Let me bring the threads of this discussion together in the form of a prescription for developing countries.

For most such countries, I believe the best policy would be to eschew the revenue from money creation, to unify its currency with the currency of a large, relatively stable developed country with which it has close economic relations, and to impose no barriers to the movement of money or prices, wages, or interest rates. Such a policy requires not having a central bank.

The second best policy, but one which has far greater political feasibility in the present climate of opinion, is to require a central bank to produce a steady and moderate rate of monetary growth, using the new money issued to finance part of government expenditures. The emphasis on a “moderate” rate of growth is partly to avoid so rapid an inflation that a large amount of real resources are wasted in efforts to hold down cash balances, partly to avoid creating pressures for government intervention to repress the inflation. The emphasis on a “steady” rate is to minimise the economic and social cost of erratic inflation, because if the inflation is erratic it is nearly impossible for people to anticipate and adjust to it.

But far and away the most important lesson of experience is that, whatever the rate of monetary growth, the resulting inflation should be permitted to be open. It should not be repressed.

As I have already emphasized, perhaps the greatest damage is done by trying to repress exchange rates. Once a country seeks to peg the exchange rate and then inflates, it is led to impose exchange control, set up multiple exchange rates with special bonuses to exports, impose quotas on imports, and so on and on, in an effort that always proves vain to defend artificial rates.

A second set of prices that it is particularly desirable to avoid repressing, and yet that is almost always subject to repression, is interest rates. By now, one lesson that Irving Fisher tried to spread some 75 years ago has been learned. There is an important difference between nominal and real interest rates. A 25 per cent rate when prices are rising at 15 per cent per year means a 10 per cent real rate of return. As a result, every country that has had substantial inflation has also had high interest rates.

Trying to repress interest rates is a particularly serious mistake for developing countries. In most developing countries capital is scarce. If the interest rate is pegged at an artificially low level, or if, as in Israel, artificial interest rates are charged on special kinds of loans or special kinds of investments, people who have access to capital at these artificial rates, generally people with political influence, will be encouraged to waste capital by using it in ways that have a low yield. Capital that escapes the controls will command an extremely high rate, much higher than the rate that would prevail in a free market.

An additional cost of trying to repress or falsify interest rates is that it leads to intervention into the development of financial institutions as a means of enforcing the legal interest rate ceiling. Yet under-developed countries have a great need for active and varied financial institutions, particularly for institutions that can serve small businesses. The best way to foster an effective and diversified financial structure is to let the financial institutions develop in response to market forces.

Repressing prices of goods and of labour, while no less frequently attempted than repression of exchange rates and interest rates, generally does less economic harm. The reason is that they are easier to evade. However, they do great social harm. Given price controls, black markets serve a socially useful purpose by preventing the distortions that would otherwise develop. The effect of price controls is therefore to make socially and individually beneficial action which is morally repugnant because it involves breaking the law. This conflict tends to undermine the moral capital of a nation.

Given favourable preconditions, good monetary policy can facilitate development. Perhaps even more important, however favourable may be the preconditions, bad monetary policy can prevent development.

Thank you.

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