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DEVELOPMENT OF COMPETITIVE FINANCIAL INTERMEDIATION IN THE CONTEXT OF PROVISION OF NON-INFLATIONARY MONETIZATION OF ECONOMY
Davoyan Lidia (PhD in Economics)
Russian-Armenian (Slavonic) University (Yerevan, Armenia)
lidia_0783@ yahoo .com Annotation
Article devoted to the problems of increasing the efficiency of financial intermediation in the context of provision of non-inflationary monetization of economy. As the recent global financial and economic crisis showed, the dilemma between the provision of the economy with sufficient money supply, especially with “long money” from one side and the provision of macroeconomic stability (what in tandem we call non-inflationary monetization) is the outstanding issue not only for transition and emerging economies, but also for mature economies. Within the article there was an attempt to find the mechanism and ways of solving the abovementioned problem mainly in transition and emerging markets. With this purpose the inflationary consequences of money supply growth in the conditions of underdeveloped financial institutes are revealed within the article as well as the concept of financial intermediation deepening in these economies is substantiated.
Keywords: financial intermediation; monetization of economy; non-inflationary monetization; financial instruments; monetary aggregates.
Additional data:
UDC 336.7
GRNTI 06.73.45; 06.73.65 JEL Code E51, E52, G20, G000 Received 15 May 2014 Accepted 21 May 2014
© Фамилия И.О., Paper ID # 6/2013/1-з
Introduction
In economic theory the issues of monetization of economy traditionally are discussed within the theory of money. Modern foreign research papers emphasize the single aspects of interconnection between financial deepening of the economy and other macroeconomic indicators. Particularly, these problems are discussed in the works by Marshall A., Freedman M., Fisher S., Fisher I., Diamond D., Tobin J., Stieglitz J., Levin R., Boyd J., Prescott E., Mishkin F., Illarionov A., Paydiev L. and others.
All the existing in the economic theory approaches envisage the role of financial intermediation in provision the non-inflationary monetization of economy were grouped by us into main five directions:
1. Financial intermediaries as “the owners of information”. This approach emphasizes the “information function” as a main (Leland H. E., Pyle D. H., 1977). Having professional information about investment opportunities financial intermediaries efficiently transform savings into investment projects and financial instruments thus contribute the growth of non-inflationary monetization of economy.
2. Financial intermediaries as a “consumption smoothing” institutes. Due to professional management of the maturity of assets and liabilities, financial intermediaries rationalize consumption via attraction and allocation of free funds into financial products and other investments thus increase the level of non-inflationary monetization. Otherwise these funds “appears” on the consumer market generating inflation or are withdrawn which we can consider at the example of countries with insufficient financial intermediation. Within this approach “a model of early and late consumption” was developed so-called Diamond-Dybvig model (Diamond D., Dybvig P., 1983) based on the ability of financial intermediaries to provide additional liquidity to their clients.
3. Financial intermediaries as a “delegated monitor”. Due to their proficiency in monitoring investment projects, financial intermediaries reduce information asymmetry while investing funds of debtors. Moreover, as financial intermediaries operates in the regulative field (public regulation and supervision of their activity) and have sufficient capital and reserves for probable loss of assets they can cover loses during investing intermediation (Darbinyan A., Sandoyan E., 2010).
4. Financial intermediaries as a “producers and consumers of financial products”. This approach considers financial intermediaries as the institutes that simultaneously create demand and supply of “financial products” (Sandoyan Ed., 2008). They are not only intermediaries between households and other economic agents while mobilizing savings, allocating funds, diversifying risks and strengthening corporate control, but also creators and suppliers of different financial products, which describes them as independent unit creates new added value in the economy. Thus, financial intermediaries not only contribute economic growth but generating it themselves.
© Фамилия И.О., Paper ID # 6/2013/1-з
У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 2, 2014 г.
SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014
5. Financial intermediaries as a “liquidity pool”. This approach envisage risk reduction and mobilization of savings as a main function of financial intermediation (Calomiris C.W., Kahn C.M., 1991).
Monetization of economy is the main indicator of money supply in economy regarding the existing supply of goods and services. As investigations proved, countries with high level of monetization are also notable for high GNI per capita. Therefore, higher monetization of economy more money is circulating within it. However that does not mean, if the economy is saturated with money the level of prices must be high. Level of prices mainly depends on the changes in money supply which is not secured with corresponding increase in the supply of goods and services (Fitzgerald J., 1999).
250
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150
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50
0
Source: World Bank: World Development Indicators, 2011 -
http://devdata.worldbank. org/dataonline/
Figure 1. Monetization of economy in selected countries
When comparing the level of monetization of Armenian economy for the last 5 years with the same indicator by transition economies (see figure 1), we consider an average indicator for Armenia slightly more 17%, yielding besides the Baltic states (an average indicator 45%), China (156%), South Korea (74%), Russia (36%), Kazakhstan (32%), lots of small transition countries (see figure 1). Thus, on the level of monetization of economy Armenia is behind of many developing and transition countries.
At the same time because of the underdevelopment of financial system in Armenia the increase of monetization leads to inflation growth as in countries with less developed financial intermediation among other financial assets, cash (including foreign currencies) is the commonly used mean of savings and payment. As regards the financial instruments which can absorb excess money there is lack of them on the local market. That’s why at the current phase of economic development in transition economies one of the most outstanding issues is the necessity of finding the ways of non-inflationary growth of the monetization of economy.
rmf Fill
2002 2003 2004 2005 2006 2007 2008 2009 2010
I Armenia I Azerbaijan I Georgia I Kazakhstan I Russian Federation I Bulgaria I Czech Republic I Estonia I Latvia United States China I Japan
© Фамилия И.О., Paper ID # 6/2013/1-з
Method and results
Based on the common scientific methods as well as specific methods as econometric, statistic and graph analysis, we investigated the correlation between different components of monetary aggregates and inflation behavior, and the behavior of financial indicators by country groups classified by the level of living as a proxy of which we used GNI per capita data annually presented by the World Bank.
Thus, according to our investigations, in economies where the dynamics of money supply significantly determined by the changes of “narrow” components of money supply and correspondingly have low level of monetization, the inflation dynamics directly depends on the growth in money supply. In such countries the main reason of insufficient level of monetization is the underdevelopment of financial intermediation. Perfectly established financial institutions contribute the growth of money supply without substantial increase in inflation rates. In other words, “qualitative”1 growth of monetization doesn’t lead to inflation.
In the results of correlation analysis between the growth of separate components of money supply as (M2-M0), (M3-M2) and inflation growth we found that the correlation of consumer price index (CPI) with (M2-M0) component is stronger (corr. coefficient is 0.81, R =0.6) than the correlation of CPI and (M3-M2) component (corr. coefficient is 0.06, R2=0.004).
y = 1,4513x + 8,6908
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M2-M0, growth
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10 10 -
CPI, %
Measures of regression
Corr. coef. 0.81
R square 0.66
Adjusted R square 0.66
P-value 0.000
Number of observations 130
Source: World Bank: World Development Indicators, 2013 -
http://devdata.worldbank. org/dataonline/
Figure 2. Regression analysis of dependence between (M2-M0) and inflation, average values for 2005-2011).
1 “Qualitative” growth means the growth of monetization at the expense of increase of medium and long-term assets in the structure of money supply.
ISSN 2222-6532 www.meconomics. org
© Фамилия И.О., Paper ID # 6/2013/1-з
Measures of regression
Corr. coef. 0.06
R square 0.004
Adjusted R square 0.004
P-value 0.000
Number of observations 122
Source: World Bank: Wcoorld Development Indicators, 2013 -
http://devdata.worldbank. org/dataonline/
Figure 3. Regression analysis of dependence between (M3-M2) and inflation, average values for 2005-2011
The confirmation of the significance of developed financial intermediation for achieving non-inflationary monetization of economy gained due to the revelation of the transmission mechanisms and channels from money market to the commodity market, the misbalance between them in short- and medium-term is adjusted by changes in the level of prices (Sandoyan, 2008). If the aggregate demand in the economy significantly determined by the level of final consumption and gross national saving are low (in some countries, can be even negative, for example, in Armenia till 2002), increase of money supply (monetization) will immediately lead to increase of inflationary pressure on the consumer market. In contrary, if there is a developed market of long-term financial instruments and high motivation (propensity) for investment, increase of money supply will partly be allocated through financial markets, which provide non-inflationary increase of monetization. Furthermore, a significant and sustainable relationship between the level of savings and market capitalization was revealed (corr. coefficient is 0.69, R =0.48, statistical significance is at 1% level). This envisages the higher the level of savings, the higher the capitalization of securities market. Identical relationship between capitalization and monetization of economy is observed (corr. coefficient is 0.74, R =0.55, statistical significance is at 1% level). Consequently, in countries with high level of savings, levels of monetization and capitalization are also high. Thus, if financial resources to relatively high extent are directed into savings than into consumption, capital market ensuring the realization of the concept of intertemporal preferences doesn’t allow this money to create inflationary pressure on consumer market, redirecting them into the real sector of economy.
Developed capital market must ensure firstly the realization of the concept of intertemporal preferences and secondly the transmission of financial resources from households to real sector of economy, thus diversifying the process of monetization. So, countries with more developed financial markets have high level of monetization and the structure of money supply of these countries is characterized by the domination of long-term financial instruments. Note, that inflation in mentioned countries is lower than in economies with less developed financial markets.
© Фамилия И.О., Paper ID # 6/2013/1-з
У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 2, 2014 г.
SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014 Table 1 confirms that absolute factor of increase in the level of national wellbeing in the long run is the creation of non-inflationary environment for monetization growth, therefore establishment of efficient financial intermediary.
The latest events taking place in some of transition countries for the last time, particularly the volatility and sharp strengthening of exchange rates of national currencies against US dollar, instability of inflationary expectations and etc. points at the necessity for developing the mechanisms and the tools of financial market. This allows to allocate financial resources more efficiently and to provide non-inflationary increase of monetization of the economy.
Table 1.
Monetization of economy by separate monetary aggregates (%) and GNI per capita (thousand US dollar), averaged for 2005-2011___________________________________________
GNI per capita, PPP (current international $) M1/GDP M2/GDP M3/GDP Number of countries in the group
Below $1000 16.2 28.6 31.9 39
$1000-$3000 17.9 41.7 47.4 15
$3000-$8000 14.9 52.8 55.1 25
$8000-$15000 25.5 83.7 86.0 8
Above $15000 26.2 89.7 95.8 6
Source: World Bank: World Development Indicators, 2013
http://devdata.worldbank. org/dataonline/
Monetization coefficient calculated for monetary aggregate M1, i.e. cash and short-term deposits, decreases while moving to the groups of countries with higher GNI per capita. Most of countries with low level of income have monetization coefficient on Ml slightly more 10%. As GNI per capita increase monetization coefficient on M3 aggregate shows the same trend. It is averaged around 95% and doesn’t drop below 50% for the group of countries with GNI per capita more 15 thousand US dollars (see table 1).
Table 2 reflects the inversely proportional relation between the level of monetization of the economy and inflation rates. For tabulation countries were divided into groups in accordance with annual inflation rates.
Table 2.
Monetization of economy by separate monetary aggregates (%) and annual rates of inflation (CPI, %), averaged for 2005-2011_____________________________________________
Annual rates of inflation (CPI, %) M1/GDP M2/GDP M3/GDP Number of countries in the group
Below 3.5% 23.2 61.0 67.3 19
3.6%-9% 15.9 41.5 44.8 25
9.1%-15% 12.2 31.1 35.6 15
Above 15% 11.8 20.9 23.3 10
Source: World Bank: World Development Indicators, 2013
http://devdata.worldbank. org/dataonline/
© Фамилия И.О., Paper ID # 6/2013/1-з
У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 2, 2014 г.
SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014
Data reflected in the table indicates that the high level of monetization on M3 monetary aggregate (liquid liabilities to GDP ratio) is shaped within the framework of low inflation rates. Thereafter, under the high inflation rates the structure of money supply will be formed mainly of the most liquid monetary aggregates as M0 and Ml.
Discussion
Thus, under the developed institutes of financial intermediation and capital market money supply is essentially formed of different financial instruments including long-term and isn’t reflected at the level of inflation. Table 2 also reflects the difference in the relation between monetization and inflation for countries with different levels of financial intermediation development. Apparently, increase in “narrow” monetary aggregates by means of multiplicative effect leads to the increase of “broad” monetary aggregates and, if the commodity market doesn’t expand for absorbing “narrow” money and financial market isn’t sufficiently developed for absorbing extra (excess) monetization, it immediately leads to the increase in the level of prices and underfunding of the real sector of economy from the external sources. But if there is enough developed financial market an enormous part of financial assets, which previously directed to the commodity market, creating inflationary pressure, now will be saved and invested into the real sector through the channels of financial intermediation (Darbinyan, Sandoyan, 2010).
In our opinion, the problem of non-inflationary monetization of economy must be settled not only within the framework of macroeconomic policy, but also a policy of active structural changes and establishment of institutions allowing to absorb, transfer and efficiently allocate an inflow of excess financial resources among the consumer market and the real sector of economy.
Such approach envisages considering financial intermediaries as institutes that create demand and supply of financial products. From this viewpoint financial institutes are considered not only as intermediaries between households and economic agents (through mobilizing savings, facilitating allocation of resources, diversifying risks and strengthening corporate management) but also creating and offering on the market financial products, which are called-for by the market participants. Moreover, financial institutes are at the same time both producers and consumers of different financial products. In this regard they are usually considered as institutional participants of financial market (Sandoyan, Hakobyan, 2008). Owing to the fact that financial intermediaries in both cases are the producers and consumers of financial products, that allows them along with minimization of intersectoral risks and other abovementioned functions to play an important function of distracting substantial funds from consumer market for benefit of long-term investments into the real sector of economy due to creating “new” demand and supply (for example, pension/retirement insurance, mortgage). In turn it will be a source of non-inflationary monetization of economy and creates new opportunities for enhancing the efficiency of monetary policy.
© Фамилия И.О., Paper ID # 6/2013/1-з
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У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 2, 2014 г.
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РАЗВИТИЕ КОНКУРЕНТОСПОСОБНОГО ФИНАНСОВОГО ПОСРЕДНИЧЕСТВА В КОНТЕКСТЕ ОБЕСПЕЧЕНИЯ НЕИНФЛЯЦИОННОЙ МОНЕТИЗАЦИИ ЭКОНОМИКИ
Давоян Лидия Мехаковна
Российско-Армянский (Славянский) университет (Ереван, Армения)
Аннотация. Статья посвящена вопросам повышения эффективности финансового посредничества в контексте обеспечения неинфляционной монетизации экономики. В статье проанализированы инфляционные последствия роста денежного предложения в условиях неразвитых финансовых институтов, обоснована концепция углубления финансового посредничества в переходных экономиках.
Ключевые слова: финансовое посредничество; монетизация экономики; неинфляционная монетизация; финансовые инструменты; денежные агрегаты.
© Фамилия И.О., Paper ID # 6/2013/1-з
