Financial System of More and Less Developed Countries
In more developed nations, monetary and financial policy plays a major direct and indirect role in governmental efforts designed to expand economic activity in times of unemployment and surplus capacity and to contract that activity in times of excess demand and inflation.
HTML clipboardBasically, monetary policy works on two
principal economic variables: the aggregate supply of money in circulation and
the level of interest rates. Expressed in traditional terms, the money supply
(currency plus commercial bank demand deposits) is thought to be directly
related to the level of economic activity in the sense that a greater money
supply induces expanded economic activity by enabling people to purchase more
goods and services. This in essence is the monetarist theory of economic
activity. Its advocates argue that by controlling the growth of the money
supply, governments of developed countries can regulate their nations' economic
activity and control inflation.
On the other side of the monetary issue, again expressed in traditional terms,
are the Keynesian economists, who argue that an expanded supply of money in
circulation increases the availability of loan able funds, A supply of loan able
funds in excess of demand leads to lower interest rates. Because private
investment is assumed to be inversely related to prevailing interest rates,
businesspeople will expand their investments as interest rates fall and credit
becomes more available. More investment in turn raises aggregate demand, leading
to a higher level of economic activity (more employment and a higher GDP).
Similarly, in times of excess aggregate demand and inflation, governments pursue
restrictive monetary policies designed to curtail the expansion of aggregate
demand by reducing the growth of the national money supply, lowering the supply
of loan able funds, raising interest rates, and thereby inducing a lower level
of investment and. it is hoped, less inflation.
Although this description of monetary policy in developed countries grossly
simplifies a complex process. It does point out two important aspects that
developing countries lack. First, the ability of developed-country governments
to expand and contract their money supply and to raise and lower the costs of
borrowing in the private sector (through direct and indirect manipulation of
interest rates) is made possible by the existence of highly organized,
economically interdependent, and efficiently functioning money and credit
markets. Financial resources are continuously flowing in and out of savings
banks, commercial banks, and other nationally regulated public and private
financial intermediaries with a minimum of interference. Moreover, interest
rates are regulated both by administrative credit controls and by market forces
of supply and demand, so there tends to be consistency and a relative uniformity
of rates in different sectors of the economy and in all regions of the country.
Financial intermediaries are thus able to mobilize private savings and
efficiently allocate them to their most productive uses. This is a critical
ingredient in the promotion of long-term economic growth.
By contrast, markets and financial institutions in many developing countries are
highly unorganized, often externally dependent, and spatially fragmented. Many
LDC commercial banks are merely overseas branches of major private banking
institutions in developed countries. Their orientation, therefore, like that of
multinational corporations, may be more toward external and less toward internal
monetary situations. The ability of LDC governments to regulate the national
supply of money is further constrained by the openness of their economies, in
some cases the pegging of their currencies to the dollar or to a basket of MDC
currencies, and the fact that the accumulation of foreign-currency earnings is a
significant but highly variable source of their domestic financial resources.
Even the money supply itself may be difficult to measure and more difficult to
control when there are, as in many LDCs, problems of currency substitution,
whereby foreign currencies serve as an alternative to the domestic currency
(e.g., U.S. dollars in northern Mexico). Most important, because of limited
information and incomplete credit markets, the commercial banking system of many
LDCs lacks transparency (full disclosure of the quality of loan portfolios) and
often restricts its activities almost exclusively to rationing scarce loanable
funds to medium and large scale enterprises in the modern manufacturing sector
that are deemed more creditworthy. This lack of transparency, and the fact that
many borrowers were no creditworthy, was a major factor in the 1997 Asian
currency and banking crisis, especially in Thailand and Indonesia. As a result,
small farmers and indigenous small-scale entrepreneurs and traders in both the
formal and informal manufacturing and service sectors must traditionally seek
financing elsewhere - sometimes from family members and relatives, but more
typically from local moneylenders and loan sharks, who charge exorbitant rates
of interest.
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About Article Author

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Rashid Javed is an Asian author. He writes articles about various topics of accounting and economics such as terms of trade and work sheet.
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