A key component of financial liberalization in underdeveloped economies is the regime
of indirect (or market-based) monetary policy. Indirect monetary policy (IMP) is seen as
the alternative to the more direct monetary policy regimes that existed prior to the wave
of financial liberalization that commenced in early 1980s in many underdeveloped parts
of the world. Direct policies such as interest rate control, credit allocations to priority
sectors, and reserve requirements are labeled as “financial repression.”

China has become, by a large margin, the largest
creditor in the group of ‘new’ donors active in
Africa. ‘Old’ donors are accusing China of “freeriding”
on the development efforts deployed by
the international community and impairing debt
sustainability in low-income countries
(notwithstanding the fact that China has also
granted debt relief). It is argued that corruption is
enhanced, democracy impaired, and debt tolerance
weakened by China’s financing practices.

Two recent worldwide stock market ‘correction’
episodes offer useful insights about the volatility of
foreign exchange and equity markets. Although the
magnitudes of the price drops were not enormous,
their importance was greater than indicated by the
attention they received in the media and public policy
debate.

As a result of the increased integration into
international capital markets in the 1990s the
International Monetary Fund proposed a series of
special facilities to support emerging market countries
facing capital flow reversals. The most recent is a 2006
Fund proposal for the Reserve Augmentation Line
(RAL).i
It provided for a pre-commitment of Fund
resources by qualified countries in the case of a loss of
confidence due to contagion from an external event. It
is intended for use by countries that do not need, and
are not anticipated to require, IMF liquidity support,
have proven policy credibility, and need no adjustment
in their macroeconomic policies. They are also
expected to have debt management policies that
produce sustainable debt profiles.

The fallout from the bursting of the US sub-prime
mortgage financing bubble continues. This now
includes losses of $900 million at the home lending
unit (ResCap) of GMAC, the financial services
group in which General Motors has a 49 per cent
stake, and losses of more than $100 million at UBS
on its investments in sub-prime mortgages, losses
which have led to closure of a recently established
in-house hedge fund.

Until recently, there has been a general acceptance
among economists of Nicholas Kaldor’s ‘stylized
fact’ that distributive shares were broadly
constanti
. Even the rise in labor’s share in the
1960s and 1970s in many OECD countries –
notorious as the ‘profits squeeze’ – was often
written off as just a temporary blip resulting from
oil and other ‘shocks’.

Lao Tzu’s adage is a concise description of
contradictory aspects of foreign aid. “Give a man a fish
and you feed him for a day” means that aid can be a
dole. But its true purpose is presumably to “teach a
man (or a national economy) to fish and … feed him
for a lifetime”. A rule of thumb for successful “fishing”
is that the economy sustains two percent annual per
capita output growth. Employment creation should
keep pace with rising population. This combination can
make a big dent in poverty by increasing average
income by 22% over 10 years and by 49% over 20.

The international economic system is a major
determinant of the economic performance and social
progress of developing countries. The international
financial system has played a particularly important role
over the last 25-30 years, through the effects of debt
and financial crises, the mechanisms used to deal with
them, and direct and indirect constraints on policy
space.

The drift away from the Bretton Woods paradigm, of a
world where financial markets are coordinated and
disciplined by a central multilateral institution, continues.
Industrialized countries have long removed themselves
from IMF tutoring. During the last decade, however,
emerging market countries have been joining the drift
away from the Fund, prepaying debts to the institution,
rejecting the Fund’s role as a debt arbiter, building up
international reserves, and above all, reforming domestic
policies to lessen the risk of financial crisis and
dependence on the IMF. At the same time, the Fund has
been losing its financial capacity to provide emergency
funding, and its human capital comparative advantage as
an adviser.