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A compendium of the earlier papers on the Fund’s approach to financial programming is also contained in International Monetary Fund (1977).
See, for example, Dell (1982) and Diaz-Alejandro (1984).
This is especially true in the volumes dealing with case studies of Kenya and Colombia. See International Monetary Fund (1981) and (1984).
Papers by Crockett (1981) and Guitian (1981) do provide general descriptions of the policy content of Fund-supported adjustment programs, but neither goes into detail on the implicit theoretical relationships.
This characterization has been used by Dell (1982), among others.
This point has been stressed by Rhomberg and Heller (1977).
This is not to imply, however, that much of the analysis in the paper may not also be relevant for industrial countries as well.
See Goldstein (1986).
Indeed, the financial programming model presented in Section III was originally designed to enable the analyst to carry out macroeconomic projections using the only two types of data—monetary and balance of payments accounts—that were available in many countries.
Whether publicly owned enterprises are included in the private nonfinancial sector or in the government sector differs among countries and depends also on the policy content of a financial programming exercise. The crucial issue is whether public enterprises are treated as primarily private (profit-seeking) firms or as primarily subject to government control.
See, for instance, Wong and Pettersen (1979) and International Monetary Fund (1981).
In order to avoid unnecessary complication of this analysis, income and the value of output are assumed to be equal. In national income accounting, the value of output exceeds that of income chiefly by (1) indirect business taxes, (2) payments to foreigners (net of payments to residents) for factor services, and (3) net unrequited transfer payments abroad.
As used in balance of payments accounting, the current account includes private and official unilateral transfers in addition to trade in goods and services. In this paper the narrower concept of current account balance is used unless otherwise indicated.
This approach was in part developed by the Fund staff (see Alexander (1952)).
Reference to unrequited transfers will be omitted in the rest of the paper for the sake of simplicity.
In a number of instances the deteriorating financial position of these enterprises has been a major factor in the expansion of domestic credit to the public sector as a whole.
This is, of course, an example of Tinbergen’s rule that in general a specified number of policy objectives cannot be attained without using at least the same number of policy instruments. See Tinbergen (1952).
In the “dependent economy model,” the analysis focuses on the distinction between tradables and nontradables, rather than on that between importables and exportables, because it is assumed that the terms of trade are exogenously determined. This model, in its modern form, originates with papers by Salter (1959) and Swan (1960).
See International Monetary Fund (1986) and Addison and Demery (1985).
See pages 10-11.
This classification, which was originally proposed by Musgrave, has been recently described by Tanzi (1986).
On the last specific point, see Blejer (1983). For a more general discussion, see Johnson (1984).
This is also true for certain performance criteria, which are explicitly formulated as floors or ceilings.
In particular, there is the issue of whether or not the chosen instruments are in principle capable, within the constraints for their use, of achieving the objectives of the program. This question touches on the problem of the relation among objectives, instruments, and performance criteria, which on the whole falls outside the scope of this paper except for some references in Section III.
See Allen (1982) and Wolf (1985).
There may, of course, also be substantial lags with regard to policy action itself, that is, between the need for action and the recognition of that need, and between the recognition of the need and the policy action.
See Edwards (1984) and Khan and Zahler (1983, 1985).
See Section IV, pages 42-45, for further discussion of this issue.
See Frenkel and Johnson (1976). The Fund has also adopted a similar definition for this approach; see International Monetary Fund (1977).
See Diaz-Alejandro (1984).
Rhomberg and Heller (1977) trace this distinction back to a paper by Triffin (1946).
See also Johnson (1958).
See, for example, the papers contained in International Monetary Fund (1977).
The assumption of a fixed exchange rate is crucial to this analysis. It may be noted that a large majority of the Fund’s member countries peg their currencies in some form. The role of the exchange rate will be discussed in Section IV.
For simplicity it is assumed here that all foreign assets are held by the central bank, so that the change in net foreign assets is identical to the balance of payments of the country. This assumption would be valid in circumstances where commercial banks were required to surrender all foreign exchange to the central bank. Alternatively, the framework could be adapted to allow commercial banks to hold foreign assets by introducing an additional term explicitly into equation (4) that captures variations in net foreign assets of commercial banks.
In the following discussion it is assumed that “other liabilities” and “other assets” of the banking system are either zero, or subsumed in the items that are listed here.
This type of analysis is characteristic of the “Chicago version” of the monetary approach to the balance of payments. See Frenkel and Johnson (1976).
Polak (1957), for example, used the constant velocity assumption for simplicity.
See, for example, Aghevli, Narvekar, and Short (1979), Crockett and Evans (1980), Khan (1980), and the papers contained in Meiselman (1970).
This question is examined in Kreinin and Officer (1978).
The more general case will be discussed in the section dealing with exchange rate policies.
This issue is discussed in Section IV, pages 42—45.
As noted earlier, in many programming exercises, the government sector (which may, or may not, include state and local governments) also comprises publicly owned nonfinancial enterprises. “Government” and “public sector” are used here interchangeably on the understanding that the definition of the public sector may vary from case to case.
The proper allocation of resources between the public and private sectors differs widely among countries. In countries where a large part of productive resources are publicly owned, more salient issues may be the allocation of resources between directly productive and other activities or the extent of subsidization of public enterprises.
This subject is addressed in a recent paper by Kelly (1982).
Foreign debt ceilings in Fund programs may take many forms; such ceilings are applied to the entire public sector, together with borrowing with official guarantee, so that foreign borrowing by the central government alone is not thereby directly limited.
The target rate of expansion of credit to the private sector can be estimated by relating it to the change in projected nominal income or to the projected rate of private investment.
At this stage, it may be useful to estimate public and private consumption, saving, and investment likely to result from these credit projections. Such an estimate provides a basis for checking the consistency and feasibility of the program, as well as its longer-term growth implications.
Since commercial banks are assumed not to hold foreign assets, the net foreign assets variable remains the same as before.
It is assumed for simplicity here that the money multiplier is constant so that Δm(R + DCB) = 0.
Note that in this case a change in net foreign assets, ΔR, now leads to a change in reserve money, ΔH, rather than money, ΔM, as in the simple monetary model. The two models would be equivalent if: (a) the money multiplier is unity (m = 1); that is, commercial banks operate under a 100 percent reserve requirement against reserves acquired through the sale of foreign assets; (b) the central bank follows a rule that automatically sterilizes changes in foreign assets by offsetting changes in net domestic assets; or (c) a change in the composition of reserve money has no further impact on the economy, as might be the case where there is an effective ceiling on total domestic credit. These issues are taken up later in this section.
See Mussa (1974).
This is why the Polak model is often characterized as “the quantity theory of money in an open economy.” This quantity theory of money equation used by Polak can also be interpreted as the demand for money. See Prais (1961).
See Prais (1961), the papers in International Monetary Fund (1977), and Aghevli and Khan (1980).
An informal financial sector plays a major role in many developing economies; see, for example, Chandavarkar (1986). Moreover, the assumption of a functioning curb market allows one to analyze the effects of interest rates on aggregate demand. Without such a market, the effects of monetary policy would be limited to those on wealth, real cash balances, and the rationing of credit.
Open market operations are not used as a tool of monetary policy in this framework for the reason that there are only limited markets for government debt in most developing countries.
The authorities can, of course, exercise direct influence over domestic credit of the formal financial sector, but such influence also has indirect effects on the interest rate, and thereby the equilibrium volume of credit extended in the curb market.
In the last case the authorities can prescribe legal reserve requirements, define the assets qualifying as legal reserves, and provide for sanctions for reserve deficiencies.
This equilibrium, however, is conditioned by the fact that lending and deposit rates are fixed by the government.
In models with fixed exchange rates and tradable goods prices in line with world prices, this reabsorption would be complete over time. These effects would be quite different if foreign exchange restrictions and a parallel market were present.
See Montiel (1985).
See, for example, Friedman (1956) and Lucas (1972).
In the constant income-velocity version of the demand for money, the last variable would not be relevant.
See also Khan (1980) for results for a cross section of 11 developing countries.
Friedman (1970) argues that real money balances rise in the transitional phase because prices do not respond immediately to a change in monetary growth.
This is the rationale used in Frenkel and Johnson (1976) and International Monetary Fund (1977).
The exchange rate might have to be adjusted at the beginning of the program to eliminate any initial overvaluation of the exchange rate. An alternative policy could involve occasional adjustments of the nominal exchange rate to any difference between domestic and international inflation.
It should be noted that in economies where credit is rationed primarily by interest rates, such sterilization would be much less likely to have these sectoral effects since credit could flow from one sector to another in response to changes in relative interest rates.
Some of the issues in these controversies are briefly discussed later in this subsection.
Issues related to the composition of spending are taken up in Section IV in connection with supply-side policies.
For example, investment in infrastructure by the public sector may increase the productivity of the private capital stock at the margin, and thus stimulate additional private investment. Empirical evidence on this type of effect has been provided by Sundararajan and Thakur (1980) and Blejer and Khan (1984).
This is known as the “Ricardian equivalence” proposition that was outlined in an important paper by Barro (1974). Many economists, however (e.g., Buiter and Tobin (1979)), argue that the discount rates applied to future tax liabilities by the private sector are sufficiently large to make the effect on current spending fairly small.
A number of models, for example, Khan and Knight (1981, 1982), introduce the real balance effect into spending decisions following the rationale provided by Archibald and Lipsey (1958).
See, for example, Blinder and Solow (1974).
This “policy neutrality” result has come to be known as the Lucas-Sargent-Wallace (LSW) proposition, after the seminal papers by Lucas (1972) and Sargent and Wallace (1975).
See Tobin and Dolde (1971).
Assuming that these interest payments do not require actions, such as taxes or increases in the money supply, that affect private sector behavior.
See Tanzi, Blejer, and Teijeiro (1987).
Tanzi, Blejer, and Teijeiro (1987).
Some of these relationships are examined in Khan and Knight (1985)). See also Blejer and Khan (1984).
Since the exchange rate is one of the most important prices in the economy, inappropriate exchange rate levels can result in several and pervasive distortions in resource allocation, particularly between the traded and nontraded goods sectors. This topic is taken up below.
See Edwards (1984) and Krueger (1985) for a discussion of the advantages and disadvantages of liberalization policies involving tariff reductions.
Notably, the marketing of basic foodstuffs, both locally produced and imported.
In an empirical paper covering 28 developing economies, Balassa (1982) found that countries with outward-oriented development policies tended to exhibit better export performance and economic growth than countries that followed inward-oriented development strategies. Balassa attributed this better performance partly to the fact that firms in countries pursuing outward-oriented strategies are exposed to foreign competition and thereby gain experience in altering product composition in response to shifts in foreign demand and changes in external competitiveness. Thus, the national economy exhibits greater flexibility than that of countries with an inward orientation, where limited competition within the domestic market gives firms less incentive to control costs or to innovate. The case studies contained in Krueger and others (1981) generally bear this out. The adoption of appropriate exchange rate policies is obviously an issue of concern in this area as well; it is discussed in detail in pages 36-42.
See, again, International Monetary Fund (1986).
The Fund collaborates closely with the World Bank in evaluating a country’s investment strategy, but its concern remains at the macroeconomic level.
This view is generally referred to as the McKinnon-Shaw hypothesis. See McKinnon (1973). For a general discussion of this issue, see International Monetary Fund (1983).
Even if domestic saving is unresponsive to the rate of interest, as is sometimes asserted, the economy could obtain a larger proportion of world saving and thus increase total saving available to the economy (S = SD + SF). In countries undertaking financial reforms, the impact on the net inflow of foreign saving (which includes net repatriation of foreign assets by residents) has tended to be more dramatic than the increase in domestic saving per se.
Under such circumstances, real interest rates in curb markets are likely to be positive.
Some evidence on these phenomena is contained in International Monetary Fund (1983).
Perhaps the best-known example of the beneficial effects of freeing interest rates is the major reform of Korea’s financial system, which took place in September 1965. Interest rates on time deposits were doubled (to 30 percent a year on new 18-month time deposits, and bank lending rates, although subsidized, were also raised from 16 percent to 26 percent a year; see Harris (1985)). This reform was among the factors responsible for a jump in the domestic saving rate and rate of fixed capital formation in Korea allowing it to achieve a real growth rate on the order of 10 percent a year over the subsequent decade. Real domestic saving as a proportion of GNP more than doubled from 7.5 percent in 1964 to 17.5 percent in 1969.
Except perhaps to establish interest rates that compensate holders of domestic financial assets for inflation.
For example, concurrently with the financial reform the Korean authorities also undertook a fiscal reform. This resulted in fiscal surpluses, which rose from 20 percent of national savings in 1965 to over 40 percent by 1971. See Harris (1985). The inability to control fiscal deficits is often considered one of the more important factors that resulted in a failure of the liberalization experiments, particularly in Argentina. See Sjaastad (1983).
This discussion assumes that interest rates are officially administered, which is common practice in developing countries. The adjustments described might also be accomplished, however, by permitting, where feasible, market determination of interest rates.
See Friedman (1953) for the classic statement of this argument.
See Black (1976).
See Ramirez-Rojas (1985).
See, for example, Guitian (1976), Johnson (1976), Dornbusch (1981), and Donovan (1981).
Since the model is static and neglects capital accumulation, the “long-run” supply curve is assumed to be vertical.
Total (domestic plus foreign) demand for domestic output becomes perfectly elastic at the world price level P0, reflecting the assumption that the country has only a negligible effect on prices prevailing in world markets and cannot alter its external terms of trade.
See Bond (1983).
Too often, for example, “the effects of a devaluation” are studied as if in isolation from other policies, and its allegedly deflationary effects are cited, as if there existed some other combination of policies that would have accomplished the same adjustment in a nondeflationary way, an eventuality that may in many cases be impossible. For arguments supporting the view that devaluations will be necessarily contractionary, see Diaz-Alejandro (1965), Cooper (1973), Krugman and Taylor (1978), Dornbusch (1981) and Hanson (1983). A contrary view is presented in Gylfason and Schmid (1982). A more recent symposium containing studies of detailed aspects of these and related questions is given in Edwards and Ahmed (1986).
See Lizondo (1984) and (1985).
See pages 22-24.
This subject of lags in trade relationships was discussed in detail in the seminal paper by Orcutt (1950). For a more recent treatment, see the survey by Goldstein and Khan (1985).
See Goldstein and Khan (1985) for a discussion of some of these.
A more detailed version of the analysis in this section may be found in Lanyi (1984).
Note that this procedure only approximates the first round or initial effects of a nominal depreciation on the real exchange rate.
See Loser (1977).
To be sure, an ongoing process of import substitution may reduce the rate of growth of exports implied by this criterion. But import substitution has natural limits in most cases, so that this qualification would be likely in most instances to apply only for a period of some years, not over the long run.
See, for example, Loser (1977) and McDonald (1982).
It might also be optimal for countries to utilize external debt to smooth consumption over time in the face of various internal and external shocks. A more general criterion would be that the pattern of distribution of world savings should be welfare enhancing. See Williamson (1973).
Furthermore, any such calculation is by definition conditional on the assumptions of the future path of a number of domestic and foreign variables. For example, what might be considered sustainable at a given interest rate may prove to be unsustainable if the interest rate should rise above the assumed value. Since most commercial debt carries a floating interest rate, calculations based on some fixed rate are bound to be only conjectural at best.
See Donovan (1984).
It is assumed here that the level of investment income payments does not depend on the realized productivity of the investment undertaken. If the external debt took the form of equity, the “reversal” of the capital inflow could simply be a capital loss for the nonresident investor.
Goods in this simple framework include merchandise and all nonfinancial services.
It is assumed that all debt carries floating rates. In a more realistic example IY would move gradually to IY’ as existing debt matures and is renegotiated at the higher real interest rate.
See also Goldstein (1986).
This can include both financial assets and real assets.
These problems are, of course, carefully considered in the formulation and implementation of Fund-supported adjustment programs.
See van Wijnbergen (1986).
This analysis is based on Ize and Ortiz (1987).
Occasional Papers of the International Monetary Fund
2. Economic Stabilization and Growth in Portugal, by Hans O. Schmitt. 1981.
5. Trade Policy Developments in Industrial Countries, by S.J. Anjaria, Z. Iqbal, L.L. Perez, and W.S. Tseng. 1981.
6. The Multilateral System of Payments: Keynes, Convertibility, and the International Monetary Fund’s Articles of Agreement, by Joseph Gold. 1981.
8. Taxation in Sub-Saharan Africa. Part I: Tax Policy and Administration in Sub-Saharan Africa, by Carlos A. Aguirre, Peter S. Griffith, and M. Zuhtu Yucelik. Part II: A Statistical Evaluation of Taxation in Sub-Saharan Africa, by Vito Tanzi. 1981.
10. International Comparisons of Government Expenditure, by Alan A. Tait and Peter S. Heller. 1982.
11. Payments Arrangements and the Expansion of Trade in Eastern and Southern Africa, by Shailendra J. Anjaria, Sena Eken, and John F. Laker. 1982.
12. Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, by Morris Goldstein and Mohsin S. Khan. 1982.
13. Currency Convertibility in the Economic Community of West African States, by John B. McLenaghan, Saleh M. Nsouli, and Klaus-Walter Riechel. 1982.
14. International Capital Markets: Developments and Prospects, 1982, by a Staff Team Headed by Richard C. Williams, with G.G. Johnson. 1982.
15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay. 1982.
16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, and L.L. Perez. 1982.
17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams. 1983.
18. Oil Exporters’ Economic Development in an Interdependent World, by Jahangir Amuzegar. 1983.
19. The European Monetary System: The Experience, 1979-82, by Horst Ungerer, with Owen Evans and Peter Nyberg. 1983.
20. Alternatives to the Central Bank in the Developing World, by Charles Collyns. 1983.
22. Interest Rate Policies in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1983.
24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller and Alan A. Tait. 1983. Revised 1984.
26. The Fund, Commercial Banks, and Member Countries, by Paul Mentre. 1984.
28. Exchange Rate Volatility and World Trade: A Study by the Research Department of the International Monetary Fund. 1984.
29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the Research Department of the International Monetary Fund. 1984
30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by the Research Department of the International Monetary Fund. 1984
33. Foreign Private Investment in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1985.
34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli. 1985.
35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.
36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed by G.G. Johnson. 1985.
38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B. Petersen. 1985.
39. A Case of Successful Adjustment: Korea’s Experience During 1980-84, by Bijan B. Aghevli and Jorge Marquez-Ruarte. 1985.
41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Khan and Malcolm D. Knight. 1985.
42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.
44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H. Mansur. 1986.
45. Switzerland’s Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.
46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal Affairs Department of the International Monetary Fund. 1986.
47. Aging and Social Expenditure in the Major Industrial Countries, 1980-2025, by Peter S. Heller, Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department. 1986.
48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans, Thomas Mayer, and Philip Young. 1986.
49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.
50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and Objective Indicators, by Andrew Crockett and Morris Goldstein. 1987.
51. The Role of the SDR in the International Monetary System, by the Research and Treasurer’s Departments of the International Monetary Fund. 1987.
52. Structural Reform, Stabilization, and Growth in Turkey, by George Kopits. 1987.
53. Floating Exchange Rates in Developing Countries: Experience with Auction and Interbank Markets, by Peter J. Quirk, Benedicte Vibe Christensen, Kyung-Mo Huh, and Toshihiko Sasaki. 1987.
54. Protection and Liberalization: A Review of Analytical Issues, by W. Max Corden. 1987.
55. Theoretical Aspects of the Design of Fund-Supported Adjustment Programs: A Study by the Research Department of the International Monetary Fund. 1987.
Note: Excludes those titles that are now out of print or that are now included in the series “World Economic and Financial Surveys.”
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