Macroeconomic Stabilization and Monetary Policyof Four Asian CountriesJapan, Korea, Indonesia, and the Philippines- Targets, Effectiveness and Results - (in Japanese)

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 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 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 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. 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 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 1 High performing Asian economies: Indonesia, Hong Kong, Japan, Malaysia, the Republic of Korea, Taiwan Province of China, and Thailand. 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. 3 See Kuroyanagi and Hamada (1993) for a survey of these studies. 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. 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).