Money, Banking and the Foreign Exchange Market in Emerging Economies
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Money, Banking and the Foreign Exchange Market in Emerging Economies

Tarron Khemraj

Despite the financial liberalization agenda of the mid-1980s, a system of bank oligopolies has developed in both large and small, open developing economies. Mainstream monetary theory tends to assume a capital markets structure and is therefore not well suited to an analysis of these economies. This book outlines a unique theoretical framework that can be used to examine monetary and exchange rate policies in developing economies or other economies in which banks dominate external finance.
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Chapter 2: Stylized facts and bank liquidity preference

Tarron Khemraj


Commercial bank liquidity preference can be seen as the demand for reserves. The stylized facts of banks’ demand for liquidity are shown in Figures 2.1 to 2.21 for 42 economies. This chapter will also discuss the reserve money programme (RMP), which is a system used by the central bank to manage the supply of excess reserves. Supply of reserves change depending on the degree sterilization (or compensation) and other exogenous shocks buffeting bank liquidity. The RMP is a liquidity management tool used by many central bank research departments around the world. Economists in developing countries often receive training at the IMF Institute in Washington DC on how to carry out a reserve money exercise. The training involves techniques necessary for forecasting reserves of commercial banks. Moreover, the framework of liquidity management should be taken in the context of oligopolistic determination of interest rates by commercial banks. Barring the exogenous liquidity supply shocks, it would be easier to change bank reserves than have banks adjust rates according to a Taylor-type interest rate rule. This type of interest rate reaction function or rule may simply not be possible because the pass-through to deposit and loan interest rates is negligible, and because of the limited development of secondary money and capital markets. Immediately below we will look at the demand side or evidence of bank liquidity preference. Section 2.3 presents a discussion on financial programming and its practical cousin, the RMP.

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