As recently as 1983 France maintained tight capital controls and a wide range of administered and cartelized interest rates, possessed relatively few financial instruments, and kept its banks strapped in a credit `corset' known as the encadrement du crédit. Today, capital controls are totally gone, the only remaining administered interest rates concern bank deposits, a host of new financial instruments has emerged, and there is no encadrement.
In Discussion Paper No. 509, Research Fellow Jacques Mélitz traces French monetary policy from the post-war period to the present. Following World War II, France adopted a highly administered system of money and credit to cope with post-war reconstruction. The government set the structure of interest rates and ensured the allocation of credit in accordance with social priorities by using selective credit controls. It also funnelled private saving directly to preferred uses through its own deposit network.
The first major relaxation of this system took place in 1966-7, when the Banque de France began to make more flexible use of interest rate intervention. There was also an injection of banking competition following a period of balanced budgets and substantial reserve inflows. The breakdown of Bretton Woods in 1971 marked the next watershed: during 1971-6 the authorities ensured monetary equilibrium principally through exchange rate adjustment but monetary policy was quite lax and inflation rose to double digits, until the Barre government implemented its price stabilization plan in September 1976. Once the Socialists took power in 1979, three successive devaluations followed the franc's entry into the EMS within two years. The government did not permit interest rates to rise high or long enough to defend the franc, which it sought to achieve instead through capital controls. In 1984, the government unexpectedly abolished the encadrement du crédit and announced a programme of financial deregulation, and this policy change has persisted through two changes in government.
Mélitz then examines France's new monetary framework and current policies. The main policy instrument is now the interest rate (specifically the inter-bank market rate). The authorities also employ legal reserve requirements, but the required ratios are low relative to those in the US or Germany. The French authorities' continued reluctance to use open market operations reflects their concern that the market for government bonds remains thin. In a theoretical discussion of the transmission mechanism, Mélitz emphasizes the endogenous nature of the reserve base, the important role of the profitability of banking and the inapplicability of the concept of a money multiplier to France.
Since the 1984 reforms, French policy objectives have centred on the target of reducing inflation to the German level and thereby eliminating pressure towards devaluation in the EMS. Furthermore, the authorities have looked forward to the formation of a unified monetary system with a single currency in the European Community. Since the last EMS realignment in January 1987, a positive real interest rate premium has emerged for francs vis-à-vis Deutschmarks, so the pursuit of a stronger franc has therefore entailed costs as well as benefits. This implies, however, that France now has more to gain from monetary union than previously, since this would virtually ensure a relative reduction in French real interest rates.