1. The United Nations General Assembly , in its proclamation of the Second Development Decade, has specified a number of objectives for economic development. In this paper, we shall confine our objectives to growth and stability.
  2. Too much attention may sometimes be paid to stability at the expense of growth. Excessive conservatism must be avoided in development. On the other hand, too much neglect of stability is very dangerous. Whereas a conservative policy will lead to slow growth, a policy which is too boldly concentrated on growth may lead to financial upheavals, payment difficulties, loss of confidence, and bankruptcy. It does not take long to produce runaway inflation; it takes several years and much hardship and massive external aid to bring such inflation under control.




  1. Fiscal and monetary policies are means to create and control the money supply to meet needs of economic activities, normal and developmental. Too little money would dampen growth potential. Too much money would result in dangerous inflation. Both deflation and inflation create instability and are inimical to growth.
  2. How much money is right? The answer varies according to the situation in a country at any particular time. The general approach is to relate the decision on money supply to the estimate of production. In Thailand, our experience shows that it is safe to aim at increasing money supply at a slightly higher rate than estimated growth of the GDP. The optimum difference appears to be 2% or 3%. Why? We cannot say for sure. Perhaps the explanation lies in increased monetization of the economy, especially in rural areas.
  3. In order to create the right amount of money supply and control it, neither fiscal nor monetary measures taken separately are adequate tools. It is always possibile that the Ministry of Finance and Central Bank might take opposite and mutually conflicting policies, resulting in a chaos. Coordination is essential.
  4. In our experience, monetary policy in a developimg country can have a chance of being effective only when fiscal policy is operative. In other words, a good budgetary and tax policy makes a central banker’s life easier; and the opposite is unfortunately too true. Realizing this fact of life, and believing that prevention is better than cure, the Central Bank should endeavour to intervene in annual budgetary and taxation considerations at an early stage. The need for coordinating monetary and fiscal policies is ample justification for such interventions.
  5. In the circumstances of developing countries, the scope of monetary measures is limited. Open market operations are hampered by absence of an active capital market and inadequacy of financial institutions of various kinds. In Thailand, rediscounting weapons have been used primarily for promoting production and exports and their usefulness for monetary control is thereby blunted. In recent years, upheaval in the world interest rates has rendered the tool of varying domestic interest rates almost useless. The cash reserve requirement imposed upon commercial banks remains a good weapon, although at times it works more effectively on the restrictive side than the expansionary side, owing to scarcity of good bank lending opportunities. On the whole, monetary measures are useful and effective, up to a point.
  6. On the other hand, fiscal measures alone as a tool for controlling money supply are clumsy and fraught with political taints. In Thailand, appropriations are normally underspent and tax revenue estimates generally exceeded by actual collection. These discrepancies must be taken into account, adding to uncertainty in calculating of money supply.
  7. Another instrument has been used by monetary authorities in Thailand, exchange rate policy. During the inflationary period of the 1950s, when budget was in chronic deficit, the Central Bank was able to mop up excess purchasing power by buying and selling foreign exchange at wide differential rates. This was the era of multiple exchange rates. More recently, the Exchange Equalization Fund has performed similar duties within a more restricted scope. Foreign exchange, in fact, is thus used for the purpose of open market operations.



  1. In paragraph 4 I have explained how we relate the change in money supply to growth of production in Thailand. This formula result:

 ∆ M = ∆ P + n

where M = money supply; P = estimated Gross Domestic Product, and n is an appropriate percentage, empirically found in Thailand in the 1960s to be 2%-3%

This means in effect that one should try to achieve an increase in money supply consistent with estimated increase in production.

How is ∆ M influenced? What are factors to be considered to bring about a desirable change in money supply?

  1. Looking at the problem from the viewpoint of the banking system, there are three factors that together affect money supply: changes in net foreign assets (F), changes in net claims on the Government (G), and changes in net claims on domestic private sector (D), This is the equation:

∆ M = ∆ F + ∆ G + ∆ D

 In plain English, money supply will increase when there is a surplus balance of payments and when the banking system lends more to the government and the domestic private sector.[1] With a deficit balance of payments, or less lending by the banking system, money supply will contract.

  1. Of these three factors. changes in net foreign assets can be considered as more or less autonomous, depending on the state of foreign trade, private capital movements, official loans and grants. These can be estimated at the beginning of the year and thereafter reviewed periodically.

When the value of ∆ P and hence ∆ M is given, and ∆ F autonomously estimated, there remain two unknowns: ∆ G and ∆ D, which together must equal ∆ M - ∆ F. If there is to be more ∆ G, there must be less ∆ D, and vice versa.

Both the government deficit (∆ G) and domestic private credit expansion (∆ D) must be estimated and decided upon in a manner consistent with desired rate of growth in GDP (∆ P). To achieve such consistency, one must consider a variety of details, e.g. total government spending, development projects, private savings and investments, trading prospects.

In view of need for a number of estimates, and because of uncertaintics involved, the situation should be reviewed periodically, preferably monthly.

  1. To give a simplified numerical example, let us suppose that ∆ P = 8% and therefore ∆ M = 10% and let us say that ∆ M of 10% is equivalent to 2,100 million baht. If we also estimate that ∆ F = -800 million baht (deficit) and ∆ D = +1,500 million baht, then the government ought to be told that they can safely borrow from the banking system a net amount of: ∆ G = 2,100 - (-800 + 1,500) = 1,400 million baht.

If the government demands more than 1,400 million Baht, then it should be advised to raise tax revenue and/or borrow more from the public and/or cut its expenditure. Failing these alternatives, ∆ D will have to be reduced.



  1. It is not possible to discuss growth, fiscal policy, and monetary policy without referring to bugetary policy. After all, investments in the public sector contribute, directly or indirectly, to economic and social development.

As in the case of an individual family, the gevernment should spend only  part of its income on consumption, saving the balance for investment. The amount thus saved is usually smaller than the desired investment; the gap is filled by internal and external loans and grants.

From the experience of Thailand, a wise aggregate budget should look something like this:

TR - CE = 30% of DE

where TR = total revenue, CE = current expenditure and DE = total development expenditure, including finance of projects from external sources. 30% is approximate.

This means that for each fiscal year, the government should try to keep down current consumption in order to save some revenue to finance about 30% of development expenditure.

  1. One of the more serious dangers to be avoided by governments of developing countries is excessive borrowing. Of course, one must borrow to develop; but it is neither accurate nor wise to borrow more and more with the object of achieving the highest possible growth rate. Beyond a point, debt servicing can become so burdensome that it will forcibly limit scope for development spending. External debt service, moreover, adds to payment difficulties and exchange instability.

In Thailand, for many years the government has agreed to the recommendation jointly made by the National Planning Board, Ministry of Finance, the Budget Bureau and Bank of Thailand, to limit borrowings by the following resolution:

(a) Public borrowings, external and internal, shall be done in such manners and terms that total debt service in any fiscal year shall not exceed 13% of the government’s total revenue in that year; and

(b) External debt service in any fiscal year shall not exceed 7% of estimated foreign exchange earnings of the country in that year.

  1. Regarding government expenditure, and especially development expenditure, the Central Bank should be entitled to be assured that the development plan and its component projects are wisely formulated according to a system of priorities, and that projects are properly and efficiently executed. Corruptive practices of various kinds are obstacles to growth. Suppliers’ credit, particularly short or medium term credit, and tied loans are usually fraught with snares and should be avoided.
  2. In difficult years, the government tends to run big budget deficits, requiring the banking system to lend more and more to it, at the expense of ∆ D. This is dangerous for the development process, because if, as a result, activities in the private sector become slack, the government’s tax revenue will suffer, creating a vicious circle of bigger deficit leading to more demand for loans. Private initiative of producers and traders should be given adequate room in the development process.
  3. Finally, there is the important problem of communication between the Central Bank on the one hand and ministers, press and public. Fiscal and, monetary policies and their coordination may be impeccable, but they will be useless if one cannot explain them in such a manner that will impress and convince others. For instance, the equations in paragraphs 10 and 11, and the numerical example in paragraph 13 may be all right for participants of the SEANZA course. When we want to convince ministers, sometimes it is necessary to sacrifice rigorous accuracy for the sake of simplicity.

The said equations can be disguised as a theory of the balloons. There is a balloon representing the national product, which needs to be inflated by 8%. For this purpose a second balloon, the money balloon, should be blown larger by 10%. There are three pumps which can inflate or deflate the money balloon, namely the foreign payment pump, government pump, and private sector pump. If any pump happens to blow too much air in, the other pumps must go easier.

If you don’t like my theory of the balloons, why not invent something of your own? It might be good fun.


9th South-East Asia New Zealand Australia

Central Banking Course,

Kuala Lumpur,

30 June 1972



[1] All these items are not interchangeable: for instance, ∆ D = gross credit expansion-increase in the time deposits – increase in capital and reserve account of the banking system.