Monetary Policy Frameworks for Emerging Markets

Monetary Policy Frameworks for Emerging Markets

Edited by Gill Hammond, Ravi Kanbur and Eswar Prasad

Financial globalization has made monetary policy formulation in emerging market economies increasingly complicated. This timely set of studies looks at the turmoil in global financial markets, which coupled with volatile inflation poses serious challenges for central banks in these countries. Featuring papers from the research frontier and front-line policymakers in developing and emerging market economies, the book addresses questions such as ‘What monetary policy framework is most suitable for these countries to confront the new challenges while they continue to open up to trade and financial flows?’, ‘What are the linkages between monetary stability and financial stability?’ and ‘Is inflation targeting or a fixed exchange rate regime preferable for developing and emerging markets?’

Chapter 13: Aid Volatility, Monetary Policy Rules and the Capital Account in African Economies

Christopher Adam, Stephen O’Connell and Edward Buffie

Subjects: development studies, development economics, economics and finance, development economics, money and banking


Christopher Adam,* Stephen O’Connell and Edward Buffie 13.1 INTRODUCTION The conduct of monetary policy in Africa has undergone significant changes since the mid-1990s. Shifts in the macroeconomic orthodoxy in favour of tighter fiscal control and the emergence of low and stable inflation as a central policy objective of governments across the continent have been reinforced by greater institutional independence of central banks and the removal of administrative controls in foreign exchange and financial markets. Together, these have afforded central banks a degree of protection against excessive fiscal pressures and provided them with the instruments with which to pursue their inflation targets. The removal of exchange controls has reduced exchange rate policy to choices regarding the degree of flexibility of a unified exchange rate, while the shift away from interest rate controls and directed credit has facilitated a move from direct to indirect instruments for controlling overall liquidity, albeit in the context of relatively thin and oligopolistic asset markets. These institutional changes have occurred against a changing macroeconomic environment across the continent. Many African central banks are currently confronting the challenge of managing rapidly rising primary export prices, often in circumstances where successful adjustment and debt relief programmes have prompted surges in official aid flows. At the same time, and in response to these same developments, short-run private capital inflows have become an important feature of the landscape. In Zambia, for example, foreign investors currently hold around 20 per cent of the stock of domestic government bonds (IMF, 2007a), while in...

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