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Mohsin S. Khan, Peter J. Montiel, and Nadeem U. Haque

Abstract

Most Developing countries at one time or another have faced the need for macroeconomic adjustment. Such a need typically arises when a country experiences a persisting imbalance between aggregate domestic demand and aggregate supply, reflected in a worsening of its external payments and an increase in inflation. While in certain cases external factors, such as an exogenous deterioration of the terms of trade or an increase in foreign interest rates, can be responsible for the emergence of the basic demand-supply imbalances, these imbalances can often be traced to inappropriate domestic policies that expand domestic demand too rapidly relative to the productive capacity of the economy. As long as adequate foreign financing is available, the relative expansion of domestic demand can be sustained for an extended period, albeit at the cost of a widening deficit in the current account of the balance of payments, a loss of international reserves, rising inflation, worsening international competitiveness, falling growth, and a heavier foreign debt burden. Eventually, however, the country would lose international creditworthiness, and as foreign credits ceased, adjustment would be necessary. This type of forced adjustment could prove to be very disruptive for the economy.

Nadeem U. Haque and Peter J. Montiel

Abstract

Shocks emanating from domestic policies or from changes in the external economic environment in developing countries invariably set off a dynamic process of adjustment that frequently takes some time to work itself out. Although analysis of the macroeconomic effects of such shocks typically focuses on impact effects or on the eventual steady state at which the economy settles, it is the intermediate run—that is, the “real-time” effect of such shocks—that is often of equal if not even greater concern to policymakers in developing countries. While explicit dynamic solutions to small analytical models can yield valuable insights into particular aspects of the economy’s response to such shocks, general-equilibrium interactions can only be studied in the context of larger models that, unfortunately, do not often prove to be analytically tractable. Thus, numerical simulation experiments with dynamic macroeconomic models become the tool of choice for understanding the real-time effects of policy measures and external shocks in developing countries.

Nadeem U. Haque, Peter J. Montiel, and Mr. Steven A. Symansky

Abstract

Macroeconomic policy in developing countries has received considerable attention in recent years as continuing external and internal imbalances have contributed to a slowdown in growth, balance of payments difficulties, and high inflation. Many countries have undertaken adjustment programs whose announced objectives have been to reduce external imbalances and to lower inflation while avoiding recession and enhancing medium-term growth. The consequences of such programs for income distribution have also received increased attention. Diverse macroeconomic targets such as these respond to policy and other shocks via fairly complex general equilibrium interactions. Thus, the analysis of the effects of policies on such variables, as well as of the trade-offs among conflicting macroeconomic targets confronted by policymakers, must necessarily be conducted by using reasonably detailed quantitative macroeconomic models. Existing quantitative models for developing countries are not well suited for exploring these issues, however, because they typically incorporate ad hoc behavioral relationships and generally provide inadequate treatment of expectations.1 The formation of expectations is generally modeled in a static or adaptive fashion, even though forward-looking expectations have by now become an important feature of macroeconomic analysis for developing countries.2

Carmen M. Reinhart

Abstract

The Concept of “growth-oriented adjustment,” or the notion that economic growth is essential for the achievement of the twin goals of a sustained reduction in inflation and a viable balance of payments, has recently received the attention of policymakers and academics alike. Indeed, growth-oriented adjustment is considered a key characteristic of the policy packages that make up Fund-supported programs. Examples of the blossoming literature on the subject of growth-oriented adjustment can be found in Bacha and Edwards (1988), Blejer and Chu (1989), and Corbo, Goldstein, and Khan (1987).1

Mohsin S. Khan and Malcolm D. Knight

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.

Bijan B. Aghevli and Cyrus Sassanpour

Abstract

The rapid increase in oil prices during the last decade has been perhaps the most significant shock experienced by the world economy. A great deal of attention has been focused on the impact of higher oil prices on oil importing countries, but relatively little on its impact on the oil exporting countries.1 The purpose of this paper is to develop a macro-model designed to analyze the impact of the rise in oil prices on the economy of Iran. The basic framework is highly aggregated and incorporates only the most important factors relevant to such an analysis. Nevertheless, the estimation results of the model are encouraging because they predict fairly accurately the movements of the main economic variables over the sample period (1960-77), which ends before the recent political developments.

Reza Vaez-Zade

Abstract

The purpose of this paper is to examine the short-run macroeconomic implications of natural resource availability—as well as its exhaustibility—in the case of Venezuela. Although considerable attention has been paid in the economic literature to the manner in which the economies of oil producers such as Venezuela are influenced by variations in the flow of income generated by oil resources, the models used in the studies have in general ignored two important distinguishing characteristics of oil-based economies. The first relates to the possible “confidence effect” that resource availability might have on the behavior of economic agents. This effect has been highlighted by the studies of the “Dutch disease”—that is, the problem of deindustrialization attributable to a booming export sector (Buiter and Purvis (1983), Corden and Neary (1982), Eastwood and Venables (1982), Neary and van Wijnbergen (1984), and van Wijnbergen (1984)). It arises from the impact of resource availability on future expected income, which can in turn influence saving behavior, the pattern of expenditure, and the composition of asset portfolios. The second important characteristic is the exhaustibility of oil resources. Although the economic literature is replete with studies of the implications of the exhaustibility of petroleum resources for optimal production and price strategies in petroleum-based economies, the short-run macroeconomic models of such economies have in general sidestepped the question of the depletability of the main source of income (Aghevli (1977), Aghevli and Sassanpour (1982), Khan (1976), and Knight and Mathieson (1980)). Although these models do recognize that the exhaustibility of oil has major implications from the point of view of economic management, in general they consider exhaustibility as a long-run concept with little or no consequences in the short run. The validity of such a position is questionable, however, because exhaustibility is likely to influence expectations about future income, thus inducing shifts in perceived wealth that may in turn affect private sector confidence and its behavior in the short run.

Mr. Ichiro Otani and and Cyrus Sassanpour

Abstract

Singapore’s recent experience with the conduct of financial and exchange rate policies suggests that the authorities’ ability to implement an independent monetary policy has been constrained. Because the economy is small and highly integrated with international markets, movements in the money supply have been influenced significantly by developments in the external sector, and domestic interest rates have been determined largely by foreign rates.1 At the same time, the authorities’ exchange rate policy has been geared toward the often conflicting objectives of mitigating external inflationary pressures and sustaining economic activity by increasing external competitiveness.

Mr. Leslie Lipschitz

Abstract

This paper models alternative policy responses to various sorts of disturbances—or “shocks”—to the steady-state path of a developing economy. Its objective is to arrive at some generalizations about appropriate credit and exchange rate policies.1 The typical “developing” country with which the paper is concerned is small (that is, it exercises no monopoly power over its trade), its structure of production and finance is relatively undifferentiated, its external capital flows are restricted, and its trade is subject to some quantitative restrictions. The model, in terms of which the analysis is conducted, reflects these characteristics and is estimated using Korean data for the period 1965-78, a period of rapid economic development and political stability. Obviously, there is no “typical” developing country, and the rapid growth in the Republic of Korea is hardly typical. Even in the limited sense specified, Korea is more representative of the characteristics of a developing country in the early part of the sample period than toward the end. Nevertheless, the availability and reliability of Korean data, and the fact that no major modifications were required to fit the institutional characteristics of the country, encouraged the use of Korea as a test case. (A detailed description of the data is provided in Appendix I.)

Pierre-Richard Agénor

Abstract

Widespread trade restrictions and foreign exchange controls have resulted in inefficient patterns of resource use and led to the emergence of parallel markets in goods and foreign currency in many developing countries. The evidence collected over the past few years has shown that current account restrictions (including import licenses, foreign exchange allocations, and import deposit requirements) create incentives for illegal transactions, such as smuggling and fake invoicing, as well as for capital flight and capital inflows via unofficial channels.