 1-20 Current Account Balance (%) : PHILIPPINES

- 43 -

Table 1-1 Main Economic Indicators of Japan, Korea, Indonesia and the Philippines Per capita GNP

1990 US$(a) (Growth rate) (1965-90 %)

Real GDP Growth (%)(b) (71-80) (81-90)

Inflation (%)(b) (65-80) (80-90)

External debt (%)(a) Debt/GNP DSR 1980 1990 1980 1990

Japan

25430 (4.1)

4.5 4.3 9.2 1.7 --- --- --- ---

Korea

5400 (7.1)

8.7 9.9 16.4 6.5 48.7 14.4 19.7 10.7

Indonesia

570 (4.5)

7.9 5.5 17.6 8.8 28.0 66.4 13.9 30.9

Philippines

730 (1.3)

6.2 1.2 13.6 14.6 53.8 69.3 26.6 21.2

(Source) (a) The World Bank, World Develpment Report 1992 (b) Asian Development Bank, Asian Development Outlook 1991 (c) GDP growth rate and rate of inflation of Japan were from IMF, IFS.

(note) Inflation rate is based on consumer price index.

Table 1-2 Current Account Balance (% of GNP)

Japan Korea Indonesia Philippines 1970 1.0 -7.2 --- -0.7 1971 2.5 -9.0 -3.8 -0.4 1972 2.2 -3.6 -3.0 0.1 1973 0.0 -2.3 -3.0 5.0 1974 -1.0 -11.0 2.4 -1.2 1975 -0.1 -9.3 -3.8 -5.7 1976 0.6 -1.1 -2.5 -5.9 1977 1.5 0.0 -0.1 -3.6 1978 1.7 -2.2 -2.9 -4.6 1979 -0.9 -6.5 2.0 -5.1 1980 -1.1 -8.8 4.3 -5.4 1981 0.4 -6.9 -0.7 -5.4 1982 0.7 -3.7 -6.1 -8.1 1983 1.8 -2.0 -7.7 -8.1 1984 2.8 -1.6 -2.2 -3.5 1985 3.6 -1.0 -2.3 -0.3 1986 4.2 4.5 -5.1 3.2 1987 3.6 7.6 -2.9 -1.3 1988 2.7 8.2 -1.7 -1.0 1989 2.0 2.4 -1.2 -3.3 1990 1.2 -0.9 --- -5.8

(Source) Asian Development Bank, Key Indicators of Developing and Asian Member Countries, Volume XIV April 1983 and Volume XXII July 1991 Economic Planning Agency, Keizai Hakusyo(White Paper of Japanese Economy), 1992

- 44 -

Chapter 2. On the Objectives of Monetary Policy

2.1 Introduction

This study evaluates monetary policy in Japan, Korea, Indonesia, and the

Philippines, highlighting aspects of the short-run stabilization policies in those countries. It

is well-known that during the early stages of development, economic growth is a principle

objective of monetary policy. As reviewed in the previous chapter, this point applies to these

countries. Thus many studies investigating monetary policy in these countries center on

those issues. However, the importance of the short-run macroeconomic policy aspects also

should not be dismissed. For example, the recent experience of some Latin American

countries would surely make this point clear.

With recently collected macroeconomic quarterly data in these countries, we focus on

the short-run stabilization aspects of monetary policy. In other words, this work attempts to

answer the following questions: Do these countries pursue consistent monetary policies as

short-run stabilization policy? If not, why? If so, how effective are those monetary policies?

What are the differences among the monetary policies of these countries and why? Can the

differences in the monetary policy explain the superior economic performance in some of the

countries?

These issues are interesting because it will give us comparative perspectives on the

monetary policies of Japan and three other countries, which might be useful in the future

development of the region. Furthermore, those investigations are also quite absorbing since

the economic growth achieved in the last decade in the east Asian countries was remarkable.

For example, the real GNP growth rate for Indonesia, Korea, Malaysia, Philippines, and

Thailand over the period 1968-1985 was 6.3%, considerably higher than the rest of the world.

So more detailed knowledge of the conduct of monetary policies in these countries, in the

fastest growing areas in the world economy, was and is still of great value for other

developing countries.

It is obvious that careful empirical inquiries are needed to answer these questions.

Nevertheless the lack of macroeconomic data, especially of the quarterly data, has been a

serious obstacle for the development of such analyses. For example, Coats and Khatkhate

(1978), a massive volume of collected papers, studied monetary policy and economic

development in depth. However, in most of their empirical analyses they had to use annual

data, sometimes even pooled cross-country data.1 Macroeconomic quarterly data, especially

1 However, some researchers used interpolation method to create quarterly figures from

annual data. For example, Aghevli etc. (1978) used such method to estimate the money

- 45 -

accumulated recently in Indonesia and the Philippines, now enable us to pursue this line of

research.

The first job in the close examination of the monetary policies in any country would

be an inquiry into the main objectives of the monetary policies. For this purpose, we use a

simple econometric method to gain those perspectives. Such empirical method has, at least,

two advantages: First, it permits us to obtain subjective information on the issue that would

probably be tough to reach by checking, say, the official documents of the central banks.

Second, it also enables us to access the quantitative as well as qualitative relevance of the

macroeconomic objectives.

This chapter is organized as follows. Next section will summarize the empirical

method used in this chapter. Section 2.3 explains the data. The estimated results would be

shown in Section 2.4. Section 2.5 will discuss those results. The empirical results of the

response function with moving regression method are shown in Section 2.6. The final section

includes concluding remarks.

2.2 Empirical Methodology

To judge the empirical significance of the key macroeconomic variables for the

monetary policy, we applied a methodology used in Dewald-Johnson (1967) to estimate the

response (reaction) function of the monetary policy.

As tools for monetary policy the discount rate of the central bank and money supply

is usually examined in this type of approach. There may exist more suitable country-specific

instruments.2 It is well known that credit rationing was widely adopted, especially during the

early years, as an important element of monetary policy in these countries. Thus another

measure of monetary policy, such as total lending of the banking sector, might be a more

appropriate indicator of monetary policy under those circumstances. Furthermore, adjusting

reserve requirement has been widely used as a monetary policy instrument during early years

as well. For example, the Bank of Korea was allowed to impose marginal reserve

requirements of up to 100% of incremental increase in deposits. Furthermore, rather frequent

and drastic change of minimum requirement ratio has been observed in practice in these

demand functions for the selected Asian countries.

2 For example, according to Zialcita and Gonzalez (1991), prior to 1984, the immediate target

of monetary policy in Philippines was the Net Domestic Asset level. However with the

outbreak of the balance of payments crisis in 1983, the immediate target has shifted to

reserve money.

- 46 -

countries (except Japan). However, we concentrate on only these two measures of monetary

policy in this study.3

Furthermore, regarding the appropriate measure of the money supply, only M2

measures of money supply were investigated in this chapter. Nonetheless, M1 or another

concepts of monetary aggregates might be particularly appropriate especially for a specific

period. For example, according to Layman (1988), prior to 1965, monetary policy of Korea

focused on M1. Nevertheless, during the 1970’s the authorities started to pay more attention

to the M2 concept of money supply.4 Inclusion of these consideration for individual countries

only remains to be seen.

Another important issue to be discussed here is the endogenously of money supply

under the fixed exchange rate system. It is well-known that under the fixed exchange rate

system with free capital mobility, central banks theoretically cannot control money supply5.

However, the degree of openness of the economy is an empirical issue to be examined.

Furthermore, in a very stimulating empirical study, Fry-Lillien-Wadhwa (1988) found a

result that is consistent with the assertion that independent monetary policy can be pursued

for the Pacific Basin counties (Indonesia, Korea, Malaysia, Philippines and Thailand). The

estimated results showing the degree of sterilization for these Pacific Basin countries were

comparable to those of most industrial countries. We believe that empirical analysis on

monetary policy of four countries still deserves some attention.

Let us explain the procedure in case of money supply. As a first step, it is supposed

that desirable money growth rate is determined by the following macroeconomic variables.

(All variables are expressed in natural logarithm, except Bt)

(2.1) t4t3t2t1ot EBPXM ∆++∆+∆+=∆ ∗ ααααα

where

1tt1t ZZZ −− −=∆

3 In fact, Kama (1987) examined the total lending of the city banks in Japan in addition to

the discount rate and money supply as main indicators of Japanese monetary policy.

4 See also for an overview of the selection of main intermediate target for Korean monetary

policy and its statistical analysis Lee (1984) and Shin (1986).

5 This issue is most serious for the Indonesian economy since unlike other developing

countries it had minimal foreign exchange controls throughout the 1970’s and 1980’s. See

Komatsu (1992) on this point.

- 47 -

Xt: real GNP

Pt: price level

Et: exchange rate (measured in own currency per dollar)

Bt: current account surplus ∗∆ tM : desirable money growth rate

Standard macroeconomic arguments suggest subsequent sign conditions for respective

coefficients; For real GNP, “leaning against the window” argument implies 01 <α . Tight

monetary policy should be adopted against ongoing inflation, hence 2α should be negative.6

Under the fixed exchange rate system, as current account deficits require restrictive

monetary policy, 3α has to be positive. Though in a pure flexible exchange rate system no

government intervention should be applied, in reality, there might exist some justification for

those actions. Here we might expect that against devaluations of its own currency, monetary

authorities respond those by tightening of monetary conditions, thereby inducing more

capital inflow. This suggests 04 <α .

As a second step, the following partial adjustment mechanism to achieve desirable

money growth rate is postulated.

(2.2) )MM(MM 1tt1tt −∗

− ∆−∆=∆−∆ δ

10 ≤≤ δ

Substituting equation (2.1) into (2.2) results in final equation to be estimated,

(2.3) 1t6t4t3t2t1ot XEBPXM −∆Ψ+∆Ψ+Ψ+∆Ψ+∆Ψ+Ψ=∆

It is clear from this calculation that expected signs of iΨ coincide with those of iα .

Furthermore, we should anticipate opposite signs for the discount rate equation. In actual

implementation, as indicators of real economic activity, indexes of industrial production

were examined in addition to real GNP. Also, wholesale price indexes, consumer price

indexes, and GNP deflators were all used for inflationary considerations. Finally, as trade

variables, foreign reserves were investigated as well as current account balance. Furthermore,

though our final equation to be estimated contains lagged dependent variables, preliminary

6 However, though difficult to implement empirically, it might be the case where the

developing countries only take contractionary monetary policy if inflation rates exceed some

permissible range of inflation rates. Same reasoning may apply for the fluctuations of real

GNP.

- 48 -

estimates indicate serious problems with the serial correlation of the error term. Hence, the

equations were re-estimated with the Cochrane-Orcutt method to correct those problems.7

2.3 The Data

The data for Japan were taken from the EPA data tape for the Japanese Economy.

All of the remaining financial data, except real GNP and GNP deflator, data for Korea,

Indonesia, and the Philippines, were taken from IFS (International Financial Statistics).

Real GNP and GNP deflator data for Korea were provided by Korean Development Institute.

Same data for Indonesia was provided by Central Bureau of Statistics. Furthermore, NEDA

provided those data for the Philippines. All of the flow variables were deseazonalized by the

Census method in EPA.

Let us briefly explain the sample periods for each country. For Japan, we divided the

data into two sub-periods, 1962:III 1973:I and 1973:II 1990:I, due to the differences in the

exchange rate system. Same reason applies for the division in 1980 for Korea. However,

divisions for the Philippines and Indonesia were not so straightforward. In the case of the

Philippines, as the data were available only from 1981:III to 1990:I, because of the degree of

freedom problem no subdivision was allowed. Finally, there is a sober issue of the data

discontinuity for Indonesia. Old data were from 1976:III till 1983:IV and new series started

from 1983:III to 1990:I. This simply obliges us to use two data sets as if those are entirely

different sub-periods.

2.4 Estimated Results

Due to potential multicollinearity problem, often occurring among macroeconomic

variables, the following two-step estimation procedure was adopted. First procedure was that

equation (2.3) was estimated with only single macroeconomic variable as an objective for the

monetary policies. Then equation (2.3) was re-estimated with all, in principle, of the

macroeconomic variables which were found individually significant in the first stage

regressions. The estimated results of the response function were contained in the Table 2.1

2.12. Let us in turn review the results.

(i) Japan

7 Betancourt and Kelejian (1981) argued that it is possible that the Cochrane-Orcutt

procedure is inconsistent at the presence of the lagged dependent variable. Hence maximum

likelihood method should be applied here.

- 49 -

TABLE 2.3: JAPANESE REACTION FUNCTION

M2, 1962: III - 1973: I CONSTANT GNP PW BP PC DEF R IP DR(-1) ρ R2 DW

-0.04

(-2.897)

1.474

(2.693)

.476

(3.031)

-.408

(-2.244)

.394 1.91

-0.117

(-1.426)

.395

(.51)

.219

(1.422)

.008 2.112

.0001

(-0.119)

-.019

(-2.203)

.157

(1.055)

.11 2.095

.0085

(.665)

-1.038

(-1.264)

.534

(3.239)

-.402

(-2.11)

.303 1.795

.0164

(2.984)

-.094

(-.701)

.657

(5.333)

.387 2.101

-.003

(-.343)

-.002

(-1.104)

.170

(1.073)

.031 2.026

-.0367

(-3.794)

1.031

(3.789)

.439

(3.083)

-.453

(-2.62)

.504 2.03

-.03

(-2.674)

-.009

(-1.214)

.92

(3.215)

.382

(2.364)

-.419

(-2.17)

.496 2.089

Notes: GNP=growth rate of real GNP, PW=rate of change of whole sale price index, BP=current account surplus.

PC=rate of change of consumer price index, DEF=rate of change of GNP deflator, R=foreign reserve. IP=growth rate of industrial production index. MR(-1)=lagged value of growth rate of money supply. ρ=serially correlated error term, R2 =adjusted R2, DW=Durbin-Watson statistics. Numbers in the parentheses indicate t values.


M2, 1973: IV - 1990: I CONSTANT GNP PW BP PC DEF R IP E DR(-1) ρ R2 DW

-.025

(-1.454)

2.257

(1.503)

.669

(5.499)

-.306

(-1.995)

.427 2.00

-.013

(-1.053)

1.445

(2.473)

.287

(2.197)

.281 1.967

-.001

(-.039)

-.0003

(-.187)

.476

(4.248)

.212 2.167

-.0007

(-.0413)

-.143

(-.156)

.487

(4.187)

.212 2.189

.009

(.753)

-1.306

(-1.491)

.675

(5.470)

-.307

(-2.001)

.427 1.961

-.028

(-1.324)

.0007

(1.485)

.474

(4.407)

.238 2.235

-.009

(-.984)

.868

(1.727)

.647

(5.486)

-.301

(-1.976)

.430 1.942

.002

(.175)

.574

(2.777)

.549

(4.609)

-.309

(-2.067)

.475 1.917

-.005

(-.509)

.038

(.065)

.878

(1.918)

.563

(2.534)

.576

(4.117)

-.373

(-2.500)

.523 1.969

See Table 2.1

- 50 -


DISCOUNT RATE, 1962: III - 1973: I CONSTANT GNP PW BP PC DEF R IP M2(-1) ρ R2 DW

.0129

(2.672)

-.203

(-2.227)

.81

(8.171)

-.419

(-2.385)

.696 1.915

.0167

(2.953)

.081

(.568)

.614

(4.697)

.385 1.927

.012

(2.905)

.005

(3.865)

.667

(6.611)

-.398

(-2.193)

.75 1.917

.015

(2.771)

.097

(.686)

.623

(5.032)

.387 2.026

.016

(2.984)

-.093

(-.701)

.657

(5.333)

.387 2.101

.019

(3.342)

.0004

(1.565)

.525

(3.756)

.415 1.893

.011

(2.297)

-.108

(-2.234)

.823

(8.044)

-.389

(-2.146)

.686 1.907

.012

(3.001)

.004

(3.091)

-.039

(-.84)

.695

(6.906)

-.436

(-2.445)

.759 1.939

See Table 2.1


DISCOUNT RATE, 1973: IV - 1990: I CONSTANT GNP PW BP PC DEF R IP E M2(-1) ρ R2 DW

.005

(2.24)

.052

(.576)

.768

(8.777)

-.631

(-6.229)

.574 2.217

.005

(2.407)

-.017

(-.726)

.788

(8.818)

-.641

(-6.347)

.579 2.255

.005

(2.294)

.00003

(.511)

.777

(8.839)

-.633

(-6.265)

.574 2.229

.005

(2.579)

.019

(.454)

.754

(7.838)

-.616

(-5.847)

.567 2.195

.005

(2.552)

.015

(.226)

.762

(7.996)

-.622

(-6.044)

.568 2.204

.005

(2.224)

.00001

(.708)

.771

(8.851)

-.632

(-6.242)

.576 2.222

.005

(2.547)

-.005

(-.205)

.774

(8.728)

-.628

(-6.191)

.571 2.215

.005

(2.415)

-.007

(-.595)

.779

(8.861)

-.634

(-6.279)

.575 2.222

See Table 2.1

- 51 -

According to Table 2.1, for the discount rate, real GNP and the current account

surplus were significant at 5% level and industrial production was significant at 1% level in

the first-stage regressions. In the second stage regression, industrial production and current

account surplus were estimated jointly, where real GNP was excluded from regressions,

because of the multicollinearity problem. While industrial production indexes were

significant at the 1% level, current account surplus was not significant even at the 10% level.

For the second period, inflation rate, measured as rate of changes in the wholesale price

indexes, was significant at 5% level, with exchange rate being significant at 1% level in the

individual variable regressions. Moreover, industrial production was significant at the 10%

level, with real GNP being significant only at the 20% level. In the joint regression, wholesale

price inflation rate was jointly examined with industrial production and exchange rate,

though industrial production and exchange rate retained their significance, wholesale price

inflation rate became insignificant.

In turn, according to Table 2.3 for the money supply regressions, current account

surplus was significant at the 1% level. Industrial production and real GNP were significant

at the 5% level for the first period as well. Moreover, foreign reserve was significant at the

20% level. In the joint estimation of current account surplus and industrial production, only

current account surplus was significant at the 1% level in the second-stage regression. For

the second period, quite surprisingly, none of the macroeconomic variables were significant.

(ii) Korea

For the discount rate, only industrial production was significant at 10% level for the

first period. Moreover, real GNP and industrial production were significant only at the 20%

level for the second period. Second-stage regression was avoided for the obvious reason.

However, using M2, current account surplus was significant at the 5% level.

Inflation, measured as a rate of change in the GNP deflator, was also significant at the 10%

level in the first-stage regressions. Wholesale price inflation rate also was significant at the

10% level. Nonetheless, in the second-stage regressions, both current account surplus and

inflation rates were significant only at the 10% level. As Japanese case, for the second period,

none of the variables were significant (Tables 2.5 - 2.8).

(iii) Indonesia

Only money supply data was available for this country. According to Tables 2.9 and

2.10, none of the variables were found to be significant with the correct sign for the first

period. Inflation rate, measured as changes in the wholesale price indexes, was significant at

10% level for the second period.

- 52 -

TABLE 2.5: KOREAN REACTION FUNCTION

DISCOUNT RATE, 1970: III - 1979: IV CONSTANT GNP PW BP PC DEF R IP DR(-1) ρ R2 DW

-.014

(-.529)

.0186

(.051)

-.561

(-3.303)

.548

(3.196)

.275 2.087

-.020

(-.684)

.172

(.419)

-.559

(-3.294)

.543

(3.146)

.276 2.071

-.021

(-.717)

-.0002

(-.481)

-.563

(-3.317)

.543

(3.131)

.277 2.063

-.013

(-.807)

.259

(.644)

.531

(3.024)

-.551

(-3.194)

.265 2.082

-.017

(-.953)

.279

(.809)

.509

(2.791)

-.534

(-2.968)

.259 2.145

-.036

(-.969)

.016

(.757)

-.538

(-2.991)

.493

(2.621)

.252 2.053

-.027

(-1.83)

.561

(1.799)

.512

(3.079)

-.549

(-3.192)

.321 2.052

See Table 2.1


DISCOUNT RATE, 1980: III - 1990: I CONSTANT GNP PW BP PC DEF R IP E DR(-1) ρ R2 DW

-.046

(-1.63)

1.311

(1.636)

.398

(2.706)

.178 1.883

-.013

(-.558)

-.276

(-.206)

.400

(2.706)

.118 1.865

-.024

(-1.058)

.00001

(1.079)

.349

(2.209)

.145 1.859

-.009

(-.316)

-.409

(-.305)

.399

(2.604)

.12 1.868

.003

(.12)

-1.283

(-1.032)

.397

(2.636)

.143 1.894

-.023

(-.701)

.001

(.307)

.399

(2.612)

.12 1.86

-.05

(-1.646)

1.22

(1.578)

.356

(2.364)

.174 1.899

-.0136

(-.624)

-.95

(-.922)

.344

(2.089)

.138 1.823

See Table 2.1

- 53 -


M2, 1970: III - 1979: IV CONSTANT GNP PW BP PC DEF R IP M2(-1) ρ R2 DW

.064

(5.402)

.132

(.939)

-.003

(-.014)

-.025 1.976

.074

(5.769)

-.198

(-1.964)

.006

(-.036)

.053 1.99

.075

(6.006)

.00002

(2.24)

-.037

(-.224)

.081 1.964

.968

(4.74)

-.13

(-.819)

.037

(.214)

-.031 2.066

.067

(5.956)

-.194

(-2.137)

.115

(.72)

.07 2.02

.059

(5.085)

.004

(1.092)

.036

(.211)

-.016 1.964

.0595

(5.296)

.214

(1.753)

-.026

(-.151)

.033 2.099

.078

(6.396)

.00002

(1.93)

-.162

(-1.816)

.0127

(.0782)

.137 1.973

See Table 2.1


M2, 1980: III - 1990: I CONSTANT GNP PW BP PC DEF R IP E M2(-1) ρ R2 DW

.006

(2.69)

.071

(.776)

.711

(8.303)

-.612

(-5.723)

.549 2.092

.006

(2.944)

-.026

(-1.143)

.748

(8.438)

-.632

(-6.022)

.563 2.164

.006

(2.825)

.00003

(.582)

.720

(8.305)

-.613

(-5.725)

.547 2.078

.007

(3.127)

.0104

(.239)

.701

(7.227)

-.599

(-5.356)

.538 2.039

.007

(3.016)

-.013

(-.253)

.723

(7.462)

-.609

(-5.615)

.543 2.072

.005

(2.224)

.00001

(.708)

.771

(8.851)

-.632

(-6.242)

.576 2.222

.007

(3.157)

-.007

(-.234)

.715

(8.169)

-.607

(-5.627)

.542 2.059

.007

(2.996)

-.007

(-.636)

.721

(8.319)

-.613

(-5.727)

.547 2.072

See Table 2.1

- 54 -

TABLE 2.9: INDONESIAN REACTION FUNCTION

M2, 1976: III - 1983: IV CONSTANT GNP PW BP PC DEF R M2(-1) ρ R2 DW

.037

(2.498)

.843

(1.183)

.187

(1.06)

.035 1.683

.045

(3.957)

.260

(1.859)

.119

(.678)

.10 1.802

.055

(3.855)

.000006

(.823)

.145

(.721)

.010 1.731

.034

(2.622)

.684

(2.169)

.13

(.767)

.136 1.788

.035

(2.776)

.483

(2.246)

.153

(.918)

.145 1.755

.046

(3.09)

.001

(.327)

.195

(.984)

-.01 1.67

See Table 2.1


M2, 1983: III - 1990: I CONSTANT GNP PW BP PC DEF R E M2(-1) ρ R2 DW

.076

(6.124)

.479

(1.552)

-.394

(-2.128)

.145 1.947

.085

(6.954)

-.437

(-1.715)

-.303

(-1.622)

.161 1.979

.085

(4.533)

.000007

(.367)

-.393

(-1.924)

.064 1.951

.084

(5.902)

-.289

(-.483)

-.335

(-1.638)

.067 1.946

.08

(6.364)

.011

(.047)

-.372

(-1.791)

.059 1.936

.028

(.56)

.011

(1.047)

-.397

(-2.076)

.1 1.946

.080

(6.359)

-.063

(-.569)

-.336

(-1.67)

.071 2.05

See Table 2.1

- 55 -

TABLE 2.11: PHILIPPINE REACTION FUNCTION

DISCOUNT RATE, 1981: III - 1990: I CONSTANT GNP PW BP PC DEF R E DR(-1) ρ R2 DW

.006

(.619)

-.373

(.353)

.374

(2.403)

.178 2.09

-.029

(-3.363)

1.067

(6.23)

-.102

(-.773)

.615 1.925

-.007

(-.568)

-.007

(-1.379)

.381

(2.547)

.197 1.841

-.039

(-4.14)

1.513

(4.981)

-.174

(-.801)

-.446

(-2.375)

.578 1.876

-.023

(-3.104)

.923

(4.478)

.272

(1.821)

-.467

(-2.734)

.713 2.113

.049

(2.768)

-.048

(-2.887)

.338

(2.456)

.325 2.026

-.014

(-1.669)

.644

(4.393)

.224

(1.753)

.469 1.849

-.003

(-.22)

.743

(4.03)

-.025

(-2.33)

.301

(2.591)

.126

(.933)

-.457

(-2.465)

.8 2.022

See Table 2.1


M2, 1981: III - 1990: I, 1981: III - 1990: I CONSTANT GNP PW BP PC DEF R E M2(-1) ρ R2 DW

.048

(3.799)

-.652

(-1.817)

.036

(.214)

.041 2.02

.03

(2.63)

.773

(3.883)

-.229

(-1.394)

.281 1.736

.03

(2.291)

-.00007

(-2.471)

-.071

(-.411)

.111 1.956

.046

(2.142)

1.093

(2.889)

-.673

(-3.432)

.477

(2.346)

.328 1.738

.036

(2.859)

.673

(2.528)

-.206

(-1.062)

.117 1.932

.026

(1.209)

-.002

(-.109)

.492

(2.282)

-.45

(-2.056)

.199 1.938

.025

(2.129)

.596

(3.759)

.073

(.492)

.266 1.896

See Table 2.1

- 56 -

(iv) The Philippines

For the discount rate, all measures of the inflation rates were significant at the 1%

level in the individual regressions. Furthermore, foreign reserve and exchange rate were

significant at 1% level as well. However, in the second-stage regression, where GNP deflator,

inflation rate, exchange rate, and foreign reserve were jointly estimated, only inflation rates

were significant at the 1% level, with foreign reserve and inflation rates being significant at

5% level. However, using M2 as monetary instruments, only real GNP was significant at 10%

level.

2.5 Discussion of the Results

Let us evaluate the estimated results for each country. The estimated results were

conveniently summarized in Tables 2.13 to 2.16. In those tables, in taking account of the

multicollinearity problem, any variables which revealed individual significance in the

first-stage regressions were listed as such.

(i)Japan

For the fixed exchange rate period, the well-known “stop-and-go” aspects of the

Japanese monetary policy during this period can be clearly discerned from the results. That

is, as current account deficit prevailed, tight monetary policy was undertaken and only

current account surplus initiated an introduction of expansionary monetary policy, which was

shown by the results in Table 2.13, using both discount rate and money supply for the first

period. Also since economic booms were usually associated with the current account deficits

during these years, the responses of monetary instruments to the changes of real GNP and

industrial production indexes were comprehensive as well. These results also accord with the

empirical results of Kama (1987).

The results for the flexible exchange rate period are more cumbersome. First, using

discount rate as a tool for monetary policy, it was found that the inflation rate as well as the

movements of the exchange rates became primarily concerns of the monetary policy. This

result supports the anti-inflationary view of the monetary policy, often claimed by the Bank of

Japan officials during these years. It also highlights the ever-increasing significance of the

exchange rate consideration in the conduct of the Japanese monetary policy.

Using M2 measure of the money supply, none of the macroeconomic variables

turned out to be significant in the response function. This result seems quite puzzling and

does not coincide that of Kama (1987). He found that, using M2 component of money supply,

inflationary consideration remained as significant factor influencing the monetary

- 57 -


PERIOD DEPENDENT

VARIABLE GNP IP PW PC DEF BP R E

1962:III - 1973:I

DR *** **** ***

1962:III - 1973:I

M2 *** *** **** *

1973:IV - 1990:I

DR * ** *** ****

1973:IV - 1990:I

M2

* : Significance at the 20% level. ** : Significance at the 10% level. *** : Significance at the 5% level. **** : Significance at the 1% level.


PERIOD DEPENDENT

VARIABLE GNP IP PW PC DEF BP R E

1970:III - 1979:IV

DR **

1970:III - 1979:IV

M2 ** *** ***

1980:III - 1990:I

DR * *

1980:III - 1990:I

M2

* : Significance at the 20% level. ** : Significance at the 10% level. *** : Significance at the 5% level.

- 58 -

policy; nevertheless, there are two distinctions between our study and his. The first is simply

that the sample periods are different: his sample period for the flexible exchange rate years

was the period from 1973:IV to 1986:III; ours is from 1973:II to 1990:I. The second is the

difference of the data sets: different methods were used for seasonality problem. He kept

original data series, however, the growth rate of the variables, which were measured as the

log difference between current value and one-year lagged value, were used as the empirical

counterparts of the macroeconomic variables. On the other hand, we used seasonally adjusted

variables for the flow variables and employed the growth rate, calculated by the log difference

against one-quarter lagged value, in the relevant empirical estimations. Since both factors

can, in principle, affect empirical results, our conclusions remain unsettled.

However, one crucial point for these discrepancies may be our longer sample period;

sample years may be long enough to contain several regimes of monetary policy. Based on

this idea, as a tentative approach, the second period was further divided into two periods:

from 1973:II to 1981:IV and from 1982:I to 1990:IV. The preliminary results for the money

supply regressions show that the inflation rates measured by the change of the wholesale

price became significant at the 10% level from 1973:IV to 1981:IV. However, none of the

macroeconomic variables became important objectives for the latter period. The basic

conclusions remain unaltered for the discount rate regressions.

(ii) Korea (Table 2.14)

One notable feature of the empirical results for Korea is that the empirical results,

using money supply, clearly signify the “stop-and-go” character of the Korean monetary policy

during fixed exchange rate years. Furthermore, our result suggests that Korean monetary

authority paid at least some attention to the movements of the inflation rates, measured by

either the rate of change of GNP deflator or that of wholesale price index. In Jae-Yoon Park

(1982), he examined monetary reaction function for the fixed exchange rate years. He

regressed natural logarithm of M2 on natural logarithm of lagged value of real GNP, inflation

rate, and lagged value of the level of net foreign assets.8 He claims that the most important

goal of Korea’s monetary policy was economic growth and the role of anti-inflationary

monetary policy was unnoticeable. Furthermore, he asserts that monetary authorities

disregarded the problem of the balance of payments. This conclusion remarkably contrasts

with ours in many aspects. Though his method thoughtfully incorporates important aspects

of Korean monetary policy that we rather dismissed, his empirical equation seems to be

subject to serious methodological dispute.

8 He estimated the reaction function of domestic credit, M1 and prime interest rate as well.

- 59 -

The result for the discount rate reveals the significance of real GNP only at 10%

level. It could be the case that the discount rate might have been mainly used for the purpose,

other than the short-run stabilization for Korea; it was sometimes claimed that more than

half of the domestic credit had been allocated by the government to heavy and chemical

industries as well as the large business firms in Korea. Hence the central role of the discount

rate might be in line with this preferential credit allocation policy of the Korean government.

In any event, this strongly contrasts with the Japanese experience, which case this

type of discrepancy was not observed. Furthermore, for the second period, discount rate only

minimally responds to the change of real economic activities. In Japan the discount rate was

extremely sensitive to the change of the macroeconomic indicators, such as inflation rates

and exchange rates. These apparent differences in the macroeconomic role of the discount

rate surely deserve further serious investigation.

The empirical result using M2 money supply for the second period was quite

confusing because it was often claimed that since 1979 Korea has used the growth rate of M2

money stock as an intermediate target of monetary policy.

However, the fact that there was a kind of “crisis” for the Korean economy might be

relevant for this aspect. As the preliminary attempts, we adopted different estimation periods,

such as starting the periods from 1982 or 1983. Nonetheless, this problem was not resolved

by this attempt.

Several other lines of explanation might also be relevant; actual implementation of

monetary policy was very rigid. Once target value was decided, allocation of domestic credits

was planned and it was strictly enforced, regardless of the macroeconomic condition

thereafter. This might, if it is true, obviously leave little room for the discretionary monetary

policy.9

Another issue surrounding conduct of the monetary policy in Korea was the problem

of the unregulated curb money markets; even in 1985, the share of the curb market remained

at one-quarter of the banking claims on the private sector. Besides the discouraging effects on

the development of the open money market, this has two critical implications for the

monetary policy. First, this curb market with growing non-banking financial sector would

probably complicate the macroeconomic information role of the traditional financial data,

such as banking loans and loan rates. Second, it is easy to understand that the effectiveness

of the monetary policy can be seriously affected by such leakage out of the traditional

9 For an analysis of Korean monetary policy, using money multiplier approach, see Jae-Yoon

Park (1982, Chapter 2, Section 5) and Keun (1983).

- 60 -

banking system.

Finally we have to admit some of the empirical results here are statistically poor.

Especially, explanatory power of the response functions for the money supply for the second

period is extremely low. This problem of our empirical methodology, however, not only for

Korea, would be re-examined further in the final section.

(iii) Indonesia (Table 2.15)

Though it is often argued that one of the primary objectives of macroeconomic policy

in Indonesia was the maintenance of external balance, this aspect is not directly reflected in

our empirical results. Nevertheless, for the second period, M2 money supply negatively

responded to the increase of the wholesale price inflation rate. Higher inflation rates,

however, can result in the depreciation of exchange rate which raises a serious barrier for the

Indonesian economy. This result may simply reflect these considerations.

It is worth noting that, for the first period, inflation rates measured as the changes

of the wholesale prices, consumer prices, GNP deflator, were significant at the 10% level, 5%

level, 5% level, respectively. Above all, none of them satisfied sign conditions.

Finally, we here also note the poor statistical performance of these monetary

response functions for both periods.

(iv) The Philippines (Table 2.16)

It is well-known that, in contrast to many other developing countries, a

“stabilization program” was rapidly achieved in the Philippines when needed. For example,

after high growth in money supply in 1983 and resulting high inflation rates, the Philippines

was highly successful in reducing inflation rates. The domestic inflation rate dropped as

quickly as it had risen; tight monetary policy was imposed in 1984 and maintained through

1985 and consumer prices actually fell during 1986. The growth rate of nominal money, as M1

or M3, was low by historical standards. It should also be noted that this particular

adjustment program was carried out by continuous face-to-face discussion with IMF and its

external creditors. The result that the discount rate was extremely sensitive to the inflation

rate, foreign reserve, and exchange rate should be understood in this context.

Nonetheless, the result with M2 money supply component revealed only real

economic activity as a significant factor for the conduct of the monetary policy. This is quite

opposite case to the first period results of Korea; here the discount rate policy reveals strong

short- run stabilization aspects, whereas money supply can not be characterized as such.

Finally, as in the case of Indonesia, for the money supply, the inflation rates

measured as the changes of the wholesale prices, and consumer price were significant at the

- 61 -


PERIOD DEPENDENT

VARIABLE

GNP IP PW PC DEF BP R E

1976:III - 1983:IV

M2

1983:III - 1990:I

M2 **

* : Significance at the 20% level. ** : Significance at the 10% level.


PERIOD DEPENDENT

VARIABLE

GNP IP PW PC DEF BP R E

1981:III - 1990:I

DR **** **** **** * **** ****

1981:III - 1990:I

M2 **

* : Significance at the 20% level. ** : Significance at the 10% level. *** : Significance at the 5% level. **** : Significance at the 1% level.

- 62 -

1% level. GNP deflator inflation rate was significant at the 5% level, but with the wrong sign.

Moreover, the exchange rate was also significant at the 1% level with unexpected sign.

Before closing the discussion of the results, it seems worthwhile to discuss several

puzzling aspects and the serious caveats of the analyses. First we may pay serious attention

to some of the estimated results of the response function for the money supply; more

specifically, second period results for Japan and Korea. Moreover, apparent discrepancy of the

results between the discount rates and money supply for the Philippine economy may also be

relevant in this respect. In most of the cases, quite unexpectedly almost none of the

macroeconomic variables affected the money growth rates. Besides the specification error

issues, a potentially critically factor for those results might be the drastic financial

innovation which occurred in these countries.

Significant financial reform in Japan started in the late 1970’s, and in Indonesia in

the early 1980’s. Although Korea has taken some steps toward financial reform in recent

years, the restrictive controls on the financial transactions still remain effective. Thus,

although the motivations, degree, and the timing of the reform vary across countries, all

these countries experienced vital changes of the financial structures.

It is obvious that these financial reforms had significant impact on the conduct of the

monetary policy. With a spectrum of new financial instruments and drastic changes of the

financial structure, it might become tough to get a proper grip on the relevant monetary

aggregates.

Second point to be focused here is the poor statistical performance of our estimated

response functions. This may be due to the omission of some of the more important

macroeconomic variables, potentially important for the developing countries. Possibilities

may include such factors as the degree of the central bank's accommodation of the credit

requirements of the government or the effect of the foreign debt outstanding and other

country-specific macroeconomic variables. Though extension of our study in this direction

only remains to be seen, we focus on the following observation: The presence of the several

macroeconomic variables which were extremely significant but with unexpected signs is

related with the first perspective. Though this is probably due to the specification error

problem mentioned above, these phenomena may reflect the information lag problem. That is,

in some of the countries, relevant macroeconomic data were not as readily available as in

Japan, or for that matter other industrialized countries, so that there may exist much longer

time-lag relationship between the macroeconomic changes and the corresponding changes of

the monetary instruments than those presumed in our theoretical model. This issue will be

examined in the next section.

- 63 -

2.6 The Lagged Values of Macroeconomic Variables

As mentioned in the introduction of the study, this study is motivated by the

emergence of the quarterly macroeconomic variables in recent years. Though financial

figures have been readily accessible in these countries, quarterly macroeconomic data has

been published quite recently. It is true that the many surrogate variables reflecting the real

economic activities exist in any economy, besides the standard macroeconomic variables.

However, the extremely poor statistical performance of our results motivates us to include

lagged values of the macroeconomic variables in the response function.

Formally if we assume that desirable money growth rate in equation (2.10) is

determined by the lagged growth rates of the macroeconomic variables, it is obvious that final

equation to be estimated such as (2.3) includes lagged values of macroeconomic variables.

To focus on the time lag problem of the macroeconomic policy formulation, we

suppose that relevant macroeconomic variables include lagged values up to two periods in the

past. In other words, we include two lagged values of the macroeconomic variables in the

estimation of the policy response function. In the following, we compare the results of this

specification with the former results for each country.

(i) Japan

The estimated results for the response function with new specification are shown in

Tables 2.17 - 2.20 and summarized in 2.29. Compared with Table 2.13, several observations

are in order. Putting the poor statistical performance of these equations aside, for the first

period, discount rate to some extent responds with lagged values of growth rates of GNP,

wholesale price indexes and foreign reserves. However, according to Table 2.13, discount rate

moves along with the contemporaneous change of those variables as well, except foreign

reserves. Regarding the money supply, it changes quite strongly according to

contemporaneous movements, the exception being the wholesale price indexes. It is possible

to view that the monetary policy in the first period responded to the contemporaneous

information.

For the second period, though discount rate changes with the current as well as the

past changes of the wholesale prices, it responds quite strongly with the contemporaneous

changes of the exchange rates. This accords with our observations on the prompt reply of the

monetary authorities regarding exchange rate movements in recent years. It is curious to

find that the money supply equation indicates the significance of the second lagged value of

the industrial production indexes. Summarizing these, we may purport that the

contemporaneous information was rather influential in the formation of the monetary policy.

- 64 -


DISCOUNT RATE, 1962: IV - 1973: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) DR(-1) ρ R2 DW

-0.051

(-2.519)

.794

(1.312)

1.172

(1.659)

.326

(1.541)

-.354

(-1.586)

.386 2.09

-0.021

(-2.460)

1.279

(1.214)

1.549

(1.297)

.138

(.894)

.169 1.979

.002

(.281)

-.0004

(-.032)

-.026

(-2.206)

.062

(.400)

.159 1.845

-.002

(-.117)

-.414

(-.466)

-.165

(-.187)

.204

(1.265)

-.021 1.945

-.031

(-1.742)

.714

(.855)

.853

(1.034)

.196

(1.259)

.017 2.011

-.006

(-.652)

-.00002

(-2.121)

.00002

(1.961)

.167

(1.080)

.089 1.833

-.0367

(-3.794)

.721

(1.601)

1.251

(2.652)

-.184

(-1.247)

.379 1.933

See Table 2.1


MONEY SUPPLY, 1962: IV - 1973: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) M(-1) ρ R2 DW

.025

(3.476)

-.191

(-1.875)

-.105

(-.983)

.554

(4.463)

.448 2.181

.010

(2.237)

.040

(.237)

-.433

(-2.444)

.797

(8.287)

-.473

(-2.72)

.721 1.871

.018

(2.849)

.003

(1.782)

.002

(.962)

.493

(2.896)

-.338

(-1.395)

.697 1.858

.014

(2.715)

.104

(.706)

-.025

(-.174)

.628

(4.979)

.393 2.156

.009

(2.827)

-.140

(-1.014)

-.018

(-.131)

.641

(5.342)

.399 2.122

.010

(1.854)

-.000007

(-.627)

.000001

(-.627)

.715

(4.954)

-.327

(-1.467)

.628 1.751

.026

(3.915)

-.147

(-1.687)

-.063

(-.639)

.533

(4.159)

.510 2.247

See Table 2.1

- 65 -


DISCOUNT RATE, 1974: I - 1990: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) E(-1) E(-2) DR(-1) ρ R2 DW

-0.032

(-1.598)

1.505

(.9679)

1.505

(.979)

.687

(5.684)

-.321

(-2.158)

.446 2.04

-0.008

(-.626)

.291

(.359)

.131

(.180)

.391

(2.972)

.164 1.963

-.005

(-.392)

-.010

(-2.209)

.011

(2.402)

.645

(5.324)

-.319

(-2.205)

.271 2.102

.006

(.3850

-.622

(-.507)

-.284

(-.240)

.453

(3.951)

.171 2.103

.005

(.283)

.671

(.152)

-.911

(-.257)

.745

(4.173)

-.427

(-2.105)

.409 2.155

-.046

(-2.261)

-.00005

(-1.298)

.00006

(1.606)

.304

(2.450)

.250 2.121

-.012

(-.904)

.544

(.734)

.334

(.438)

.403

(3.560)

.178 2.041

.002

.298 .320

(.995)

.290

(1.083)

(1.619)

.159 2.189

(.140)

See Table 2.1

TABLE 2.20: JAPANESE REACTION FUNCTION CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) E(-1) E(-2) M(-1) ρ R2 DW

.002

(2.218)

.109

(1.078)

-.075

(-.734)

.774

(8.669)

-.644

(-6.193)

.576 2.207

.002

(2.238)

-.035

(-.774)

.008

(.206)

.788

(8.749)

-.637

(-6.095)

.595 2.258

.005

(2.139)

.001

(.425)

-.00008

(-.2810)

.781

(8.451)

-.628

(-5.902)

.565 2.222

.005

(2.715)

.032

(.361)

-.013

(-.154)

.756

(7.841)

-.621

(-5.703)

.559 2.177

.006

(1.627)

.217

(.737)

.029

(.129)

.690

(4.325)

-.649

(-4.333)

.365 2.139

.005

(2.206)

.00000007

(.363)

-.00000004

(-.281)

.769

(8.512)

-.630

(-5.944)

.564 2.219

.006

(3.002)

.067

(1.556)

-.120

(-2.818)

.763

(9.116)

-.656

(-6.403)

.629 2.318

.005

(2.451)

-.004

(-.335)

-.01

(-.672)

.770

(8.575)

-.636

(-6.041)

.572 2.224

See Table 2.1

- 66 -

(ii) Korea (Table 2.21 - Table 2.24)

For the first period, in the discount rate equations, lagged values of the balance of

payments and the GNP deflator were significant. For the money supply equations, lagged

value of the consumer price indexes were significant. However, according to Table 2.14, it

responds with the current changes of the wholesale price indexes, GNP deflators, and the

balance of payments.

For the second period, the lagged values did not change the fundamental conclusion

obtained in the former results. Although there might be slight possibilities of the time lag

problem for this country, the order was apparently not so serious.

(iii) Indonesia (Table 2.25 - Table 2.26)

Unlike Japan and Korea, the inclusion of the lagged values of the macroeconomic

variables yielded new insights in this country.

For the first period, lagged value of the foreign reserve was insignificant at the 10%

level. Moreover, lagged values of the balance of payments and exchange rate were significant

at the 5% level. Compared with the results in Table 2.15, the time lag problem might be much

more serious than for Japan and Korea.

(iv) The Philippines (Table 2.27 - Table 2.28)

Comparing Tables 2.16 and 2.32, it seems fair to say that the monetary policy in this

country was responsive to contemporaneous information. Thus the time lag problem was not

so critical.

As an overall conclusion, the acclaimed time lag problem in the formation of the

monetary policy was only critically relevant for Indonesia. Hence the issue of the poor

statistical performance of our response functions remains unresolved.

However, the study of Asako and Kanoh (1989) sheds some light on this problem. In

this analysis, we used the data from entire period to estimate the policy response function.

Though this is the standard practice on this topic, Asako and Kanoh (1989) employed

sophisticated Bayesian method to estimate the response functions of monetary and fiscal

policy for the Japanese economy. Their recursive estimation of the policy function produced

several important findings. Following them, we would adapt the recursive estimation method

in the next section.

- 67 -


DISCOUNT RATE, 1970: IV - 1979: IV CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) DR(-1) ρ R2 DW

-.016

(-.009)

.228

(.492)

.094

(.189)

-.024

(-.139)

-.082 1.94

-.008

(-.601)

-.163

(-.448)

.318

(.841)

.530

(3.025)

-.547

(-3.153)

-.062 2.007

-.006

(-.641)

.00006

(1.389)

-.00008

(-1.730)

.552

(3.407)

-.575

(-3.471)

.318 2.143

-.035

(-1.449)

.464

(.760)

.309

(.506)

-.049

(-.284)

-.043 1.946

-.049

(-1.845)

.182

(.538)

.707

(2.12)

-.034

(-.202)

.040 1.925

-.032

(-.866)

-.00002

(-.314)

-.000005

(-.061)

-.526

(1.080)

.493

(2.584)

.231 2.098

-.032

(-1.383)

.184

(.415)

.464

(.854)

.427

(2.048)

-.513

(-2.499)

.260 2.092

See Table 2.1


MONEY SUPPLY, 1970: IV - 1979: IV CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) M(-1) ρ R2 DW

.033

(2.407)

-.104

(-.698)

-.070

(-.494)

.543

(2.449)

-.438

(-2.043)

.208 2.176

.071

(4.931)

-.125

(-.981)

.006

(.051)

.011

(.063)

-.044 1.906

.076

(5.602)

.00001

(.618)

.00001

(.827)

-.043

(-.244)

.026 1.873

.075

(5.120)

-.357

(-2.151)

.054

(.317)

.037

(.219)

.061 1.895

.054

(3.433)

.059

(.559)

.071

(.709)

.103

(.572)

-.063 1.917

.065

(5.410)

.00003

(1.615)

-.00003

(-1.516)

-.021

(-.202)

-.001 1.919

.059

(4.972)

.221

(1.689)

-.019

(-.143)

-.007

(-.039)

.002 1.855

See Table 2.1

- 68 -


DISCOUNT RATE, 1980: IV - 1990: IV CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) E(-1) E(-2) DR(-1) ρ R2 DW

-.031

(-.722)

.109

(.111)

.681

(.737)

.386

(2.365)

.106 1.812

.002

(.146)

.758

(.361)

-2.458

(-1.498)

.323

(2.102)

.186 1.912

-.024

(-.999)

.00003

(1.148)

-.00002

(-.666)

.358

(2.243)

.034 1.818

.023

(.766)

.740

(.397)

-3.014

(-1.768)

.317

(2.092)

.201 1.791

.026

(.836)

-.663

(-.519)

-1.971

(-1.714)

.330

(2.149)

.179 1.818

-.015

(-.450)

-.00001

(-.418)

.00001

(.433)

.417

(2.607)

.096 1.841

-.023

(-.564)

.189

(.225)

.125

(.158)

.386

(2.318)

.104 1.856

-.011

(-.501)

.871

(.501)

-1.166

(-.717)

.413

(2.519)

.104 1.856

See Table 2.1


MONEY SUPPLY, 1980: IV - 1990: IV CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) E(-1) E(-2) M(-1) ρ R2 DW

.033

(3.794)

-.099

(-.861)

-.166

(-1.494)

.369

(2.412)

.144 2.065

.027

(3.798)

.131

(.495)

.142

(.694)

.316

(1.994)

.162 2.048

.026

(3.483)

-.000002

(-.556)

.000001

(.352)

.406

(2.559)

.096 2.043

.025

(3.639)

.235

(.979)

.079

(.365)

.292

(1.778)

.201 1.791

.024

(3.414)

.105

(.653)

.254

(1.768)

.312

(2.104)

.185 2.052

.022

(2.960)

.000003

(.856)

-.000002

(-.681)

.416

(2.599)

.119 2.043

.031

(3.631)

-.063

(-.635)

-.094

(-.967)

.367

(2.353)

.122 2.086

.026

(3.582)

.223

(1.082)

-.172

(-.859)

.397

(2.535)

.116 2.038

See Table 2.1

- 69 -


MONEY SUPPLY, 1976: IV - 1983: IV CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) E(-1) E(-2) M(-1) ρ R2 DW

.033

(2.088)

.809

(.511)

-.216

(-.133)

.297

(1.611)

.044 1.946

.035

(3.798)

.144

(1.187)

.108

(.861)

.234

(1.294)

.127 1.956

.044

(3.395)

.00001

(1.196)

-.000004

(-.482)

.297

(1.630)

.082 1.813

.032

(2.248)

.064

(.171)

.307

( 365)

.278

(1.422)

.058 1.924

.030

(2.750)

.110

(.250)

.632

(1.314)

.027

(.149)

.303 1.994

.031

(2.095)

.00002

(1.952)

-.00001

(-1.714)

.329

(1.861)

.053 1.888

.035

(3.142)

.038

(.573)

.007

(.107)

.332

(1.849)

.031 1.970

See Table 2.1


MONEY SUPPLY, 1983: IV - 1990: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) E(-1) E(-2) M(-1) ρ R2 DW

.082

(5.852)

-.029

(-.072)

-.146

(-.570)

-.365

(1.611)

.029 1.901

.092

(5.700)

.429

(-1.448)

.114

(.665)

-.489

(-2.326)

.126 1.958

.094

(6.081)

-.00002

(-.1.167)

.00005

(2.321)

-.379

(-2.094)

.208 1.760

.101

(4.701)

-.933

(-1.637)

-.025

(-.045)

-.433

(-2.188)

.119 1.883

.083

(5.674)

-.263

(-1.215)

.108

(.578)

-.381

(-1.927)

.084 1.863

.0446

(.828)

.00002

(1.195)

-.00001

(-.936)

-.407

(-2.049)

.072 1.962

.091

(6.710)

-.209

(-1.996)

-.029

(-.411)

-.457

(-2.394)

.172 1.954

See Table 2.1

- 70 -


DISCOUNT RATE, 1981: IV - 1990: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) E(-1) E(-2) DR(-1) ρ R2 DW

.003

(.511)

.095

(.219)

.144

(.384)

.781

(4.396)

-.430

(-2.161)

.252 1.947

-.021

(-1.591)

.429

(1.167)

.351

(1.304)

.052

(.241)

.336 2.196

-.006

(-.567)

.00007

(1.814)

-.0001

(-2.739)

.472

(3.227)

.352 2.125

-.021

(-1.624)

.913

(2.572)

-.013

(-.041)

.094

(.461)

.361 1.937

-.024

(-1.909)

.746

(2.946)

.324

(1.315)

.010

(.0476)

.384 1.975

.007

(.411)

-.00003

(-1.258)

.00003

(1.256)

.725

(4.679)

-.421

(-2.191)

.585 1.832

-.003

(-.242)

-.186

(-.875)

.437

(2.642)

.495

(2.568)

.335 2.151

See Table 2.1


MONEY SUPPLY, 1981: IV - 1990: I CONSTANT GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) E(-1) E(-2) M(-1) ρ R2 DW

.018

(1.570)

.169

(.368)

.246

(.574)

.556

(2.692)

-.458

(-2.305)

.222 2.004

.046

(3.220)

.731

(1.882)

-.472

(-1.391)

-.161

(-.781)

.020 1.911

.032

(2.378)

-.00005

(-.884)

-.00002

(-.446)

-.103

(-.554)

.055 1.967

.0429

(2.709)

.148

(.327)

-.042

(-.099)

.029

(.144)

-.090 1.967

.042

(2.709)

.176

(.615)

-.029

(-.108)

.014

(.071)

-.082 1.955

.057

(2.343)

-.00005

(-1.576)

.00003

(1.159)

.103

(.571)

-.011 2.067

.042

(2.938)

.171

(.709)

.100

(.489)

-.041

(-.192)

-.059 1.949

See Table 2.1

- 71 -

TABLE 2.29: JAPANESE REACTION FUNCTION PERIOD DEPENDENT

VARIABLE

GNP(-1) GNP(-2) PW(-1) PW(-2) BP(-1) BP(-2) PC(-1) PC(-2) DEF(-1) DEF(-2) R(-1) R(-2) IP(-1) IP(-2) E(-1) E(-2)

1962:IV -

1973:I

DR * *** *** * ***

1962:IV -

1973:I

M2 ** *** ** *

1974:I -

1990:I

DR ***

1973:I -

1990:I

M2 ****

* : Significance at the 20% level.

** : Significance at the 10% level.

*** : Significance at the 5% level.

**** : Significance at the 1% level.


PERIOD DEPENDENT

VARIABLE


1970:IV -

1979:IV

DR ** ***

1970:IV -

1979:IV

M2 *** * *

1980:IV -

1990:I

DR

1980:IV -

1990:I

M2 *






PERIOD DEPENDENT

VARIABLE


1976:IV -

1983:IV

M2 **

1983:IV -

1990:I

M2 * *** * ***






PERIOD DEPENDENT

VARIABLE


1981:IV -

1990:I

DR *** *** **** ***

1981:IV -

1990:I

M2 *





- 72 -

2.7 Response Function with the Rolling Regression Method

As mentioned above, the Bayesian estimation method employed in the study Asako

and Kanoh (1989) resulted in several insights on the objectives of the Japanese monetary

policy. Let us briefly review their findings. They revealed that (1) business cycle measured by

the fluctuations of the growth rate of real GNP sustained its importance throughout most of

the period (1968:II - 1986:II). (2) However, the importance of the inflationary consideration

depends on the period. It was highly significant in the interim period between the two oil

crises, but not so much in the early 80’s. (3) The movements of the exchange rate have

increased their significance in the 1980’s.

These findings also indicate a limitation of the standard method used in this study.

Especially their findings highlight the issue of the continuous change of the importance of the

macroeconomic conditions over time. We suspect that the same reasoning might be applicable

for the experiences of the other countries: Korea, Indonesia, and the Philippines. Hence we

investigate this possibility for four countries.

Though we try to evaluate the possibility of the relevance of the macroeconomic

conditions over time, applying Asako’s Bayesian method directly to our study is beyond the

scope of our paper. Thus, as a first step, we employ a much simpler moving regression method

for that purpose. In carrying out rolling regressions, we use the data of the past three years

(an admittedly arbitrary choice) to estimate the response function in each period. Using the

data of 12 consecutive quarters raised a serious problem for the estimation of the response

function for the discount rate: since the changes of the discount rates are discontinuous, the

rolling regression method in this setting was not appropriate for the analyses of the discount

rate changes. Hence we report the estimated results only for the money supply.

For saving spaces, only estimated results for the first period for Japan are

summarized in Tables 2.33 - 2.37.10 New findings can be summarized as follows.

(i) JAPAN

For the first period, the most influential macroeconomic condition throughout the

period for the implementation of the Japanese monetary policy is the business cycle

condition measured by the fluctuations of the industrial production indexes. Regarding the

inflationary considerations, though the movements of the GNP price deflator had strong

impact in the latter half of the 1960’s, wholesale price index was significant in the early

10 Complete results are available upon requests.

- 73 -

1970’s as well. It is quite interesting to see that relevance of the trade considerations depends

on the variables considered. As the balance of payments is concerned, significance is only

revealed in the 1965. However, reserve outstanding was influential in 1969 and 1970. On the

whole, the relevances of the macroeconomic conditions in this period apparently show

considerable variability.

For the second period, the former results revealed significance of none of the

macroeconomic variables in the response function for the money supply. Nevertheless, the

importance of the inflationary consideration was revealed for the early I980’s, most strongly

with wholesale price indexes, but weakly with consumer price indexes and GNP deflators as

well. Moreover, the trade consideration both with balance of payments and reserve

outstanding surprisingly retained its significance by this estimation method.

These findings, however, suggest that, in line with Asako and Kanoh (1989),

consequential macroeconomic variables for the Japanese monetary policy have been changed

continuously during these years.

(ii) Korea

For the first period, as for our former results, stop-and-go character of the Korean

monetary policy is apparently confirmed in these results. Especially the balance of payments

retains its significance throughout the period. It is interesting to see that unlike the former

result, the movements of the consumer price indexes had some influence in the latter half of

the period. This result also echoes with the view of the variability of the macroeconomic

objectives of the monetary policy.

For the second period, in our previous results, as Japan, the response function of the

money supply did not reveal relevance of any macroeconomic variables. In the new results, it

is interesting that stop-and-go character still remains in 1984. Furthermore, in terms of

significance of the IP variables, stabilization aspects of the Korean monetary policy can be

discerned in 1983. The anti-inflationary aspects with the GNP deflators can be revealed in

1988. These results may also support our view of changing relevances.

(iii) Indonesia

For the first period, the former results of the response function, none of the

macroeconomic variables revealed their importance. On the contrary, in these results,

stabilization character of the monetary policy is weakly revealed in 1979. Moreover, monetary

policy responded quite strongly to the movements of the trade balance in 1980. Hence the

variability of the macroeconomic objective might be supported in this case.

For the second period, earlier result only revealed the significance of the inflationary

- 74 -

consideration with the wholesale price indexes. Nonetheless, the rolling regression method

produced many insights here. The inflationary considerations either by using consumer price

indexes or GNP deflators substantially increased its significance from 1987. The exchange

rate aspects were also taken seriously in the late 1980’s.

Hence for the second period, it is possible to claim that monetary policy in Indonesia

has regained its stabilization aspects only in the late 1980’s.

(iv) The Philippines

The results for this country are the most puzzling. None of the macroeconomic

variables were significant with the expected signs throughout the period, most of the

variables were constantly significant with wrong signs.

An idea to reconcile this finding would be the potential time-lag problem concerning

the macroeconomic conditions. Nevertheless, this is inconsistent with the conclusion

regarding lag issue for this country in the last section. This issue requires further

investigations at this point.

2.7. Concluding Remarks

Tentative conclusions obtained in this chapter may be summarized as follows: The

monetary policy of Japan and Korea is largely characterized as stop-and-go policy for their

first sample period either by standard estimation method or rolling regression method. For

the second sample period, the results with standard estimation method, especially the

discrepancy between the results for the discount rate and money supply, suggest a strong

influence of the financial innovation. Moreover, the information lag problem was not

apparently serious for the two economies. The results with moving regression estimation

method, however, highlight the changing relevance of the macroeconomic variables over the

sample periods for these countries.

Although standard analyses yielded poor results for Indonesia, the time lag in

obtaining information on macroeconomic conditions of the economy could be of consequence

for this economy; the significance of the trade consideration and exchange rate movements

were found by substituting lagged values. Furthermore, the moving regression method

supports the view that the main objective of the monetary policy has been changed

throughout the two periods.

In contrast, the standard analyses characterize the Philippines monetary policy as

systematic stabilization policy. Quite naturally the time lag problem should not be so serious.

However, the results with rolling regression method are hard to understand at this stage.

Although the information problem and the moving regression estimation added some useful

- 75 -

insights concerning the conduct of the monetary policy in these countries, these results are

still quite unsatisfactory under usual standard and merit further investigation.

Finally, before closing this chapter we have to mention a critical limitation of this

study. That is, we have excluded a potentially important factor for the implementation of the

monetary policy in the developing counties: influence of fiscal policy. For many developing

countries with immature tax administration systems, massive fiscal deficit has been, to some

extent, financed by money printing.11 Besides the fiscal deficit problem, it is well-known that

monetary policy in developing countries is closely linked to fiscal policy in general. For

instance, the Chairman of the Monetary Board of the Bank of Korea is the Finance Minister.

He approves its budget and has the power to veto the Board’s decision. Sometimes it is even

claimed that authorities in developing economies do not pose two independent policy

instruments for short-run stabilization purposes.12 Though four countries examined here

were successful in avoiding this practice and we had a data problem with incorporating this

factor in this study, without doubt further empirical investigation of this issue is in order.13

11 Of course, foreign borrowing is another important source of the financing of the large fiscal

deficit.

12 On this point, see, for example, Aghevli and Khan (1978).

13 Another subtle issue, not discussed here, is the interest rate target instead of the monetary

aggregate target. Especially following the financial reform in 1983, the Indonesian

authorities shifted their attention on targeting interest rate from that of monetary

aggregates. Other countries might be subject to this issue (see, for instance, Yoshikawa (1993)

for Japan). Recognizing this point, Kama (1987) estimated response function of money

market rate for the Japanese economy. However, we felt that applying same method for the

interest rate is not final solution of this problem. Hence we just leave this issue for further

investigation.

- 76 -

Table 2.33 Japan

Period 62:III - 73:I

DEP.VAR, GNP

TERM constant s. e. GNP s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.022 0.012 -0.410 0.262 0.707 0.200 2.091 0.576 -0.670

65.3 0.017 0.010 -0.320 0.229 0.739 0.172 2.482 0.651 -0.790

65.4 0.018 0.010 -0.300 0.237 0.723 0.179 1.930 0.601 -0.710

66.1 0.023 0.005 -0.260 0.113 0.555 0.095 2.848 0.777 -1.300

66.2 0.025 0.007 -0.300 0.142 0.511 0.177 2.175 0.433 -0.540

66.3 0.038 0.013 -0.110 0.149 0.086 0.292 2.096 -0.130 -0.910

66.4 0.051 0.014 -0.170 0.146 -0.240 0.316 1.767 -0.040 -0.500

67.1 0.045 0.014 -0.110 0.154 -0.100 0.317 2.218 -0.160 -0.650

67.2 0.050 0.015 -0.130 0.171 -0.230 0.368 1.705 -0.120 0.670

67.3 0.050 0.014 -0.120 0.171 -0.240 0.327 1.842 -0.120 0.950

67.4 0.054 0.013 -0.160 0.150 -0.310 0.306 1.864 -0.020 0.702

68.1 0.053 0.016 -0.160 0.182 -0.300 0.349 1.819 -0.090 0.456

68.2 0.052 0.015 -0.140 0.197 -0.280 0.336 1.864 -0.110 0.821

68.3 0.057 0.016 -0.230 0.209 -0.370 0.367 1.602 -0.030 1.180

68.4 0.055 0.012 -0.170 0.179 -0.400 0.272 1.984 0.060 1.181

69.1 0.055 0.008 0.153 0.091 -0.640 0.219 1.927 0.423 0.202

69.2 0.050 0.013 0.000 0.115 -0.370 0.338 1.357 -0.080 0.099

69.3 0.042 0.012 -0.050 0.122 -0.090 0.316 1.568 -0.190 1.357

69.4 0.035 0.013 -0.080 0.125 0.124 0.337 1.805 -0.150 0.323

70.1 0.033 0.012 -0.070 0.122 0.176 0.329 1.669 -0.160 0.117

70.2 0.032 0.011 -0.080 0.106 0.230 0.284 1.797 -0.090 0.188

70.3 0.030 0.013 -0.050 0.098 0.255 0.322 1.927 -0.120 0.050

70.4 0.031 0.012 -0.040 0.099 0.242 0.321 2.003 -0.130 -0.060

71.1 0.033 0.013 -0.120 0.091 0.257 0.335 1.821 0.037 0.303

71.2 0.021 0.016 -0.180 0.108 0.640 0.376 1.522 0.318 0.028

71.3 0.019 0.009 -0.140 0.086 0.691 0.197 1.314 0.591 0.564

71.4 0.019 0.010 -0.140 0.089 0.653 0.206 1.460 0.554 0.096

72.1 0.021 0.009 -0.230 0.115 0.643 0.193 1.587 0.583 0.571

72.2 0.021 0.010 -0.220 0.124 0.638 0.207 1.813 0.551 0.205

72.3 0.020 0.011 -0.200 0.133 0.663 0.215 1.548 0.518 0.602

72.4 0.010 0.017 -0.160 0.211 0.893 0.337 1.003 0.366 1.506

73.1 0.033 0.015 -0.190 0.306 0.422 0.285 1.947 0.034 -0.090

Note: s. e. indicates standard error of corresponding variables.

D-H(ALT)=Durbin’s H (alternative measure) statistic.

- 77 -

Table 2.34 Japan


DEP.VAR, PW

TERM constant s. e. PW s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.000 0.008 -1.010 0.314 1.028 0.174 1.982 0.750 -0.290

65.3 0.001 0.008 -0.870 0.359 0.992 0.172 1.893 0.743 0.213

65.4 0.000 0.008 -1.050 0.406 1.085 0.199 1.282 0.730 1.114

66.1 0.011 0.007 -0.390 0.346 0.722 0.180 1.548 0.691 0.932

66.2 0.011 0.010 -0.570 0.356 0.710 0.261 1.539 0.337 0.654

66.3 0.034 0.013 0.000 0.325 0.121 0.326 2.074 -0.200 0.476

66.4 0.044 0.014 -0.010 0.322 -0.150 0.372 1.460 -0.190 0.700

67.1 0.040 0.013 0.066 0.303 -0.050 0.336 2.112 -0.220 0.719

67.2 0.043 0.014 -0.270 0.390 -0.110 0.370 1.730 -0.130 0.769

67.3 0.044 0.012 -0.430 0.410 -0.100 0.316 1.972 -0.050 -0.090

67.4 0.046 0.011 -0.540 0.389 -0.140 0.292 1.844 0.046 0.254

68.1 0.045 0.011 -0.580 0.364 -0.100 0.298 1.936 0.075 0.200

68.2 0.044 0.011 -0.540 0.352 -0.100 0.294 1.984 0.068 0.029

68.3 0.047 0.014 0.063 0.389 -0.270 0.380 1.610 -0.160 1.261

68.4 0.052 0.010 0.371 0.352 -0.470 0.288 2.290 0.077 -1.150

69.1 0.061 0.008 0.507 0.246 -0.760 0.222 2.624 0.485 -2.570

69.2 0.051 0.012 0.205 0.358 -0.400 0.338 1.446 -0.040 -0.210

69.3 0.043 0.013 0.187 0.397 -0.190 0.364 1.704 -0.180 -0.160

69.4 0.040 0.013 0.362 0.358 -0.090 0.378 2.080 -0.090 -1.120

70.1 0.039 0.013 0.374 0.348 -0.070 0.370 1.793 -0.060 -0.720

70.2 0.038 0.011 0.371 0.259 -0.040 0.306 1.994 0.051 -0.500

70.3 0.036 0.012 0.377 0.258 0.010 0.332 2.058 0.068 -0.230

70.4 0.036 0.013 0.321 0.261 0.024 0.343 1.981 0.009 -0.170

71.1 0.032 0.015 0.083 0.286 0.200 0.407 1.743 -0.150 -0.190

71.2 0.013 0.016 -0.320 0.265 0.752 0.396 1.676 0.220 -1.260

71.3 0.015 0.006 -0.560 0.140 0.758 0.132 2.348 0.809 -1.190

71.4 0.018 0.007 -0.540 0.161 0.679 0.150 2.288 0.750 1.090

72.1 0.018 0.010 -0.300 0.179 0.631 0.205 1.288 0.539 1.210

72.2 0.018 0.010 -0.300 0.171 0.636 0.209 1.490 0.543 0.991

72.3 0.017 0.011 -0.220 0.188 0.676 0.224 1.327 0.478 1.108

72.4 0.006 0.016 0.045 0.286 0.930 0.343 0.918 0.328 1.609

73.1 0.028 0.016 -0.140 0.308 0.467 0.321 1.876 0.016 0.113

See Table 2.33

- 78 -

Table 2.35 Japan


DEP.VAR, BP

TERM constant s. e. BP s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.016 0.006 0.006 0.001 0.577 0.130 2.761 0.835 -1.640

65.3 0.016 0.006 0.006 0.002 0.590 0.132 2.482 0.823 -0.940

65.4 0.015 0.005 0.007 0.002 0.607 0.109 2.800 0.862 -1.120

66.1 0.016 0.005 0.005 0.004 0.588 0.112 2.662 0.699 -0.840

66.2 0.022 0.008 0.005 0.005 0.409 0.199 1.968 0.235 -0.350

66.3 0.038 0.010 0.009 0.005 0.021 0.262 2.466 0.112 -0.630

66.4 0.054 0.012 0.010 0.005 -0.440 0.304 1.463 0.195 0.331

67.1 0.045 0.011 0.006 0.005 -0.180 0.302 1.922 -0.010 0.278

67.2 0.046 0.013 0.009 0.006 -0.240 0.331 1.539 0.055 0.966

67.3 0.047 0.011 0.009 0.006 -0.280 0.302 1.530 0.031 1.710

67.4 0.049 0.011 0.008 0.006 -0.300 0.294 1.508 0.035 1.676

68.1 0.048 0.012 0.009 0.006 -0.290 0.314 1.398 0.028 2.267

68.2 0.051 0.012 0.009 0.006 -0.380 0.310 1.420 0.078 1.933

68.3 0.052 0.014 0.009 0.007 -0.440 0.371 1.597 0.023 0.354

68.4 0.049 0.010 0.004 0.006 -0.370 0.276 2.037 0.017 0.692

69.1 0.056 0.009 0.004 0.004 -0.580 0.236 2.042 0.309 -0.350

69.2 0.050 0.012 0.003 0.005 -0.370 0.332 1.483 -0.040 -0.430

69.3 0.042 0.011 0.004 0.005 -0.150 0.310 1.770 -0.120 -0.590

69.4 0.036 0.012 0.007 0.005 0.015 0.315 2.339 0.016 -1.320

70.1 0.037 0.012 0.006 0.005 -0.030 0.328 2.182 0.003 -2.600

70.2 0.034 0.011 0.003 0.005 0.105 0.312 2.145 -0.110 -2.280

70.3 0.031 0.013 0.004 0.005 0.162 0.331 2.420 -0.080 -2.500

70.4 0.031 0.012 0.004 0.005 0.160 0.325 2.456 -0.080 -2.570

71.1 0.032 0.013 0.006 0.005 0.136 0.351 2.354 0.014 -3.180

71.2 0.009 0.017 0.007 0.008 0.740 0.409 1.765 0.169 -0.600

71.3 0.014 0.009 0.002 0.006 0.707 0.251 1.522 0.475 0.229

71.4 0.006 0.012 -0.000 0.005 0.943 0.325 1.177 0.482 2.210

72.1 0.006 0.013 -0.000 0.004 0.958 0.321 1.229 0.464 2.183

72.2 0.006 0.013 -0.000 0.004 0.954 0.326 1.132 0.454 2.236

72.3 0.006 0.013 -0.000 0.004 0.987 0.327 1.033 0.470 2.723

72.4 0.009 0.020 0.001 0.006 0.837 0.513 0.943 0.331 2.026

73.1 0.036 0.018 0.003 0.006 0.213 0.472 1.787 0.020 0.594

See Table 2.33

- 79 -

Table 2.36 Japan


DEP.VAR, PC

TERM constant s. e. PC s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.010 0.011 -0.170 0.290 0.828 0.253 1.377 0.480 0.769

65.3 0.009 0.009 -0.150 0.240 0.834 0.209 1.688 0.594 0.779

65.4 0.010 0.009 -0.140 0.244 0.802 0.224 1.410 0.544 -0.730

66.1 0.020 0.005 0.261 0.145 0.398 0.137 2.345 0.741 -0.770

66.2 0.020 0.009 0.289 0.254 0.388 0.198 2.066 0.253 -0.790

66.3 0.029 0.012 0.323 0.266 0.135 0.276 2.335 -0.030 -0.800

66.4 0.038 0.012 0.396 0.248 -0.130 0.290 1.827 0.070 -0.200

67.1 0.040 0.011 0.227 0.246 -0.110 0.305 2.053 -0.120 -0.010

67.2 0.043 0.015 0.139 0.344 -0.180 0.366 1.745 -0.170 0.405

67.3 0.046 0.012 0.154 0.303 -0.240 0.340 1.928 -0.150 0.369

67.4 0.048 0.012 0.261 0.295 -0.330 0.325 1.970 -0.060 0.160

68.1 0.045 0.013 0.006 0.248 -0.170 0.350 1.801 -0.190 1.562

68.2 0.045 0.012 -0.030 0.249 -0.180 0.333 1.821 -0.170 1.568

68.3 0.046 0.014 0.093 0.270 -0.280 0.378 1.610 -0.150 1.306

68.4 0.048 0.010 0.128 0.225 -0.370 0.279 2.084 -0.000 0.438

69.1 0.057 0.009 0.047 0.184 -0.580 0.246 1.909 0.249 -0.410

69.2 0.051 0.013 -0.050 0.233 -0.370 0.339 1.345 -0.080 0.332

69.3 0.041 0.012 0.006 0.224 -0.100 0.320 1.643 -0.210 0.702

69.4 0.035 0.013 0.099 0.196 0.045 0.355 1.912 -0.180 -0.800

70.1 0.031 0.013 0.097 0.183 0.139 0.325 1.762 -0.160 -0.480

70.2 0.031 0.011 0.094 0.130 0.176 0.282 1.849 -0.100 -0.380

70.3 0.026 0.012 0.128 0.134 0.267 0.312 1.979 -0.050 -0.030

70.4 0.028 0.012 0.101 0.133 0.244 0.314 1.965 -0.090 -0.040

71.1 0.027 0.013 0.211 0.142 0.247 0.329 1.670 0.069 0.437

71.2 0.008 0.016 0.212 0.195 0.759 0.400 1.250 0.202 0.725

71.3 0.011 0.010 0.087 0.167 0.760 0.218 1.131 0.482 1.006

71.4 0.012 0.010 0.074 0.171 0.731 0.222 1.206 0.449 2.217

72.1 0.012 0.011 0.095 0.174 0.711 0.229 1.143 0.411 1.760

72.2 0.011 0.012 0.098 0.179 0.735 0.237 1.093 0.410 2.047

72.3 0.011 0.012 0.119 0.180 0.749 0.235 1.041 0.425 2.220

72.4 0.002 0.017 0.236 0.284 0.946 0.332 0.934 0.374 1.894

73.1 0.026 0.017 0.190 0.389 0.438 0.295 1.774 0.019 0.326

See Table 2.33

- 80 -

Table 2.37 Japan


DEP.VAR, DEF

TERM constant s. e. DEF s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.017 0.009 -0.470 0.216 0.762 0.181 2.406 0.648 -1.250

65.3 0.014 0.008 -0.370 0.203 0.778 0.160 2.361 0.690 -0.660

65.4 0.014 0.008 -0.530 0.260 0.841 0.168 1.975 0.679 0.197

66.1 0.017 0.005 -0.080 0.140 0.590 0.126 2.044 0.660 0.230

66.2 0.021 0.008 -0.170 0.140 0.501 0.208 1.722 0.264 0.843

66.3 0.037 0.011 -0.170 0.155 0.113 0.280 1.832 -0.060 1.007

66.4 0.047 0.012 -0.190 0.152 -0.180 0.304 1.348 -0.020 1.034

67.1 0.041 0.011 -0.160 0.139 -0.030 0.286 1.987 -0.070 0.789

67.2 0.050 0.013 -0.260 0.137 -0.220 0.315 1.426 0.139 1.435

67.3 0.047 0.011 -0.220 0.136 -0.140 0.286 1.532 0.093 1.350

67.4 0.049 0.010 -0.250 0.125 -0.190 0.263 1.239 0.200 1.887

68.1 0.047 0.010 -0.270 0.118 -0.130 0.265 1.441 0.256 1.320

68.2 0.048 0.009 -0.300 0.111 -0.170 0.239 1.537 0.360 1.118

68.3 0.048 0.013 -0.210 0.153 -0.230 0.341 1.280 0.034 1.359

68.4 0.051 0.010 -0.180 0.133 -0.340 0.257 1.835 0.146 1.500

69.1 0.058 0.009 0.107 0.172 -0.660 0.272 1.996 0.274 -0.750

69.2 0.052 0.012 -0.150 0.190 -0.360 0.327 1.420 -0.010 0.002

69.3 0.040 0.012 -0.140 0.191 -0.050 0.319 1.621 -0.140 0.016

69.4 0.033 0.013 -0.130 0.199 0.162 0.351 1.887 -0.160 -0.290

70.1 0.032 0.012 -0.120 0.205 0.187 0.332 1.842 -0.150 -0.380

70.2 0.031 0.011 -0.020 0.195 0.197 0.295 1.979 -0.160 -0.770

70.3 0.029 0.013 -0.020 0.195 0.241 0.326 2.073 -0.150 -0.660

70.4 0.030 0.013 -0.010 0.195 0.230 0.324 2.114 -0.160 -0.710

71.1 0.029 0.014 0.185 0.212 0.203 0.358 2.006 -0.070 -0.630

71.2 0.011 0.017 0.122 0.285 0.742 0.424 1.529 0.112 0.080

71.3 0.016 0.011 -0.140 0.227 0.723 0.222 1.149 0.489 1.096

71.4 0.016 0.012 -0.100 0.239 0.695 0.236 1.178 0.448 2.282

72.1 0.016 0.013 -0.070 0.240 0.670 0.247 1.133 0.397 2.224

72.2 0.012 0.018 0.035 0.374 0.729 0.306 1.259 0.391 1.501

72.3 0.010 0.019 0.113 0.408 0.779 0.317 1.268 0.402 1.508

72.4 -0.020 0.018 0.719 0.371 1.197 0.320 1.784 0.525 0.114

73.1 0.024 0.018 0.291 0.467 0.444 0.291 1.761 0.035 0.815

See Table 2.33

- 81 -

Table 2.38 Japan


DEP.VAR, IP

TERM constant s. e. IP s. e. M2(-1) s. e. D-W R2 D-H(ALT)

65.2 0.018 0.008 -0.260 0.081 0.745 0.153 2.797 0.747 -3.810

65.3 0.013 0.007 -0.190 0.070 0.782 0.139 2.786 0.768 -1.740

65.4 0.012 0.007 -0.210 0.076 0.816 0.145 2.374 0.749 -1.170

66.1 0.016 0.005 -0.110 0.059 0.642 0.110 2.986 0.745 -1.550

66.2 0.019 0.008 -0.120 0.071 0.568 0.203 2.363 0.357 -1.010

66.3 0.036 0.011 -0.070 0.077 0.121 0.285 2.245 -0.100 -1.630

66.4 0.052 0.011 -0.160 0.067 -0.260 0.262 2.053 0.263 -0.730

67.1 0.051 0.012 -0.140 0.074 -0.240 0.285 2.132 0.114 0.097

67.2 0.059 0.012 -0.170 0.068 -0.440 0.301 1.741 0.303 0.728

67.3 0.060 0.011 -0.170 0.066 -0.440 0.264 1.843 0.330 0.280

67.4 0.062 0.010 -0.170 0.055 -0.480 0.234 2.094 0.444 -0.160

68.1 0.063 0.011 -0.180 0.058 -0.500 0.254 2.143 0.430 -0.480

68.2 0.063 0.010 -0.190 0.063 -0.480 0.243 2.296 0.431 -0.620

68.3 0.064 0.015 -0.230 0.120 -0.510 0.340 1.412 0.178 0.290

68.4 0.055 0.012 -0.130 0.140 -0.390 0.272 1.913 0.052 0.870

69.1 0.051 0.009 0.261 0.159 -0.700 0.228 1.927 0.418 -0.550

69.2 0.049 0.014 0.044 0.215 -0.380 0.346 1.348 -0.080 0.264

69.3 0.042 0.012 -0.070 0.256 -0.060 0.356 1.666 -0.200 0.229

69.4 0.037 0.013 -0.150 0.247 0.172 0.358 1.861 -0.160 -0.410

70.1 0.034 0.013 -0.180 0.252 0.284 0.372 1.808 -0.130 -0.220

70.2 0.032 0.011 -0.050 0.238 0.228 0.331 1.934 -0.160 -0.630

70.3 0.030 0.013 -0.030 0.227 0.263 0.368 2.060 -0.150 -0.620

70.4 0.030 0.013 -0.030 0.208 0.257 0.368 2.098 -0.150 -0.660

71.1 0.031 0.013 -0.180 0.128 0.376 0.346 2.014 0.041 -0.220

71.2 0.023 0.014 -0.290 0.116 0.685 0.331 1.546 0.460 -0.400

71.3 0.031 0.008 -0.250 0.067 0.467 0.160 1.608 0.787 0.086

71.4 0.032 0.008 -0.250 0.069 0.439 0.162 1.536 0.775 0.628

72.1 0.031 0.010 -0.220 0.080 0.436 0.194 1.253 0.670 1.008

72.2 0.030 0.010 -0.230 0.077 0.450 0.191 1.651 0.689 0.581

72.3 0.027 0.011 -0.200 0.098 0.513 0.220 1.399 0.589 0.598

72.4 0.009 0.019 -0.060 0.166 0.888 0.363 0.870 0.335 1.794

73.1 0.031 0.015 -0.160 0.183 0.444 0.281 1.876 0.075 0.227

See Table 2.33

Documents

THE KEIZAI BUNSEKI - ESRITHE KEIZAI BUNSEKI (THE ECONOMIC ANALYSIS) No. 145 March 1996 Macroeconomic Stabilization and Monetary Policy of Four Asian Countries Japan, Korea, Indonesia,