Can Monetary Policy Be Effective During Transition?: Lessons from Mongolia

AuthorTorsten Slok
PositionEconomist in the World Economic Studies Division of the IMF's Research Department

    Mongolia has undergone dramatic changes during its transition to a market economy, with fundamental restructuring in both the real economy and the financial sector. How effective is monetary policy in such a changing environment?

A key element of each former centrally planned economy's transition to a market economy has been the establishment of financial markets and institutions that can support such an economy. But introducing and, in particular, creating confidence in, such markets and institutions has been a long process. Moreover, difficulties such as banking crises, high ratios of nonperforming loans to total loans, inexperienced management, political interference, currency appreciation, and high or moderate inflation rates have posed additional challenges for monetary policy.

The policy of Mongolia's monetary authorities has been to keep the growth rate of the money supply stable while dealing with these transition-specific challenges as they occur. In addition, because of Mongolia's climate, which is characterized by extremes of temperature, the Mongolian economy is highly seasonal, and the authorities have occasionally intervened in the foreign exchange market to avoid excessive exchange rate fluctuations stemming from large, weather-related swings in exports and imports. Such a pragmatic approach to monetary policy has been necessary in many transition economies. This article discusses whether Mongolia's approach has been facilitated by a stable money demand and a predictable relationship between inflation and monetary variables.

Mongolia's experience

Mongolia's experience has been different from that of most other transition countries in four respects. First and most important, there has been a political consensus on the need for a bold and comprehensive approach to reforms. Despite significant shifts in the governing coalitions and periods of political gridlock, national governments have pursued essentially the same objectives. Second, Mongolia did not-unlike many other transition countries-experience a prolonged period of moderate inflation. Annual inflation fell below 10 percent in the first half of 1998 and has stayed low since then. Third, unlike the Central and Eastern European transition countries, Mongolia has not been a recipient of large capital inflows and has therefore not confronted the challenges that such inflows present for the monetary authorities. Fourth, the Mongolian economy has been significantly affected by both the Asian crisis of 1997 and, in particular, the Russian crisis of 1998. Consequently, its currency has appreciated considerably (in both nominal and real terms). This appreciation has been instrumental in lowering annual...

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