This paper discusses three important extensions of the developing country scenario and adjustment model used in the World Economic Outlook exercises. First, to analyze the impact of changes in domestic policies, fiscal and monetary sectors are introduced and private and public components of aggregate demand are modeled separately. Government revenue is determined endogenously and takes into account the lagged adjustment of revenue to inflation. Government expenditure is divided into current expenditure, which is endogenously determined, and capital expenditure, which is treated as an exogenous policy variable. With regard to the monetary sector, the stock of money is endogenously determined and prices are determined by the interaction of the money demand and supply functions. Government policy influences output directly through the effect of changes in expenditure on aggregate demand and indirectly through the effect of changes in the stock of money and prices on domestic absorption and exports. A change in the government’s capital expenditure also affects the economy’s productive capacity and the supply of exports.
Second, the external sector is modified to take account of the effect of domestic factors on imports. This is implemented by specifying that imports are externally constrained--and thus determined residually--only when the option of using reserves or foreign borrowing is not available to the country. The model is therefore made more flexible, so that, depending on the availability of reserves or new loans, imports may switch from being residually determined by external financial flows and export earnings, as in the original version of the model, to being determined in a behavioral manner by a mixture of domestic and external factors.
Third, the model system is extended to net creditor countries, whose imports are assumed to be determined primarily by domestic factors. The equation for private absorption is also modified to take account of the absence of external constraints, and, for the oil exporters within this group, a specific equation is developed for oil exports. Both export and import equations for the oil exporters are estimated using pooled cross-section time-series data and cross-country equality restrictions on the slope parameters.
The revised model is estimated separately for each of the 95 developing countries, and parameter estimates are presented for all developing countries, grouped both by geographical region as well as by analytical group with countries classified according to their predominant export. The paper also presents the results of four simulation exercises to illustrate how the new model system may be used to assess the effects of changes in domestic monetary and fiscal policies and in the external environment.