The design of adjustment programs is a difficult task, involving analysis of a complex and incompletely understood set of economic relationships, as well as hard political decisions. Programs must be aimed to meet the country’s principal economic objectives, including both a satisfactory rate of growth of output and general macroeconomic balance. The goal of sustaining a viable balance of payments position over the medium term is closely related to the specification of domestic macroeconomic objectives: the targeted excess of domestic expenditure over income must not exceed the amount of additional external debt that can be accumulated without undue increase in the relative burden of debt service. The formulation of a feasible set of objectives is thus the first step in designing a program; for this, a general framework of analysis is needed. The next step is to choose the instruments with which to achieve the objectives of the program; this, in turn, requires knowledge about the transmission process whereby policy variables affect output, prices, and the balance of payments.
While national authorities must take into account a broad range of economic and noneconomic objectives in their decision making, the Fund focuses typically on a few central macroeconomic targets. It is argued in an earlier section that while Fund-supported programs are necessarily focused on external balance, a focus inherent in the Fund’s legal basis, there is also a serious concern with efficient utilization of resources and with long-run economic expansion, which underlies the Fund’s commitment to ensuring the maintenance of a multilateral payments system as the basis for the sound growth of international trade. This concern is strengthened by the need to embed even short-term adjustment programs in a medium-term setting that takes full account of the likely evolution of external indebtedness and the relative burden of debt service.
The relationship between external and internal balance, as shown in the absorption approach and the accounting framework for financial programming, provides the basis for defining the fundamental macroeconomic adjustments necessary. Nevertheless, there is a whole range of policy packages compatible with achieving those objectives; some of these packages are stimulatory to long-run economic growth and some are not. The Fund is in principle committed to favoring programs that involve a minimum sacrifice of growth objectives. Macroeconomic balance, while a necessary condition for sustained growth, is certainly not a sufficient condition, and where resources are poorly utilized and growth rates are inadequate, it is necessary to undertake changes of various sorts to raise current output, increase rates of saving and investment, and improve the return on investment. While the paper makes an analytical distinction between policies that improve utilization of resources currently available and those that raise the rate of growth of productive capacity, it also points out that a number of supply-side measures have a positive impact in both these respects: policies that induce an improved allocation of resources also induce better investment decisions. It is also true, however, that policies to improve growth rates of output over the medium to long term may not show substantial results within the program period of even an extended Fund facility program.
Another major argument of the paper is that the standard financial programming framework is consistent with a wide range of hypotheses about the transmission mechanism between stabilization policies and the targeted macroeconomic variables, and therefore with different overall policy strategies. In particular, the time lags between policy changes and changes in the economic variables being targeted will have an important bearing on the choice of policy measures and the timing of their implementation. This last point is of particular importance because of the difficult decisions that must always be made with regard to the pace at which various measures, such as the reduction of a fiscal deficit, should be implemented.
At various points in the paper reference is made to questions with regard to the nature and timing of relationships between economic variables, for which up to now only partial answers have been discovered. It is also mentioned that these relationships may vary among countries, so that empirical estimation of such relationships must be made on a country-by-country basis. Among the relationships of interest in this connection are the demand for money function, the reaction of imports and exports to exchange rate changes, and the impact of changes in relative prices on output in agriculture and other sectors.
It was shown, also, that the role of exchange rate policies always raises difficult questions in a Fund-supported program and also influences the choices with respect to the conduct of monetary policy. While exchange rate adjustments are often the simplest way of altering the relative prices of traded and nontraded goods in a desired direction, they may be ruled out by fixed exchange rate arrangements that are embedded in a country’s economic system. A fixed exchange rate, or limited exchange rate flexibility, raises the further question of how much scope exists for the authorities to influence the stock of money in an open economy. The greater the flexibility of exchange rates, the greater is the degree of control that can be exercised by the monetary authorities over the money supply. With flexible rates, there may be circumstances under which a monetary aggregate other than domestic credit would be a more appropriate, or at least a desirable supplementary, policy target, especially when inflation is a major concern.
More broadly, an important factor in the design of adjustment programs is the institutional and political setting. Aside from the question of exchange rate regime, which in the extreme case of membership in a currency union limits the scope for the use of both exchange rate and monetary policies in carrying out needed adjustments, there are other institutional features of crucial importance. For example, the degree and the modalities of central planning in an economy affect the scope for the use of prices and exchange rates to affect economic decision making in the nongovernmental sector. Even in economies that are not “planned,” the adherence to government controls and the political resistance to structural reforms vary widely across countries.