The theoretical and empirical material presented thus far is relevant for assessing the likely size and direction of any global effects of Fund-supported adjustment programs. In this section, attention is turned toward an equally important and closely related subject, namely, if and how the Fund accounts for aggregation and interdependence effects in both the advice it gives to member countries and in the design of Fund programs themselves. This latter subject is important because even if Fund-supported programs did have strong potential global effects, these effects could in principle be compensated for, both in the design of programs and in the advice given by the Fund to non-program countries. For example, if the process of achieving greater fiscal responsibility in program countries had significant multiplier effects on aggregate demand in non-program countries, and if these spillover effects were both larger than desired and their size and timing were known, then an adjustment could be made to the design of programs to reduce such spillovers. Similarly, if the international adjustment process is working smoothly, any reduction in absorption in countries with balance of payments deficits should be offset by an increase in absorption in surplus countries, leaving global aggregate demand little affected. In other words, trouble arises only if the global effects of programs are significant and if these effects are ignored in the design of policy in program countries and in the Fund’s advice to non-program countries.
By its very nature, the Fund must be concerned about the global or systemic effects of policies of its individual members. Indeed, the raison d’etre of the Fund and most of its activities is precisely the principle that the effects on other countries of the policies of individual members can be significant and that an institution is needed to ensure that countries with balance of payments problems do not take measures that have dramatic and unsatisfactory international repercussions. In fact, both the Fund’s lending activities and its surveillance functions are largely directed toward meeting that objective. Also, as suggested in Section II, some of the Fund’s most visible activities during the past few years have been motivated by just such global or systemic concerns. Two of the best examples are the Fund’s efforts to deal with the debt problems of members that had borrowed beyond their debt-servicing capacity and the Fund’s recent policy advice to the United States concerning its fiscal policy. The relevant question is not whether the Fund ought to consider the global and systemic effects of its advice and programs but rather how it can best do so.
Since so many of the Fund’s normal activities are associated with monitoring of the third-party or systemic effects of member-country policies (such as new trade and exchange restrictions), the discussion of aggregation and interdependence effects in this section will be selective. Specifically, it will concentrate on three aspects of policy advice and program design: (1) consistency and aggregation of policy effects across countries, as analyzed with the Fund’s World Economic Outlook exercises; (2) the incorporation of information on other countries’ policies into policy recommendations for a given country; and (3) the provisions for waivers and modifications in Fund programs.
Consistency and Aggregation of Policies Across Countries
If there is a single guiding rationale for the Fund’s World Economic Outlook exercises, it is that surveillance of the international monetary system, or even of an individual country’s economic policies, must at some stage have a global framework. Only in such a framework can consistency of policy objectives and macroeconomic forecasts across countries be checked, the repercussions of one country’s policies on others be examined, and the aggregate effect of (largely) uncoordinated policy strategies be evaluated. Appraisal of country policies in the depth normally associated with individual Article IV consultations is of course also necessary—but it does not ensure global consistency.
The methodology employed in the World Economic Outlook is largely geared to achieving global consistency, especially in its short-term projections, which at the moment cover the period to the end of 1986. For the purposes of this paper, three aspects of that methodology are important. First, the projections for growth, trade flows, balance of payments, external debt, and debt service are derived in three complementary ways: by a survey approach that relies on the forecasts of desk economists in the Fund’s Area Departments; by an econometric approach that involves the estimation of regression equations for key trade relationships (for example, the response of exports to market growth and changes in competitiveness); and by an historical approach that relies on past historical relationships when econometric estimates are not available.
A virtue of this multiplicity of approaches is that it provides some protection against “independence” error, that is, against the error that arises when each country does not take into account the actions of other countries in making its own forecasts. Suppose, for example, that each non-oil developing country assumes (incorrectly) that its own devaluation will not be matched by other non-oil developing countries. In that case, each country will overestimate the impact on its export earnings. This type of independence error should be uncovered either when estimates are aggregated across all countries or when the survey projections are compared with the projections derived from the econometric approach. Without offsetting errors, the overestimation of export earnings will lead to more global exports than global imports and to an improvement in the global balance on current account. These developments in turn should trigger a search for the likely source of the difficulty, a search that should include checking the econometric evidence. This evidence should, at least in principle, serve to pinpoint the cause of the inconsistencies, since (for non-oil developing countries) the econometric approach takes analytical subgroups of these countries (for example, major exporters of manufactures, or low-income oil-importing countries) rather than individual countries, because construction of the group variables requires explicit accounting for all component-country changes within the group, and because the econometric analyses are made by another department (the Research Department) that acts as the clearing house for all material from the Area Departments.
A second related feature of the World Economic Outlook exercises is that the final projections emerge out of an iterative process that itself provides some safeguard against aggregation errors. (For an overview of the iterative process with respect to the short-term projections in the World Economic Outlook, see Chart 2.) Perhaps the best example of this is the interaction between the so-called environmental assumptions and projections for developing countries. The environmental assumptions pertain to those features of the world economy that have the greatest impact on the developing countries, such as average growth of GDP among partner countries, prices of manufactured goods imported by developing countries, interest rates on commercial credits to developing countries, or the world price of oil. In some sense, these environmental assumptions can be thought of as the “exogenous” variables necessary to make projections for developing countries in either a regression equation or in the survey approach. But as the projection exercise continues, the environmental assumptions themselves need to be checked for consistency against the forecasts that they generate for developing countries. Suppose, for example, that each program country desk economist ignores other program country policy actions in making projections for exports and imports. Suppose, too, that the effect of this neglect is to make the country projections of both exports and imports too large, so that when they are aggregated, projected exports by all developing countries are inconsistent with the imports of industrial countries that correspond to the assumed real GNP in industrial countries. In that case, the initial forecasts will have to be scaled back to be consistent with the environmental assumptions.
Interactions in the Elaboration of the Short-Term Projections of the World Economic Outlook
Note: Short-term projections encompass the period to the end of 1986.1 Mostly summations of weighted averages of individual country variables.2 The main variables screened by the staff for global inconsistencies are: the global balances on trade, investment income, other invisibles, and the current account; the world’s terms of trade, net real exports, and oil balances; and the balance between the demand for and supply of developing country finance. Beyond these areas of accounting consistency, the staff also screens many areas for behavioral consistency, e.g., whether the relationship of imports to GDP is in line with the historical and/or econometric evidence.Alternatively, the effects of programs could be adequately captured in the survey projections but underestimated in the environmental assumptions. Those assumptions will then have to be adjusted to ensure consistency with the projections for the individual countries. But so long as an adjustment for the global effects of programs is made for one of the country groups, and so long as the consistency of projections is checked across country groups, any error due to the omission of cross-country effects of programs should be uncovered.67 By an analogous argument, it also follows that such an (iterative) consistency check of projections across country groups should bring to light cases where the policy stance in, say, the industrial countries is inconsistent with the overall objectives in Fund programs. For example, if the monetary, fiscal, and commercial policies followed by industrial countries implied a demand for imports that was considerably below the export forecasts specified in countries with Fund-supported programs, one would expect to find an inconsistency between the export projections in the survey approach and the import projections for the industrial countries from the econometric approach.
The third relevant feature of the World Economic Outlook exercises is the attention paid to the impact of alternative environmental assumptions on developing countries. This feature is characteristic of the medium-term scenarios. Assuming changes in either one environmental variable, or a combination, from their values in the “base scenario,” can be quite helpful for inferring, inter alia: (1) what changes in the global environment would be necessary to satisfy the types of external and internal objectives typically specified in program countries; and (2) how the prospects for different groups of non-oil developing countries (including, in principle, program countries) are likely to be affected in the medium term by alternative optimistic or pessimistic states of the world economy and by alternative degrees of effectiveness of their own policies. In brief, such scenario exercises provide some protection against the risk that judgments about the feasibility of the objectives of program countries would be too narrowly tied to one uncertain combination of policies and events in the world economy.
Information on Other Countries’ Policies
The biannual World Economic Outlook exercise ensures that aggregation and interdependence effects of Fund-supported programs get some consideration by Fund staff at the time when projections are being debated and finalized. But what about recognition of interdependence and aggregation effects at the level of the Fund mission to an individual country? Here, at least three aspects of Fund operations should be explicitly noted.
First, Fund programs are set sequentially—not all at any given moment for the year to come.68 Thus, when designing a program for country y, it is possible to recognize the consequences, direct and indirect, for y of an earlier program for country x. This recognition is assisted by the practice of circulating among Heads of Departments all back-to-office reports sent by mission chiefs to Management, and by the circulation for comment by other departments of all staff appraisals (including those from missions where use of Fund resources has been discussed or agreed). This means that Fund missions have recent information on earlier Fund missions and on earlier Fund-supported programs. Such country reports not only describe past policies but also provide some discussion of the authorities’ policy intentions over the next year or so. All of this suggests that the design of Fund programs ought to be able to incorporate some estimate, albeit often rough, of how country’s program targets are likely to be affected by policies in its trading partners.
Second, as a useful by-product of the data collected and of the projections made for the World Economic Outlook, it is possible to provide each outgoing Fund mission with a table of summary indicators of foreign demand and prices for both partner and competitor countries. These indicators cover not only the current and the three previous years but also extend roughly a year and a half into the future. The weights used to average foreign developments are also “custom-made” for the particular country; both export and import weights are used to compute changes in a country’s competitive position, and more than one measure is employed for both foreign demand and competitiveness. These indicators provide the mission with at least a crude assessment of how prospective developments in other countries may influence the feasibility of a potential Fund-supported program. For example, if adjustment efforts in partner countries with Fund programs entail some slowing of import growth in those countries, this should be reflected in the figures for import volumes of partner countries. Similarly, the approximate impact of multilateral exchange rate changes by other program countries on this country’s competitiveness ought to be captured by the indicators for costs and prices in partner suppliers. This is not to say that such summary indicators can act as a substitute for a more comprehensive analysis of the interactions between a given program country and other program countries. Clearly, they cannot, nor has it been possible to revise these summary indicators as frequently as one might like for program negotiations. Nevertheless, they can be a useful ingredient in the analysis of interdependence.
More recently, yet a third mechanism for introducing information on the policies of other countries to Fund missions has been used: the assignment of a mission chief from a close trading partner to act as an additional member of a mission. Thus far, the experiment has been carried only for the major industrial countries where interdependence effects are strong and, perhaps most important, where the global effects of policy actions by the countries in question are likely to be most significant. In any case, one of the primary purposes of such a staffing procedure is to have first-hand information on other countries’ policies in the design of Fund policy advice to a given country. One might also note that staff members in most Fund Area Departments typically go on missions to a number of countries in their region. Therefore, first-hand knowledge of policies in close trading partners is often available on Fund resource missions as a matter of course.
Waivers and Modifications in Fund-Supported Programs
No matter how careful the design of Fund-supported adjustment programs, it is almost inevitable that events unforeseen at the time of inception of programs will occur during the program period. Given that Fund performance criteria are stated in explicit quantitative terms and that these criteria are usually set with a reasonable degree of tightness so as to monitor closely developments in the economy, it is to be expected that such unforeseen developments will sometimes produce departures from these performance criteria—and sometimes for reasons beyond the control of the country authorities. It is for this reason that provisions for waivers and modifications in Fund programs have evolved. In brief, the basic guidelines for these pro-visions can be summarized as follows:
… waivers were seen as appropriate for dealing with minor ex post deviations from performance criteria, that is, with deviations that did not represent departures from agreed policies and that were considered of a temporary or reversible nature; modifications would be appropriate when departures from performance criteria were expected to occur because of the failure of basic program assumptions to materialize or of the emergence of developments that had not been anticipated at the inception of the programs. However, when divergences were of a nature or magnitude so as to cast doubts on the program’s viability, new understandings or further policy measures were to be reached, at times within the framework of the existing arrangement, but in cases of unusual severity, in the context of a new arrangement altogether.
These provisions for waivers and modifications in Fund programs have indeed been used. For example, in 1974–77, upper credit tranche arrangements with waived or modified performance criteria accounted for 26 percent of the total number of arrangements approved during that period, and the corresponding figure for 1978–80 was 57 percent. A review of experience for the 1981–84 period is not yet complete. The important implication of the waiver and modification provisions is that Fund-supported programs are not set in concrete.
Summary
The view that the policies of individual countries can generate serious “externalities” for other countries is central to the justification for an International Monetary Fund appraisal and indeed many of the Fund’s activities involve the monitoring or “surveillance” of just such externalities. In this sense, the global effects of the policies of program countries, or interdependences among program countries, are certainly no less a cause for concern than are the global effects of, or interdependencies among, policies of non-program countries. The main mechanism within the Fund for appraising the global effects of country policies, as well as the consistency of policies across country groups, is the World Economic Outlook—the Fund-wide projections exercise. Because of the sequential nature of Fund programs and because of the distribution to outgoing missions of information on both previous Fund programs and foreign demand and price developments, it is also possible for program design to incorporate effects from other programs. In a similar vein, the provisions for waivers and modifications in Fund programs represent a well-established mechanism for dealing with departures from performance criteria, including those attributable to unforeseen aggregation and interdependence effects. None of this, of course, means that aggregation and interdependence effects of Fund programs are fully and adequately accounted for in all individual programs. But it does suggest that if reference to the global or cross-country effects of Fund programs and policy advice is not found more often in Board papers on particular programs or consultations, it is because of the formidable difficulties of estimating of these effects rather than because of the failure to be cognizant of them.