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Abstract
Most developing countries have at one time or another faced the twin problems of a high domestic rate of inflation and a deficit in the balance of payments. The cause of these problems can often be traced to a situation of government fiscal deficits that result in excessive monetary expansion and feed domestic demand. Stabilization programs are typically put into effect to reduce these pressures. Policymakers have long recognized that the implementation of a stabilization program will have simultaneous effects on output, inflation, and the balance of payments. While practitioners generally attempt to make allowances for these effects in qualitative terms, relatively little is known about the precise quantitative nature of the relationships among these major economic aggregates in the context of developing countries. This lack of knowledge, of course, creates considerable problems when one wishes to assess the effects of a particular policy initiative—say, for example, a change in monetary policy—on important macroeconomic variables, and, conversely, to derive the appropriate policy to achieve specific stabilization objectives.
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