International Monetary Fund. Secretary's Department
It was with feelings of confidence that at our last few Annual Meetings we have been able to turn our gaze backwards noting the positive achievements of the past and at the same time to look forward into the future with more justified expectations and hopes.
The role of exchange rate policy in economic adjustment has been widely studied and is the subject of numerous theoretical and empirical papers produced in the Fund and elsewhere. The Fund staff has reviewed from time to time the effectiveness of adjustment programs incorporating an active exchange rate policy.1 Other issues relating to exchange rate policy, including, in particular, the interaction between the exchange rate and other macroeconomic policy variables, also have received considerable attention.2 However, little detail is available on the methodology of developing and implementing exchange rate policies in the context of adjustment programs. Besides examining general issues related to formulating exchange rate policy in adjustment programs, this paper reviews the experience with development of exchange rate policy in programs supported by the Fund in 1983.
Whenever a country undertakes a program of balance of payments adjustment, it needs to consider whether a change in the exchange rate is required to achieve a viable external position and a reasonable rate of economic growth over the medium term. The ways in which exchange rate policy works to correct balance of payments problems and to improve the allocation of resources are well known and need no repetition here. To provide a setting for the discussion in the remainder of the paper, however, this section briefly considers four conceptual issues: (1) the use of indicators to assess the appropriateness of the exchange rate in adjustment programs; (2) the role of exchange rate policy in relation to other program policies; (3) the extent to which exchange rate stability should in itself be a proximate policy objective in adjustment programs; and (4) the attention given to exchange rate policy when use of Fund resources is involved.
Since the Fund granted the first stand-by arrangements in the 1950s, its policies regarding the programs supported by such arrangements consistently have emphasized the need for an appropriate structure of relative prices to promote the attainment of a viable balance of payments. In the relatively stable economic environment of the 1950s and 1960s there tended to be more emphasis on adjustments through demand management, and most programs could exclude exchange rate action without seriously compromising their objectives. At the same time, there was a general international commitment to fixed exchange rates. In the 1970s the economic environment changed. Partly in response, commitment to fixed exchange rates was regarded as less important than before, and exchange rate action began to figure in the majority of Fund-supported adjustment programs. In the 1980s, the difficult economic environment, together with the need to correct serious distortions resulting from policy failures, has contributed to a continued increase in the incidence of exchange rate action in Fund-supported programs.
Federico Di Pace, Luciana Juvenal, and Ivan Petrella
When analyzing terms-of-trade shocks, it is implicitly assumed that the economy responds symmetrically to changes in export and import prices. Using a sample of developing countries our paper shows that this is not the case. We construct export and import price indices using commodity and manufacturing price data matched with trade shares and separately identify export price, import price, and global economic activity shocks using sign and narrative restrictions. Taken together, export and import price shocks account for around 40 percent of output fluctuations but export price shocks are, on average, twice as important as import price shocks for domestic business cycles.
The objective of Fund-supported adjustment programs is to bring about a viable balance of payments in the medium term. The formulation of exchange rate policies in such programs takes into account the overall stance of domestic and foreign policies, as well as prospective internal and external conditions over the medium term. Such an analysis may bring out the implications of various exchange rate policies, or, conversely, may be used to indicate the exchange rate policy consistent with a given set of assumptions about exogenous developments and the stance of other policies.