This module outlines the basic principles of pro-poor monetary policy.1 Monetary policy refers essentially to the government’s regulation of the supply of money and the level of interest rates. These factors affect the level of economic activity, the composition of output, the structure of employment, the distribution of income and the direction of economic transfers. Monetary policy also influences fiscal policy (for example, the level of interest rates affects domestic public debt service), the balance of payments (the interest rates also influence the exchange rate and the level and direction of international capital flows) and the stability of the domestic financial system (the central bank is the regulator of financial institutions and the lender of last resort). Through these various channels, monetary policy affects the outcome of short-run stabilisation, and influences the policy remit of the state and the economic growth rate in the long run. Therefore, it can make an important contribution to a pro-poor development strategy.
International experience during the last 30 years shows that the orthodox development strategy, focusing primarily on price stability and static market-based allocative efficiency, is problematic both conceptually and empirically. The orthodox approach is plagued by inconsistencies at several levels, and its assumptions are at variance with the realities of developing countries. These shortcomings help to explain the continuing failure of conventional stabilisation and structural adjustment programmes to achieve their stated aims of rapid economic growth, poverty reduction and balance of payments sustainability. In the words of an informed researcher linked to the World Bank:
How to explain that after sustained involvement and many structural adjustment loans, and as many IMF’s Stand-bys, African GDP per capita has not budged from its level of 20 years ago? Moreover, in 24 African countries, GDP per capita is less than in 1975, and in 12 countries even below its 1960s level ... How to explain the recurrence of Latin crises, in countries such as Argentina, that months prior to the outbreak of the crisis are being praised as model reformers ... How to explain that the best ‘pupils’ among the transition countries (Moldova, Georgia, Kyrgyz Republic, Armenia) after setting out in 1991 with no debt at all, and following all
the prescriptions of the IFIs [international financial institutions], find themselves 10 years later with their GDPs halved and in need of debt-forgiveness? Something is clearly wrong.2
The inability of the orthodoxy to contribute to rapid welfare gains for the poor is a severe indictment of mainstream economics, especially in the light of the substantial resources currently available in the world economy, in addition to those that could be generated through faster growth and more equitable distribution. In the light of these shortcomings, pro-poor policy alternatives deserve close consideration. Such policies aim to strengthen the connection between the Poverty Reduction Strategy Papers PRSPs and the Millennium Development Goals (MDGs) in both concept and implementation, and link the MDGs with broader human development targets.3 They include some of the distributive elements of Keynesian and Kaleckian macroeconomics, enriched by a clear assessment of the role of public policy in the current era, and are deployed in order to achieve human development objectives as rapidly as possible. This module does not provide a ready-made set of monetary policy alternatives valid for every country and context, but it does offer a platform for devising alternative policies in country-specific contexts.
This module includes five sections. This introduction is the first. Section 2 outlines the orthodox approach to monetary policy. Section 3 explains the key features of pro-poor monetary policy, including its basic principles and the main features of pro-poor anti-inflation policy. Section 4 examines the problems of inflation and stabilisation in developing countries, in the light of orthodox stabilisation programmes and of the specific case of inflation targeting, which is the most important strategy of inflation control today. Section 5 draws the appropriate conclusions.
The author is grateful to Terry McKinley, Acting Director of the International Poverty Centre, who supported the formulation of this module, along with its companion modules, gave comments on its contents and helped edit it. I am also grateful for comments received on an earlier version of this module that was presented at the UNDP Workshop on Pro-Poor Macroeconomic Policies and the MDGs, supported by the Regional Bureau for Africa and the Bureau for Development Policy, in Dar Es Salaam, 20-25 June 2005. This module draws upon, and develops, UNDP research on pro-poor macroeconomic policy, especially Chandrasekhar (2004), Chowdhury (2004), Saad-Filho (2005a) and Roy and Weeks (2003).
Milanovic (2003, p. 679), emphasis added.
See McKinley (2005a) and (2005b).