Money and monetary policy in a less developed economy. The case of Ceylon (Sri-Lanka), 1950-1970.

Abstract

The main object of this work is to discover quantitative information about Monetary Policy in an independent less-developed economy, the economy of Ceylon. The examined period is 1950-1970, using annual data. Chapter I serves as an introductory outline to the whole work. Chapter 2 undertakes a brief overview of the main issues outstanding in Monetary Policy and to show how our study is relevant to some of these issues. Chapter 3 looks at the basic characteristics of the economy by examining the general economic background and the institutional features of the monetary, banking and financial structure. The implications of the high dependence on foreign trade for various features of the economy and for the working of the monetary system are outlined. Chapter 4, with the background and the issues raised in chapter 3, examines the economic stabilization policies followed by the Monetary Authorities. The main problems encountered by the Authorities were: (i) To mitigate the effects of fluctuations in the export sector which caused disequilibrium in the balance of payments with further effects throughout the economy. (ii) To meet the consequences of the liquidity created because of the Government financing of its deficits through borrowings from the Central Bank. (iii) Strong necessity for economic development. The imposition of controls and restrictions on imports after I960, created a new situation with important implications for the kind of the monetary measures adopted to check liquidity. The relationship of changes in the price level and changes in the money supply and the changes in the public's portfolios to keep currency and demand deposits are examined too. On the other hand, the difficulties that face fiscal policy in LDCs are brought out together with remarks that a strong conflict can exist between the price stability and economic development, the strong connection of the balance of payments situation and fiscal actions, and the high interdependence of monetary and fiscal policy which cannot, therefore, be examined separately. Chapter 5 investigates the properties of the demand function for money and is preceded by a review of the development of some basic issues in the subject. In our empirical investigation, the tests performed refer to some simple models, but particular attention is given to the dynamic formulations of the partial adjustment-income expectations models and to the stability of the function. Chapter 6 takes up the supply of money. The analysis, based on the money supply-multiplier-Base formula (fiTWiB), proceeds from simple expressions of the multiplier, such as those of Cagan and Friedman, to more elaborate ones, by considering the evolution and the variability of the multiplier and the various ratios such as the currency ratio, the time deposit ratio, and the reserves ratio. In this context, the discussions of the "monetarist" view and "new" view of the money supply mechanism are entered. In addition, specification of behavioural equations for the various ratios is undertaken, with the object of specifying a money supply function together with the various interest elasticities. Attention is also drawn to the monetary base from the sources point of view and to the problems encountered in controlling the monetary base. Chapter 7 develops a relatively simple model consisting of 14 structural equations and 7 identities, representing the Private sector, Commercial banks, real sector, and the Government sector, with the purpose of discovering quantitative information of these sectors and any particular characteristics in their behaviour, to find any links between the real sector and the financial variables, and finally, to evaluate the effectiveness of the various policy variables. Chapter 8 states the main conclusions and suggests directions that future work could take

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