World Development, Vol. 10, No. 9, pp. 813-827, 1982. 0305-750X/82/090813-15$03.

00/0
Printed in Great Britam. Pergamon Press Ltd.

Inflation, Interest Rates, and the Balance of

Payments during a Financial Reform:
The Case of Argentina

DONALD J. MATHIESON*
International Monetary Fund, Washington, D. C.

slumnary. - In order to evaluate the impact of recent financial reforms on the Argentine
economy, this paper presents the results of estimating a small, monthly structural model of the
Argentine economy which emphasizes the linkages between the financial system, inflation and
the balance of payments. The results are used to examine the portfolio interest rate elasticities
of both the fmncial and non-financial sectors, the determinants of the real levels of and spread
between the loan and deposit interest rates, and the responsiveness of inflation and the balance
of payments to Iarious policy measures.

1. INTRODUCTION the spread between lending and deposit rates

While the number of financial reforms that
have been undertaken in developing countries
has increased significantly in the last few years,
there is still considerable uncertainty about the
impact of such reforms on not only financial
markets but also growth, inflation and the
balance of payments. To a significant degree,
this uncertainty is the result of the rather
limited empirical evidence concerning the
impact of these reforms’ which reflects both
the absence of data on key variables (e.g. how
private sector investment is financed) and the
relatively short duration of some of the most
recent reforms. In Argentina and Chile, how-
ever, the monetary authorities have begun to
collect and publish data on financial market
variables which, at least on a monthly basis,
provide considerable information about the
effects of their financial reforms. The objective
of this paper is to utilize this new monthly
data to estimate a small structural model of
the Argentine economy which emphasizes the
linkages between the financial system, inflation
and the balance of payments.
The rest of this paper is divided int6 five
sections. Section 2 describes the model’s basic
theoretical structure, and Section 3 discusses
the parameter estimates for this model obtained
from a sample of monthly data from March
1977 to December 1979. Section 4 considers
how the estimarion results can be used to
explain the behaviour of real interest rates
and examines the impact of the financial
reforms on inflation, the balance of payments
and the financial markets. The final section
includes a summary of our results.
2. BASIC MODEL
Prior to the financial reform, the Argentine
financial system was highly centralized. From
1973 to June 1977, banks and non-bank
financial institutions were required to hold
their deposits to the account of the central
bank. These institutions were paid a fixed
commission over the deposit rate on all deposits
transferred to the central bank’s account. The
banks’ loanable funds were provided by
advances and discounts from the central bank.
*The author wishes to thank Tomas Balino and
Ernest0 Gaba of the Central Bank of Argentina for
generously making available their loan and time
deposit interest rate series. Hernan Puentes, Frits van
Beek and Jose Braz suggested numerous data sources
and patiently described the institutional and regu-
latory structures of the Argentine financial system.
Thanks are also due to Kellett Hannah for his usual
excellent computational assistance. Sterie T. Beza,
Ernest0 Hernandez-Cata and Mohsin Khan provided
helpful comments on an earlier draft. The views ex-
pressed in this paper are the author’s own and do not
necessarily represent those of the International Mone-
and tary Fund.
814 WORLDDEVELOPMENT
Financial institutions were subject to a variety
of restrictions, including control over the
composition of credit, interest rate ceilings on
loans and deposits, and high required reserve
ratios. In March 1976, the new government
indicated that its policy objective was the
decentralization of deposits and loans and the
freeing of interest rates. The initial reform in
May 1976 allowed financial instituticns to
expand their operations with 30day certificates
of deposit which carried freely negotiated
interest rates and to use these funds to make
loans at market interest rates.
In June 1977, the decentralization of
deposits took place. This was accompanied by
the freeing of interest rates and the establish-
ment of a uniform reserve ratio of 45% on all
deposits. In the period rhrough mid-1980, there
has been rapid real growth of financial asset
holdings (especially time deposits), high nominal
and real (when adjusted for actual inflation)
lending and deposit rates, and a relatively large
spread between lending and deposit rates. In
addition, the 1977-1980 period witnessed a
significant decline in inflation and a sustained
balance-of-payments surplus which has primarily
reflected large capital inflows.
The overall impact of the financial reform
on growth, inflation and the balance of pay-
ments can only be accurateiy identified within
the context of a general equilibrium model of
the Argentine economy. Since our sample
is composed of monthly data, there are certain
variables such as investment expenditures for
which there are no observations. Our model
thus focuses on the linkages between the
financial reform, interest rates, re31 financial
assets, inflation and the balance of payments
that were generated by private bank and non-
bank sector portfolio adjustments. These
linkages can best be described by first con-
sidering the portfolio behaviour of the private
sector.
(a) The non-bank sector’s portfolio behaviour
It is useful to distinguish between the
portfolio behaviour of the bank and non-
bank sectors. The bank sector consists of the
financial institutions, and the non-bank sector
is composed of firms and households. The non-
bank sector’s portfolio adjustments reflect
attempts to establish a preferred mix of assets
and liabilities. The desired real holdings of any
asset or liability (Xf) are assumed to depend
on the vector of expected real returns ($) that
can be earned on portfolio instruments and the
expected (or ermanent) level of real income
(Y”). Thus Xig =f,(i,)Y” for each asset i.’
The existence of adjustment costs makes it
unlikely that desired portfolio holdings will be
maintained at each instant of time. House-
holds and firms will nonetheless attempt to
move towards this optimal portfolio mix. The
desired change in the private sector’s portfolio
holding of a given asset is assumed to take the
form of D In -Yi = yi[ln Xp - L In Xi] where
In is the natural logarithm, LXi,t = Xi,t_r, and
D = the differential operator d/dt.
In examining the non-bank sector’s portfolio
behaviour, this study will focus on the behaviour
of four key assets: currency, time deposits,
broad money and bank loans. Holdings of
currency (C) change according to
- cr3(rG - 7re)+ In Ye (la)
where3 P = price level
rre = expected rate of inflation
‘T = rate of return on time deposits
rG = rate of return on government
treasury biIls
u” = expected or permanent income.
This implies that desired real holdings of
currency rise with increases in the level of
permanent income and the expected real rate
of return on currency and fall with higher real
yields on time deposits or government treasury
bills. The expected real return on currency is
defined as the negative of the expected rate of
inflation.4 Since time deposits and government
treasury bills are viewed as substitutes for
currency, a rise in the expected rate of return
on these alternative assets would reduce desired
currency holdings.
The behaviour of non-bank sector holdings
of time deposits (T) is given by
Din(a) = -y,[In($-Lln (:)I
+ XrZr with (2)
= a4 - ag(- ne) + @rT - n’)
--7f)+ln r’
- &7(rG (24
where Z, = a dummy variable reflecting the
decentralization of deposits.’ Desired real
holdings of time deposits increase whenever
 THE CASE OF ARGENTINA
there is a rise in permanent income or in the
expected real rate of return on time deposits.
In contrast, a higher real return on currency or
government securities would lead to a decline
in desired holdings of real deposits. The presence
of the yield on government treasury bills reflects
the fact that the authorities have used this yield
to provide a ‘floor’ under the time deposits rate.
Broad money (M) equals the sum of currency
(c), demand deposits (A’) and time deposits (T),
i.e. M = C + N + T.While we could work with
the individual demand functions, the concept
of an overall excess demand or supply of
monetary assets will be usefulin our formulation
of price and balance-of-payments behaviour.
This reflects the fact that currency, demand
deposits and time deposits are the most liquid
assets in the private non-bank sector’s portfolio
and thus are most likely to respond quickly to
changing portfolio preferences. Thus, the adjust-
ment function for the overall stock of money is
Dh(f)= [h($-Lln($]
y3
+ h2Z1, with
= CKa+ ag(- n’) + cr,,(rT - ne)
- arc3 -7T=)+ln P.
Since In (M/P)d reflects the sum of three
individual demands, this implies that there
is some ambiguity regarding the signs of os
and ~1~0.For example, a rise in the time.deposit
rate would increase the demand for time
deposits but reduce the demands for currency
and demand deposits. The oie term can thus be
positive (negative) if the change in the demand
for time deposits dominates the change in the
demands for currency and demand deposits.
In addition to being a major holder of
financial system liabilities, the non-bank sector
(especially firms) is also a major borrower. The
non-bank sector’s adjustment of its holdings of
bank loans (B) is given by
Din(f) = -y,[ln ($-Lln(f)]
+ hsZ1, with
cx13(rg - 7re)+ a14(&- ne)
+ %(rc -7P)fln r’
where rb = nominal cost of foreign borrowing
rB = nominal cost of domestic bank
loans.
815
The non-bank sector’s desired holdings of
bank loans therefore would fall as the expected
real cost of bank loans rises, the expected real
cost of foreign loans falls, the expected yield
on government securities declines, and as
permanent income is reduced. (~12 is assumed
to encompass the real return on capital (taken
as a constant in the short run). The rG -rre
term reflects the fact that firms and households
can always sell off their holdings of government
securities to finance other purchases but are less
likely to do so if the yield on such assets is
relatively high. oi4 is positive since foreign
borrowing is viewed as an alternative to
domestic borrowing.
The expected cost of foreign funds is com-
posed of three elements: (1) the nominal cost
of the foreign loan (+), (2) the expected
capital loss (gain) associated with any anticipated
exchange rate depreciation (appreciation)
during the period of the loan (xe), and (3) the
cost imposed by any government capital
controls. In Argentina, government regulations
have affected not only the maturity structure
of foreign liabilities but also the cost of forward
(3)
cover. For example, in October 1977, the
authorities established a one-year minimum
maturity on foreign borrowing, and this was
subsequently increased to a two-year minimum
(34 maturity in December 1977. The two-year
minimum maturity requirement was not
eliminated until 1979. This type of capital
control adds a significant risk premium to the
cost of foreign borrowing. This means that the
cost of such borrowing (expressed in local
currency will equal rF + xe + p (where p is
the risk premium induced by the minimum
maturity requirement) rather than just rF + xe.
An additional capital control which had a
significant impact on the cost of foreign bor-
rowing was the establishment in May 1978
of a deposit requirement on foreign borrowing.
At that time, domestic borrowers were required
to deposit 20% of all foreign borrowing in zero
interest deposits in domestic currency. This
increased the cost of foreign
(rF + xe)/0.8. This requirement wasba\zz?g
in December 1978. Ignoring for the moment
the risk premium induced by the minimum
(4) maturity requirement, this means that the cost
of foreign borrowing becomes 6i(rF + x=)/0.8,
where 6, takes on the value 1 during periods
when the deposit requirement is in effect and
is zero otherwise.
(W In addition to these capital control measures,
the cost of forward cover also has been influ-
enced by government policies. From the
beginning of our sample until July 1977, the
816
authorities offered forward cover on approved
foreign borrowing at a guaranteed swap rate.
During this period, the swap rate represented
the cost of forward cover. After July 1977, the
absence of a well-developed forward market
meant that the private sector would measure
the cost of forward cover in terms of the
expected rate of depreciation of the exchange
rate (x’). Taken together, these factors imply
that the cost of foreign borrowing will be
given by
6 = (rF+xq(l-6i -8a)+Si(rF+P)
IO.8 + b@F + rS> + Pl + P2
where rF = nominal foreign interest rate (in
% per month)
rs = cost of central bank exchange
guarantee in forward cover (in
% per month)
xe = expected rate of depreciation of
the exchange rate (in % per
month)
= 1 from S/78 to 12/78,0 otherwise
Ei2 = 1 from 3177 to 7/77,0 otherwise
Pi = risk premium induced by estab-
lishment of minimum maturities
of one Cpr) and two (pa) years.
Throughout our specification of non-bank
behaviour, the expected rate of inflation and
the expected rate of depreciation of the
exchange rate have played important roles in
determining the real rates of return on financial
assets. To simplify, we will assume that the
private sector forms its exchange rate and price
expectations on the basis of past experience
with actual exchange rate and price movements.
Thus
Dxe = &(Lx - Lxe) with 0 < pi < 1 (5)
x = actual monthly rate of change of
where
the exchange rate
L = lag operator (Lx, = xtwl)
D=l-L
and
Dne = f12(Ln - Ln”) with 0 <pa < 1 (6)
where n = actual rate of change in the
wholesale price index (per % per
month).
One objective of our study will be to identify
the values of & and & which best describe the
revision of exchange rate and price expectations.
It is often argued that this type of adoptive
expectations structure is ‘irrational’ in the
sense that it can imply extended periods during
which there is a significant gap between actual
and expected price movements. As White
(1980a) and Brunner, Cukierman and Meltzer
WORLDDEVELOPMENT
(1980) have recently argued, however, such an
expectations structure is perfectly ‘rational’
(represents an optimal forecasting technique)
whenever economic agents are uncertain about
whether observed shocks to the economy are
permanent or transitory. In the Argentine
economy, which is undergoing extensive
structural changes, such uncertainty is endemic.
When this is the case, all past observations on a
given variable are useful in determining the
permanency of past shocks. In Brunner et al.
(1980), it has also been argued that the size of
our pi and f12 will be positively related to the
ratio of the variance of permanent shocks to
the variance of temporary shocks. Thus, if the
ratio of the variance of permanent shocks to
the variance of temporary shocks is low, then
the 0, will be low, giving important weight to
past history. This means that the values of the
0, which provide the best description of the
revision of exchange rate and price expectations
will also yield information about the relative
variance of permanent and transitory shocks
in the Argentine economy.
(b) The bank sector
Financial institutions make two important
simultaneous decisions: (1) what sources of
funds they will attempt to utilize, and (2) what
earning assets they will purchase. The sources
of funds include retained earnings, owners
subscriptions, foreign borrowing, borrowing
from the central bank and issuance of demand
and time deposits. In the short run, we will
take the owner’s commitment of funds as
given and assume that the use of the other
sources of funds depends on relative cost of
these funds and any restrictions the authorities
impose on their use. This means that the use
of source Si as a proportion of total funds (fl
will be taken as a function of the vector (?n)
of relative nominal costs of the various sources
of funds and the returns that can be earned
on bank assets. Nominal returns are used since
bank profits are based on the differential
between the cost of their funds and the yield
on their assets. In addition, the banks’ utilization
of a given source will be influenced by any
government reguIations affecting such portfolio
selections. The vector of these restrictions will
be denoted by g. Thus Si/F=fiB(iBpg). The
use of any given source of funds would decline
as its cost rises relative to other sources.
At the same time the decision is taken as to
the source of funds, banks also have to decide
on the earning assets to be purchased. The
 THE CASE OF ARGENTINA
desired holdings of each asset Aj relative to
total bank assets (F’) will also be a function of
the vector of the nominal returns on bank
assets and the cost of bank funds and any
government restrictions (g) on asset selection.
Thus Aj/F = Q&B, g). The purchases of any
given asset will rise as its yield rises relative to
other asset yields.
In an economy such as Argentina’s where all
bank assets and liabilities (apart from owners’
subscriptions) have relatively short maturities
(many loans are renegotiated every 30 days), it
is assumed that banks are in a position to con-
tinually rearrange not only their sources of
funds and asset holdings but also their loan and
deposit rates so as to achieve their desired
portfolio positions within the observation
period. Short-run financial market equilibrium
would be achieved when market interest rates
adjust to ensure that banks’ desired holdings
of their portfolio assets and liabilities equal the
actual stocks being generated by non-bank
portfolio adjustments. Thus, while it is assumed
that interest rates adjust so as to clear the
market in the short run, it is not assumed that
the non-bank sector necessarily holds its
desired mix of portfolio assets at each instant
in time.
Under this market clearing hypothesis, the
short-run behaviour of the loan (rn) and time
deposit (IT) interest rates reflect the behaviour
of the non-bank sector demands for time
deposits [equation (2)l and loans [equation
(4)] and the banking system’s desired holdings
of loans to the private sector and issuance
of time deposits. The desired supply of bank
loans to the private sector is given by
S
In E = or6 + (Yr,[rs(l -K) -r’r + &K]
0
where K = required reserve ratio
r&?= interest paid on required reserves.
Banks’ holdings of private sector loans are
assumed to rise as the loan rate increases
relative to the cost of domestic deposits,’
the cost of foreign funds, or the return on
government securities. The impact of the
government treasury bill rate reflects the
fact that government securities can substitute
for loans to the private Sector in banks’ port-
folios. The supply function for bank loans is
based on interest rate differentials primarily
because bank profits are generated by the
difference between the cost of bank funds and
the returns earned on bank assets.
817
In this formulation, total bank funds are
defined to equal
F = (1 -K)ZV+(l -K)T+BB+CA+ZO
(8)
where BB = banking system borrowing and
advances from the central bank
CA = banking system capital account
IO = other sources (net) of banking
system funds.
Since our sample covers the periods of both
centralized and decentralized deposits, there
have been substantial changes in the sources of
bank funds. Prior to the decentralization of
deposits, bank loanable funds came primarily
from central bank advances and their own
capital resources. In the post-decentralization
period, however, the much lower required
reserve ratio meant that demand and time
deposits became a much larger proportion of
disposable bank assets.
The banks’ desired supply of time deposits
is given by
= azo-crzl[rT-rEK-rB(l -K)]
- a22 [rT - rEK - rc 1
- (Yz3[rT - r,qK - rb]. (9)
This means that the desired proportion of
bank funds generated by issuing time deposits
will rise when there is a decline in the cost
of time deposits (adjusted for interest payments
on required reserves), a higher return on either
bank loans or government securities, or a rise
in the cost of foreign funds.
(c) Price behoviour
Portfolio disequilibrium in the non-bank
sector not only affects financial markets but
also spills over to affect inflation, output and
the balance of payments. Since our analysis
is based on monthly data, data availability limits
the types of variables that can be treated as
endogenous. Our efforts will focus on explaining
the linkages between financial markets and the
behaviour of prices and the balance of pay-
ments.
Our analysis of prices is based on the
distinction between the domestic and foreign
components of the wholesale price index. The
overall wholesale price index (P) will equal
P = a&-$=P$-a= (10)
where Pr, = price index for domestic goods
PF = price for foreign goods.
818
Domestic goods are those produced locally.
Foreign prices will equal world prices adjusted
for exchange rate and tariff (or quota) effects.
The prices of domestic goods are assumed to
respond to both international price arbitrage
influences and domestic demand factors8 Thus
PDE 1
Dln(P~fPp) = a26--27LIn - will be influenced
i PF
+ oL2fdLIn (M/P) - In (M/P)dl + X4Z2 + X5Z3
where 22, Za= dummy variables (see Appendix
2). The rate of increase of the prices of
domestic goods would rise relative to the
foreign rate of inflation (inclusive of the effects
of tariff and exchange rate changes) whenever
the prices of domestic goods are sufficiently (as
determined by el) below foreign prices. In
addition, domestic demand pressures, as
measured by the excess suppiy of real money,
can drive the domestic rate of inflation above
the international inflation rate. The presence of
both international price arbitrage and monetary
disequilibrium effects arise because the Argen-
tine economy is neither completely closed nor
opened. While the Argentine authorities have
been gradually reducing trade barriers, domestic
prices have not been perfectly aligned with
foreign prices due to the effects of the remain-
ing trade barriers and the fact that it takes time
to develop the types of import and wholesale
institutions that will quickly arbitrage any
profit opportunities between foreign and
domestic markets.
(d) Balance ofpayments
Portfolio disequilibrium can also affect the
state of the balance of payments. This will be
especially true with regard to any excess supply
of money. To reflect the relationship between
the excess money supply and the balance of
payments, it is important to recognize that the
domestic monetary base can be increased by
central bank purchases of either domestic or
foreign assets. This implies that simultaneous
equation bias can only be avoided if the model
contains (1) a balance-of-payments equation,
(2) an identity linking the money supply,
domestic credit and the balance of payments,
and (3) an equation explaining the behaviour of
domestic credit. This last equation requires
specification of the relationship between the
central bank’s issuance of domestic credit and
the determinants of the government deficit.
Unfortunately, there is little monthly data on
WORLD DEVELOPMENT
the overall government deficit and the variables
(e.g. government expenditures) that determine
its size. At this time, our model therefore only
includes a balance-of-payments equation. This
makes it less likely that our equation will be
free of simultaneous equation bias.
It is assumed that the balance of payments
by attempts to arbitrage
1 goods and security prices across countries and
by portfolio disequilibrium. In the long run,
goods market equilibrium will require that
(11)
domestic prices increase at the same rate as
world prices adjusted for any changes in the
exchange rate and trade restrictions. Similarly,
steady-state equilibrium in the asset market
requires that domestic interest rates do not differ
from foreign interest rates plus the expected
rate of depreciation of the exchange rate by
more than the risk premium attached to lending
to Argentine nationals by foreign financial insti-
tutions (i.e. interest rate parity must hold). In
the short run, any departures from either
relative purchasing power parity or interest rate
parity will lead to arbitrage flows and give rise
to changes in holdings of foreign exchange
reserves (assuming the authorities are following
a given exchange rate policy).
In addition, portfolio disequilibrium will
affect decisions regarding trade and capital
movements. Since monetary holdings represent
the most liquid assets, an excess supply (or
demand) of money is likely to have a strong
short-run impact on the balance-of-payments.
The overall growth of Argentina’s stock of
international reserves is thus given by
DlnR = azg- OL~(DhPD-DhPF-C12)
+ cx31(rB -rb - E13) + osz(ln M d-LlnM)
+ xez, + h,Z&+ (12)
This implies that the balance of payments will
improve whenever the domestic rate of infla-
tion (inclusive to the effects of changes in the
exchange rate and trade restrictions), the
domestic loan rate rises relative to the foreign
interest rate (adjusted for both the expected
rate of depreciation of the exchange rate and
any risk premium), and as any excess nominal
demand for money is created.
3. EMPIRICAL RESULTS
(a) Parameter estimates
Table 1 presents the empirical results for our
model based on a sample of monthly data from
March 1977 to December 1979. The estimates
were derived by using a full information, maxi-
 THE CASE OF ARGENTINA 819

Table 1. Parameter estimates for Argentina *

Equation Dependent variable Explanatory variable Parameter Estimate t-Ratio

(1) D In (C/F? Adjustment parameter 0.059 2.03

Constant 0.636 0.80
--ne 22.354 2.22
rT- ne 10528 2.05
ro-rrne
(2) Din VIP) Adjustment parameter 0.061 6.69
Constant 1.175 4.01
--ne -5.911 1.63
rT-# 30.989 6.01
ro --ne 30.466 4.23
Z, 0.013 1.04
(3) Adjustment parameter 0.039 2.95
Constant 1.390 6.33
--rre 1.393 1.61
rT-fi 4.861 2.65
ro- ne 2.892 1.91
Z, 0.016 2.68
(4) D In (B/P) Adjustment parameter 0.030 1.91
Constant 1.470 2.50
rg--ne 12.417 1.75
rk- 7re 6.807 1.51
ro-ti
Z, -0.002 0.18
(5) Xe 0.25
(6) 0.50
(7) L&p Constant 0.497 14.68
Ml -K) --IT+ ‘EK 5.509 9.41
rB-rG 1.020 5.67
‘B -rb
Constant 1.411 11.01
rT-rEK-rg(l -K) 15.164 7.25
‘T-rEK-rG 4.411 5.78
rT-rEK -rb
(10) In (P) Constant 1.001 2J99.08
PD 0.937 817.21
(11) D In @D/&d Constant 0.164 1.70

L m @DEI/&) 0.359 13.04

[L hl W/PI - ln omdl 11.550 2.98
Z2 -0.152 4.31
Z3 0.064 5.08
(12) DlnR Constant -0.030 1.77

D~PD -DhPp-•E,, 0.650 7.81

1.991 6.31
$$L.-L&fj 0.717 4.07
Z, 0.023 0.95
Z, 0.034 2.88

* All of the behavioural parameters are defined to be positive.

t Imposed.
t Chosen to maximize the value of the likelihood function (no standard error).

mum likelihood estimator (see Wymer, 1978, mates are generally of the anticipated sign and
for a discussion) that allowed for the im- significant.
position of the approximate cross-equation The private non-bank sector’s portfolio
restrictions. All of the demand and supply func- demands show a sharp distinction between the
tions are well identified and the parameter esti- short- and long-run responses to interest rate,
820 WORLD DEVELOPMENT

Table 2. Elasticities*

Short-m Long-run
Dependent Explanatory elasticity ‘t elasticity
Equation variable variable (t-ratio) (t-ratio)

(1) In (C/P) -l+ 0.006 (0.49) 0.101 (0.50)

rT -0.045 (5.67) -0.758 (2.05)
-0.043 (5.67) -0.735 (2.05)
0.059 (2.03) l.O$
0.031 (2.92) 0.500 (2.81)
0.137 (12.46) 2.231 (6.01)
-0.130 (5.27) -;A$7 (4.23)
0.061 (6.69)
ln @f/P) 0.010 (2.82) 0:261 (5.51)
*T 0.014 (2.58) 0.350 (2.65)
-0.008 (1.99) -0.202 (1.91)
ln?e 0.039 (2.95) l.O$
(4) -iTe -0.003 (0.29) -0.093 (0.28)
rB -0.032 (3.27) -1.080 (1.75)
‘Z 0.014 (2.70) 0.464 (1.51)
0.014 (2.70) 0.475 (1.51)
In’%! 0.030 (1.91) 1.0%
(7) rB 0.743 (11.01) 0.743 (11.01)
rG -0.071 (5.67)’ -0.071 (5.67)
rk -0.070 i5.67) -0.070 (5.67)
rT --r,& -0.270 (9.41) -0.270 (9.41)
(8) f-B 1.557 (7.25) 1.557 (7.25)
rG 0.308 (5.78) 0.308 (5.78)
ri; 0.301 (5.78) 0.301 (5.78)
‘T -~EK -1.175 (8.55) -1.175 (8.55)

* Evaluated at sample means.

t The short-run elasticity is the product of the relevant explanatory variable parameter (ais) and the correspond-
ing adjustment parameter (r#) evaluated at the sample means.
$ Imposed.

inflation and expected income movements. on government treasury bills increased.

Desired real holdings of currency have respon-
ded positively to the expected real return on
currency (fl) and negatively to the expected
real returns on time deposits (TT- 7re) and
government treasury bills irG - ?re). As shown
in Table 2, however, there was a much smaller
initial response to changes in Ile, rT, and rG
than in the long run. For example, a 1%
increase in the time deposit rate would initially.
reduce real holdings of currency by only
0.045%. In the long run, this same change in rT
would induce an 0.76% reduction in real cur-
rency holdings. To a significant degree, this
reflects the relatively slow adjustment of actual
to desired holdings of currency. The adjustment
of actual to desired real holdings of currency
show a mean time lag of somewhat greater than
18 months.
Real non-bank sector holdings of time
deposits increased whenever there was higher
expected income or a real return on time
deposits and fell whenever the expected return
Although the effect of a higher expected real
return on currency (CQ) is not significant, it is
of the opposite sign of that hypothesized. This
could reflect the fact that a reduction in the
expected rate of inflation represented more
than just a higher return on currency holdings
and, in addition, implied that in general
financial assets became more attractive as infla-
tion declined. The significant negative relation-
ship between time deposit holdings and the
expected real return on government securities
implies that the Argentine authorities were suc-
cessful in using the government security rate to
provide a floor under the time deposit rate.
The estimate of y2 indicates that the mean
time lag involved in the adjustment of actual to
desired real holdings of time deposits was about
16 months. This relatively slow adjustment
meant that the initial effects of an increase in
rG, rT or ne on aCtLId holdings of time deposits
were relatively small (see Table 2). A 1%
increase in rG, for example, yielded a reduction
 THE CASE OF ARGENTINA
of real time deposit holdings of only 0.13% in
the short run vs a 2 .l% reduction in the long
run.
Since broad money equals the sum of cur-
rency, demand deposits and time deposits, our
earlier theoretical discussion indicated that
there was some ambiguity surrounding the signs
of the partial elasticities of the real demand for
money with respect to the expected real returns
on currency (-ne) and time deposits (rT - rr”).
Our estimation results nonetheless yielded
positive and significant coefficients for both [~a’
and ale. The composite elasticities implied by
the estimates of cr9, ala and al1 (see Table 2)
nonetheless indicate lower interest rate elastici-
ties with reSpeCt to Changes in ?f, r~, and rG
than those suggested by the individual demands
for currency and time deposits. This reflects the
fact that changes in asset yields induced some
substitution amongst the components of M. For
example, whereas the real demand for time
deposits has a long run elasticity of 2.1 with
respect to a 1% change in r~, the corresponding
elasticity for real holdings of broad money is
only 0.4%. The lower elasticity for overall
money demand reflects the fact that a higher
rT not only induces larger real holdings of time
deposits but small real holdings of currency and
demand deposits. Note, however, that a reduc-
tion in the expected rate of inflation or an
increase in the yield on time deposits will still
induce an increase in real holdings of broad
money. Although not highly significant, the
estimated value of or1 also indicates that a rise
in the government treasury bill rate did lead to
a reduction in real money holdings. This pri-
marily reflected the movement out of time
deposits.
As with the individual demand for currency
and time deposits, the short-run elasticities of
the overall demand for money were much
smaller than the long-run elasticities. A 1%
reduction in the expected rate of inflation
induced only a 0.01% initial increase in the
demand for real money vs a 0.26% increase in
the long run. This reflected a mean time lag in
the adjustment of actual to desired broad
money holdings of approximately 25 months.
The private non-bank sector’s demand for
bank loans is not as well estimated as the other
portfolio demand equations. Although the co-
efficients on the expected real cost of bank
loans and foreign funds and the expected return
on government securities all have the correct
sign, they are not as highly significant as for the
other demand functions. These estimates none-
theless imply both a slow adjustment of actual
to desired holdings of bank loans and low
821
interest rate elasticities in the short run. The
mean time lag implicit in the estimated adjust-
ment parameter (74) is over 33 months. This
relatively slow speed of adjustment results in a
sharp distinction between the short- and long-
run interest rate elasticities. For example, in the
long run, a 1% increase in the loan rate would
lead to a 1 .l% reduction in the real demand for
loans. In the short run, however, such an
increase in rB would result in only a 0.03%
reduction. This low short-run elasticity is con-
sistent with the view that such loans were
primarily used to provide working capital (see
McKinnon, 1973). As will be argued later, the
interest inelastic nature of the short-run
demand for bank loans played an important
role in explaining the existence of a high real
loan rate in the Argentine financial system.9
The proportion of total bank assets devoted
to loans to the private non-bank sector [equa-
tion (7)1 was most sensitive to changes in the
loan rate and the net cost of time deposits but
was considerably less responsive to changes in
the foreign loan rate or the treasury bill rate. A
1% increase in the loan rate would raise the pro-
portion of total bank assets held as loans to the
private sector by 0.74%. In contrast, a 1%
increase in the net cost of time deposits (rT-
r&C) would lower BJF by only 0.27%.”
The proportion of total bank funds gener-
ated via time deposits was quite responsive to
the net cost of time deposits (rT- rj$), the
cost of foreign funds (r-h), the yield on govem-
ment securities, and the loan rate. The
relatively high elasticity with respect to the net
cost of time deposits (- 1 .I 75%) indicates a
willingness to substitute other sources of funds
for time deposits whenever the cost of time
deposits increased. This proportion was also
very responsive to increases in the loan rate
(1.557%).
As shown in Table 1, the likelihood function
attains the maximum value when the adaptive
expectations coefficient for exchange rate
expectations was assigned a value of 0.25 and
the coefficient for price expectations was given
the value of 0.50. This implied a mean time lag
in the formulation of expectations of five
months for the exchange rate and three months
for prices. As argued earlier, the somewhat
longer lag for exchange rate expectations could
imply that the ratio of the variance of perma-
nent shocks to the variance of transitory shocks
is viewed as being lower than the corresponding
ratio for prices. This relatively low variance
ratio for exchange rate expectations may reflect
the fact that the authorities followed a policy
of preannouncing exchange rate changes toward
822 WORLD DEVELOPMENT

the end of our sample period, which would more successful than during the second two
have had the effect of reducing the variance of months.
permanent changes. The parameter estimates in the balance of
The price equations [ ( 10) and ( 1 I)] indicate payments equation indicate that price and
that both the overall and domestic goods price interest rate arbitrage and portfolio disequilib-
levels responded systematically to influences of rium factors have played important roles in
international price arbitrage and monetary dis- determining the short-run behaviour of the
equilibrium. From equation (lo), it is clear that balance of payments. For example, a 1%
domestic prices have received the largest weight increase in the domestic rate of inflation
in the overall price index (some 94%). The relative to the foreign inflation rate (adjusted
results for equation (11) imply that the prices for exchange rate and trade restriction changes)
of domestic goods responded not only to the would lead to a 0.65% reduction in the rate of
rate of change of foreign prices but also to any growth of the central bank’s accumulation of
departure of the prices of domestic goods foreign exchange reserves. There was an even
relative to foreign prices from a longer term more dramatic response to a change in the
equilibrium value (represented by er). As a interest rate differential between domestic and
result of this concurrent and lagged response, foreign interest rates. The estimate of ojl indi-
the price arbitrage process involved a mean time cates that a 100 basis point increase in the
lag of approximately three months between any domestic interest rate relative to the foreign
changes in foreign prices and the resulting cost of funds (adjusted for expected exchange
change in domestic prices. In addition to these rate movements) would lead to approximately a
price arbitrage effects, domestic prices have also 2% increase in the monthly rate of growth of
been influenced by any excess supply of Argentina’s stock of international reserves. This
money. is indicative of a significant interest rate
The dummy variables 22 and 23 reflect the elasticity for short-term capital flows.
effects of the four-month ‘price truce’ during Any excess supply of nominal money affec-
March-June 1977 when the authorities ted not only inflation but also the balance of
imposed limitations on price and wage increases payments. A 1% increase in any excess supply
in an effort to curb inflation. As can be seen of nominal money would result in a 0.72%
from the estimates of ho and As, this price truce reduction in the rate of growth of the central
was somewhat successful in slowing domestic bank’s stock of foreign exchange reserves.
inflation relative to foreign inflation although The estimate for the coefficient (X4) on the
the efforts during the first two months of the dummy variable (24) for the one-year mini-
truce (represented by 22) appear to have been mum maturity restriction on foreign borrowing
appears to be of the wrong sign. Ordinarily, one
would expect the imposition of such minimum
maturity requirement to reduce foreign borrow-
Table 3. Means-squarederrors of in-sampleforecasts,
ing and hence the accumulation of foreign
March 1977-December 1979*
exchange reserves. The positive sign on X4 may
Mean-squared Mean-squared reflect the fact, however that the one-year mini-
error of error of mum maturity (established in October 1977)
Variables static forecasts dynamic forecasts was quickly followed by a two-year minimum
maturity (in December 1977). Thus, it is
In C 0.075 1 0.8250 conceivable that in anticipation of even tighter
In T 0.275 3 0.2512 capital controls, the private sector increased its
In M 0.1335 1.4718 foreign borrowing in the period immediately
In B 0.1027 0.8872 following the establishment of the one-year
rBt 0.0109 0.0344 minimum maturity.
rTt 0.0092 0.008 1
In P 0.0698 0.3689 (b) In-sample forecasting efficiency
In PD 0.0744 0.4144
lllR 0.1885 15.4322 Table 3 provides information on the static
and dynamic in-sample forecasts using our
* In per cent.
model. The static forecasts utilize the actual
t Prediction errors on the interest rates are in units of
percentage points. Static and dynamic means-squared values of the exogenous variables and the lagged
errors as a proportion of the average interest rates are endogenous variables; whereas the dynamic
0.1253 and 0.3961% respectively for the loan rate and forecasts imply mean squared forecast errors of
0.1281 and 0.1132% respectively for the time deposit less than 1% for all variables. These are reason-
rate. ably small errors for monthly data which
 THE CASE OF ARGENTINA
generally show much greater variability than
quarterly or annual data. The means-squared
errors for the dynamic forecasts are somewhat
larger than those for the static forecasts. The
dynamic errors range from less than 1% to more
than 15% (in the case of the level of foreign
exchange reserves). The relatively large error for
the balance-of-payments equation reflects the
fact that we have modelled only a subsector of
the economy and have not captured the full
feedback between the balance of payments and
the financial and real sectors of the economy.
4. THE IMPACT OF THE FINANCIAL
REFORM
It is useful to consider what our empirical
results imply about two controversial aspects of
the Argentine financial reform. First, why did
such high real interest rates appear during the
early stages of the financial reform? Second,
why did the spread between lending and
deposit rates become so large at various times?
It has been argued that in both Argentina
and Chile the freeing of interest rates resulted
in very high nominal and real rates of return
that discouraged capital formation and produc-
March 1977
* The seosonolly adjusted nominal
+ The seosonolly adjusted nominal
Figure 1. Ex post and ex ante real loan rate.
823
tion. During our sample period, for example,
the average real ex post loan rate was 1.55% per
month and the corresponding average real time
deposit rate was 0.06% per month. As shown in
Figures 1 and 2, however, there has been con-
siderable variability in these real rates with
generally higher ex post real rates in the begin-
ning of the sample period than at the end.
It is also important to note that our esti-
mates of the average ex ante real loan and
deposit rates are considerably lower, which
reflects the fact that inflation has generally
been declining during our sample period and
that the expected rate of inflation is based on
past as well as recent inflation. The expected
real loan rate has averaged 0.9% per month
which is approximately only half the ex post
real loan rate. The ex ante real time deposit
rate was actually negative at - 0.5% per month.
Figures 1 and 2 also illustrate that here has
been considerable variability in real interest
rates with the ex ante real loan rate ranging
from -2.1 to 4.0% per month and the expec-
ted real time deposit rate varying from - 3.4 to
1.9% per month.
Another characteristic of the financial
reform process has been a large spread between
the loan and time deposit rates. This spread has
Ex post real loon rote,, ,,/
1978 I979 December
loon rote (ess the expected rote of inflotlon
Loon rote Less the octuol rote of mflotfon
824 WORLD DEVELOPMENT

2 c
r
E
2 ’
$
a
‘; 0

z
&
a -I
1

-2

-3

-4
March 1977 1978 1979 December
* The seasanatly adjusted nominal deposit rate Less the expected rate of lnflotton
+ The seasonally adjusted nomlnat deposit rate Less the actual rate of inflation

Figure 2. Ex post and ex ante real deposit rates.

averaged 1.5% per month. This unadjusted
spread reflects the impact of both regulatory
and market factors. The authorities have influ-
enced this spread through changes in the
required reserve ratio and the payment of
interest on reserves. The resulting net spread is
defined as the loan rate less the time deposit
rate adjusted for the payment of interest on
required reserves (QK) divided by one minus
the required reserve ratio (rB - [r~ - QKI/
(1 -K). The division by 1 -K reflects the fact
that banks could only use 1 -K% of each peso
of time deposit they received. This net spread
for the period from June 1977 to December
1979 has tended to decline over the sample
period but has still averaged 1.3% per month.
How can our results be used to explain the
presence of high real interest rates and the size
of the net spread between lending and deposit
rates? First, it must be emphasized that, on an
expected basis, the real loan and deposit rates
do not seem to have been equally high. The
expected real deposit rate has averaged a
negative 0.5% per month and the real loan rate
less than 1% per month (approximately 11.4%
on an annual basis). This real loan rate
primarily reflects the high real loan rates of the
early period of the financial reform.
Even if expected real interest rates have not
been ‘too’ high there are still the issues of why
there has been such substantial variation in
these rates and why the net spread between the
deposit and loan rates has been relatively large.
The answers to these questions he in the charac-
teristics of the Argentine portfolio demands
and supplies as well as in the types of regula-
tory changes that have occurred. In analysing
this issue, it is useful to distinguish between the
period immediately following the initial
reforms and the subsequent time period. During
the early stages of any financial reform which
attempts to correct the distortions that have
been created by past financial repression, one
would have to expect a fair degree of interest
rate instability. This instability reflects the
fact that the newly liberalized financial system
would usually inherit from the repressed system
not only a history of high and variable inflation
but also small initial real stocks of financial
assets (representing the response to highly nega-
tive real yields on such assets), and a lingering
system of financial payments on reserves, and
limitations on entry and competition in the
financial system).
In the period starting early in 1978, the
behaviour of the real rates of return and the net
 THE CASE OF ARGENTINA
spread between lending and deposit rates were
less affected by the inherited financial stocks
and inflation experienced and more influenced
by the continuing regulatory reforms and the
nature of the interest elasticities of the private
sector’s portfolio demands and supplies of
financial assets. The most crucial reforms have
been the gradual reduction of the required
reserve ratio and the payment of interest on
reserves which have helped to reduce the gross
loan-time deposit interest rate spread. The
influence of portfolio elasticities can be illustra-
ted by considering the demand and supply of
bank loans. As shown in Table 2, the short-run
elasticity of the non-bank sector’s demand for
bank loans was only - 0.03%. Similarly, the
supply of bank loans had a higher but still
inelastic response of 0.74%. The presence of
relative inelastic demand and supply functions
for bank loans meant that exogenous increases
in the demand for loans could drive up the loan
rate quite sharply in the short run even though
the long-run response would be much more
moderate.
The net loan-deposit rate spread was also
influenced by the relatively interest inelastic
nature of the short-run demand for time
deposits (an elasticity of only 0.14%) combined
with a high supply elasticity on the part of
banks (an elasticity of - 1 .18%). A rise in the
time deposit rate would not induce a very large
short-run increase in non-bank sector holdings
of time deposits but would result in a signifi-
cant effort on the part of financial institutions
to seek alternative (especially foreign) sources
of funds.
These characteristics of the demands and
NOTES
1. See Fry (1980) for a study of recent empirical
and theoretical work in this area.
2. This approach does not require that all asset
yields influence each asset demand.
3. See Appendix 1 for a summary of notation.
4. Since interest is not paid on demand deposits in
Argentina, this is also taken as the expected real return
on demand deposits.
5. See Appendix 2 for the definition of the various
variables.
6. This formulation assumes that borrowers are not
required to maintain compensating balances. William
White has indicated that at least until 1978 Argentine
borrowers were required to maintain compensatory
balances of roughly 25%. Unfortunately, there is no
time series regarding this variable. See White (1980b)
for a further discussion.
7. Note that when r~ is compared with the cost of
825
supplies of bank loans and time deposits
implied a loan rate much more responsive than
the time deposit rate to changes in demand or
supply conditions. And in a system character-
ized by an excess demand for real credit, one
could therefore expect a significant departure
of the loan rate from the time-deposit rate.
5. SUMMARY
This paper has described the results of esti-
mating a small structural model of the Argen-
tine financial system, the price formation
process and the determinants of the overall
balance of payments during its recent financial
reform. Our results have indicated that move-
ments in domestic interest rates, good prices
and the balance of payments have been strongly
influenced by domestic portfolio preferences as
well as policy actions and foreign variables.
Differences between actual and expected infla-
tion have implied that ex post real interest rates
have been higher than e.x nnte (or expected)
real interest rates. The spread between the
deposit and lending rates has been influenced
not only by domestic financial policy (e.g. the
reduction in the required reserve ratio and the
payment of interest on reserves) but also by the
elasticity characteristics of the demands and
supplies of bank loans and time deposits.
Domestic price behaviour has been shown to
reflect the effects of both international price
arbitrage and domestic monetary disequilib-
rium. Similarly, the balance of payments has
been influenced by international price and
interest rate arbitrage and monetary disequilib-
rium.
time deposits @T-Q+) it is multiplied by 1 - K to
reflect the fact that K% of each time deposit must be
held as reserves and cannot be used to acquire earning
assets.
8. See Khan and Knight (1980) for a similar formu-
lation.
9. Arturo Brillembourg has suggested that another
reason for the low interest rate elasticity could be the
existence of loan rationing by banks. While this is
clearly a possibility, it should also reduce the interest
elasticities of the banking system supply functions
which are significantly higher than those for the non-
bank sector demand functions.
10. In estimating (7), we were confronted with a non-
linearity reflecting the fact that, in the expression
association with Q,,, r~ enters as the product
rB(l -K). In order to avoid having to use a non-linear
estimator, the expression rg(l --K) was replaced by a
Taylor’s series expansion about the sample mean.
826 WORLD DEVELOPMENT
REFERENCES
Brunner, K., A. Cukierman and A. H. Meltzer,
‘Stagflation, persistent unemployment and the
permanence of economic shocks’, Journal of
Monetary Economics (October 1980), pp. 467-
492.
Fry, M. J., ‘Financial development and stabilization
models for fmancially repressed developing econo-
mies’, paper presented at the American Economic
Association Yeeting, Denver (5-7 September
1980).
International Monetary Fund, International Financial
Statistics(Washington, D.C., various).
Khan, M. S. and M. D. Knight, ‘Stabilization Programs
in Developing Countries: A Formal Framework’,
International Monetary Fund, DM/80/63 (29 Sep-
tember 1980).
Knight, M. D. and D. J. Mathieson, ‘Economic Change
and Policy Response in Canada under Fixed and
Flexible Exchange Rates’, International Monetary
Fund, DM/80/21 (21 Match 1980).
Leff, N. H. and K. Sato, ‘Macroeconomic adjustment
in developing countries: instability, short-run
growth, and external dependence’, 77re Review of
Economics and Statistics (May 1980), pp. 170-
.“,.
1 /Y.
Mathieson, D. J., ‘Financial reform and capital flows
in a developing economy’, IMF Staff Papers (Sep-
tember 1979), pp. 450-489.
APPENDIX 1: NOTATION
C = stock of currency
T = stock of time deposits
N = stock of demand deposits
M = stock of broad money (currency plus demand
deposits plus time deposits)
5 = stock of bank loans
P = wholesale price level
ng = expected rate of change of wholesale price level
PO = domestic price component of wholesale price
index
PF = foreign price component of wholesale price
index
rT = interest rate on time deposits
rc = interest rate on government treasury bills
APPENDIX 2: VARIABLE DEFINITIONS
IFS = International Monetary Fund, International
Financial Statistics. The line numbers reported be-
low refer to the page containing the Argentine
data.
ES = Mlnisterio de Economia, Instituto National de
Estadistica y Censos, EstadisticaMensual.
The stocks used in the analysis are the monthly
averages of the endof-month stocks given below.
Currency = line 14A in IFS
Demand deposits = line 24 in IFS
Time deposits = line 25 in IFS
Mathieson, D. J., ‘Financial reform and stabilization
policy in a developing economy’, Jcurnal of
Development Economics (September 1980). pp.
359-395.
Math&on, D. J., ‘Interest Rates and Monetary Aggre-
gates During a Financial Reform’, Internati&ml
Monetary Fund, DM/79/95 (26 December 1979).
McKlnnon, R. I., Money &d ‘Cbpital in Economic
Development (Washington, D.C., The Brookings
Institution, 1973).
Shaw, E. S., Finnnctil Deepening in Economic
Development (New York: Oxford University Press,
1973).
Tobin, J., ‘A general equilibrium approach to mone-
tary theory’, Journal of Noney, Credit, and Bank-
ing (February 1969). pp. 15-29.
Tobin, J. and W. Brainard, ‘Pitfalls in financial model
building’, American Economic Review (May 1968),
pp. 99-122.
White, W. H., ‘The Case For and Against “Disequilib-
rium” Money’, International Monetary Fund,
DM/80/67 (30 September 1980a).
White, W. H., ‘The Importance of “Blocked” Compen-
sating Deposit Balances for Monetary Policy in
LDCS’, International Monetary Fund,. DM/8@15
(27 February 1980b).
Wymer, C., Computer programs: resimul manual’, un-
published (March 1978).
‘B = interest rate on bank loans
Ye = expected (or permanent) income
rF = interest rate on foreign borrowing
rb = interest rate on foreign borrowing plus expec-
ted rate of change in exchange rate plus any
risk premium
K = required reserve ratio
F = total bank funds
rE = interest rate paid on required reserves
BB = banking system borrowing and advances from
the central bank
CA = banking system capital accounts
OI = other sources of banking system funds
R = stock of international reserves (in US dollars).
AND SOURCES
Broad money = sum of lines 14A, 24 and 25
Price level (wholesale price index) = taken from
‘Precios al por Mayeor’ in ES. Overall price level
equals ‘Nivel General’. Domestic prices equal
‘National’, and foreign price equals ‘Importado’
Expected income = time trend for the Central Bank of
Argentina’s quarterly real GDP series provided by
the Western Hemisphere Department of the Inter-
national Monetary Fund
Bank loans = bank claims on the private sector (line
22D, IFS-)
 THE CASE OF ARGENTINA
Bank disposable assets = credit from the central bank
(line, 26G, ZZra + capital ccounts (line 27A, IFS)
+ other items net (line 27R, IFS) + (1 -K)
(N + T + G) where N is demand deposits, T is time
deposits, and G is government deposits (line 26D,
IFS). K was set equal to 1 until May 1977 and then
took on the value of the actual required reserve
ratio
Loan rate (in % per month) = loan rate on 36-day
loans. Obtained from the Central Bank of Argen-
tina
Deposit rate (in % per month) = deposit rate on 30-
day certificates of deposits Obtained from the
Central Bank of Argentina
Government security rate (in % per month) = interest
rate on 28day treasury bills. Obtained from the
Western Hemisphere Department of the Inter-
nationaf Monetary Fund
Foreign interest rate (in % per month) = Eurodollar
deposit rate (converted to a monthly percentage
rate) given in line 60D of the United Kingdom page
in IFS
Central Bank Swap rate on forward foreign exchange
827
= this is the swap forward exchange rate offered
by the central bank on forward borrowing (con-
verted to per cent per month) until 1 July 1977.
Reported in First National Bank of Boston,News-
letrer Argentina
Interest uaid on reauired reserves against time deposits
= international Monetary Ft&d staff estimates.
This rate excludes the rate charged on the loanable
portion of demand deposits which was also estab-
lished at the same time.
Dummy variables
,gJ = dummy for period of decentralization of de-
posits (1 in May 1977)
22 = dummy for first two months of wage-price
‘truce (1 in March-April 1977)
23 = dummy for second two months of wage-price
‘truce’ (1 in May-June 1977)
24 = dummy. for impostion of one-year minimum
maturity on foreign borrowing (1 in October-
November 1977).