Journal Issue

Measuring macroeconomic performance: Careful analysis of indicators and policies needed

International Monetary Fund. External Relations Dept.
Published Date:
June 1983
  • ShareShare
Show Summary Details

Donal Donovan

Quantitative indicators that measure such macroeconomic variables as the growth of national product, inflation, or the current account of the balance of payments have long been used to assess a country’s overall economic performance. National policymakers use them to analyze, explain, and defend alternative courses of policy action, while such indicators mold popular perceptions of economic performance and, consequently, the positions taken by various interest groups. Accurate, timely, and meaningful information on aggregate economic performance is also essential for the assessment of a country’s creditworthiness by international commercial lenders and for the appropriate allocation of resources by multilateral lending institutions.

But care is needed in relying on quantitative indicators as a measure of economic performance—even readily quantifiable indicators of aggregate performance as opposed to broader indicators of welfare that are beyond the scope of this article. Not only are there problems in capturing actual changes accurately—in prices or gross national product (GNP), for example—via official records of transactions, but there are also difficulties in arriving at appropriate weights for aggregating detailed data, as well as major pitfalls in establishing workable cross-country comparative indicators. Apart from such purely statistical issues, there are broader economic questions about the validity of using aggregate indicators, particularly in isolation, as a measure of overall economic performance. Indeed, a strong case can be made for requiring a qualitative evaluation of the appropriateness of the domestic policy actions that underlie movements in measured indicators as a central part of any overall assessment.

Statistical problems

Statistical problems of measurement can be of very substantial economic importance. One type of difficulty arises when officially published statistics do not cover many economic transactions; this can so distort the recorded series as to greatly reduce their usefulness. Price inflation indices, for example, may be based only on officially controlled prices in a situation where many transactions are conducted at substantially higher free market prices. Also, official statistics for exports and imports, if recorded in situations of severe external disequilibrium when the currency is significantly overvalued and there are widespread quantitative import restrictions, may seriously understate the transactions occurring via smuggling activities. These examples have aspects in common with a more general problem that has come to be known as that of the “underground economy,” whose many transactions are either not recorded or are recorded inaccurately.

A second set of statistical problems involves establishing an appropriate weighting system for aggregating data. Typically, the weights used by statisticians are derived from detailed investigations undertaken in a chosen base year, and it is time-consuming and expensive to update them frequently. Often the measurement errors involved in not revising them every year or so may not be very large, but if they are unaltered for very long periods when major structural changes are occurring, the distortions may become quite significant. For instance, for a developing country gradually shifting its production structure away from agriculture, the importance attached to year-to-year changes in agricultural output in the estimated aggregate economic growth rate will become progressively exaggerated, unless the base year weight assigned to agriculture is reduced.

Sometimes weights may need to be updated quickly after a major structural change. A striking example concerns the oil price component of a country’s import price index. Following the first oil price shock in 1973, the actual share of the oil bill in total imports rose very sharply for most countries. Unless the oil weight in the index were adjusted upward, the measured change in the import price index during 1979-80 would seriously underestimate the impact of the second oil shock during that period on aggregate import costs and thus understate the deterioration in many countries’ terms of trade.

Individual country performance

In measuring overall economic performance, it is important to address the issue from a conceptual framework that sets out feasible and internally consistent objectives. As a starting point, a widely accepted standard for measuring a country’s macro-economic performance over a long period of time is the goods and services it produces, namely, the rate of increase in its gross domestic product (GDP). However, focusing on past growth rates does not provide a reliable indication of the extent to which growth can be maintained in the future. Therefore, as a first guiding principle, the measurement of growth rates must be supplemented by an examination of major financial indicators, such as the inflation rate and the size of the external deficit, which have a direct bearing on the sustainability of economic growth. In the case of inflation, a reduction in inflationary pressures per se is also widely regarded as an independent objective of policymakers. As a second principle, for various reasons, measured changes in financial indicators by themselves may not convey sufficient meaningful information. It is important to bear in mind, therefore, the policies which caused these indicators to change.

The above approach, which seeks to measure performance in light of the objectives of maximizing the rate of growth consistent with external and internal stability, stresses the importance of a simultaneous emphasis on measures of “real” activity (of, for example, growth and employment) and financial indicators. Focusing largely on the economic growth rate, for instance, could be misleading in situations where governments may have considerable flexibility in achieving increases in the rate of growth through expansionary demand management policies. In addition, undue emphasis should not be given to financial indicators by themselves; for instance, in principle, a virtually zero rate of domestic price inflation could be attained, provided the authorities are prepared to depress domestic demand sufficiently. But such a “good” performance on inflation may well have unduly adverse effects on growth, at least in the short run.

Similarly, a lower external deficit does not, by itself, imply that economic performance has been “good,” nor does a higher deficit imply that performance is, in any sense, less satisfactory. The issue is rather whether a given external deficit, which is financed by foreign resources, is consistent with sustainable rates of economic growth over the medium- and long-term. This, in turn, depends on the uses to which the foreign resources are put. From this perspective, measuring performance cannot be confined solely to backward-looking analyses. It is inherently a dynamic forward-looking exercise and it must include some assessment of what the contribution of current developments to future economic prospects might be.

The importance of considering several indicators in a dynamic context becomes particularly relevant during periods when needed economic and financial adjustment measures are undertaken. In such situations, sharp adverse movements frequently occur in real variables, such as growth and employment, and a casual observer might view such changes as constituting “bad” economic performance. However, it is essential to view “performance under adjustment measures” in comparison with “performance without adjustment measures,” not vis-à-vis some hypothetical continuation of past trends for selected variables. In particular, a reduction in the rate of economic growth in a country that implements adjustment policies in response to a deteriorating financial situation cannot be compared with previous growth rates, but with what would have happened had no adjustment policies been undertaken. In the case of external disequilibrium, the rate of economic growth might well have been much less without than with adjustment policies, due to the binding nature of the external financing constraints.

Similarly, a needed currency depreciation may lead to increases in administered prices, but if official prices of imports had been artificially low prior to the depreciation, limited supplies may have forced unofficial prices higher. Even more to the point, in the immediate future without policies of adjustment, available external resources and hence imports would probably be reduced and prices in any case would tend to rise.

Finally, changes in commonly used indicators, such as the ratios of deficits to GDP or to some other scaling variable, should be interpreted with caution in measuring economic performance in a country undertaking adjustment measures. The changes in the ratios of the current account deficit or budget deficit, say, to GDP, are useful as a measure of the “effort” implied by an individual country’s policies, for example, to cut expenditures relative to income. However, in the case of the ratio of the external deficit to GDP, a relevant point is that a sharp measured change may occur solely as a result of a change in the official exchange rate used to convert the deficit measured in foreign currency to local currency terms. Also, when interpreting the size of a budget deficit, one should bear in mind aspects such as the definition of the government sector and the possible role of extra-budgetary outlays. More fundamentally, without an analysis of what constitutes a sustainable level for the deficit in question, a change in one indicator cannot by itself be expected to show whether and to what extent the needed adjustment is being undertaken. These points are especially important for cross-country comparisons.

Cross-country comparisons

Governments and commercial bank lenders require some assessment of the comparative performance of different countries. In the case of international agencies, it is also important that there is uniformity of treatment (both actual and perceived) of countries in similar situations. For example, the Fund’s resources are made available to member countries on the basis of adequate efforts to overcome balance of payments difficulties. Thus, the Fund must make judgments of the adequacy of different members’ adjustment efforts, taking into account the nature and the extent of the external problems present in each instance.

The importance of assessing performance under adjustment in the context of the prevailing world economic situation should be emphasized. For instance, the external current account deficits of all the non-oil developing countries had to rise—at least initially—following the successive oil price increases of the past decade. The performance of any individual country in this initial period should be assessed against this background. At the same time, some countries’ deficits rose more than others—or have remained higher for longer—partly because of structural factors or inadequate domestic policies. Although there are serious conceptual and measurement difficulties involved, any meaningful assessment of economic performance must also try to distinguish the effect of these influences from those of an unfavorable external environment.

Similarly, economic growth in the world economy has slowed substantially in the last several years for a variety of reasons. Under these circumstances, if an individual country accepted lower real growth rates than were common, say, in the early 1970s, that cannot reasonably be construed as “bad” performance if it were the maximum sustainable rate that could be achieved.

Basing comparisons of economic performance of different countries largely on aggregate indicators also involves difficulties that are partly an extension of the problems in measuring the economic performance of individual countries. The meaning of individual variables differs between countries due to both statistical problems and institutional differences. For example, any inter-country comparison of levels of GNP, apart from being fraught with ambiguities arising from differences in national accounting techniques, involves the difficult problem of how to convert individual indices to a common denominator. If a country’s official exchange rate is too high, its GNP estimate will be overestimated relative to others; the converse is true in the case of an undervalued currency.

These difficulties are especially present in the case of aggregate financial indicators. In measuring inflation, countries may have quite different approaches to price controls, if any, and thus to interpret uniformly published indicators of inflation rates would be inappropriate. Similarly, apart from the problems relating to the reliability of the GDP estimate itself, the interpretation of the size of a public sector deficit relative to GDP should take into account the absolute size of the public sector, which may vary according to the institutional or ideological approach of the country. The size of the external current account deficit should also be assessed in light of the degree of openness of the economy (again, a question involving institutions and, to some extent, ideological considerations) and perhaps most important, the country’s access to international capital markets, both now and in the future.

More fundamentally, when comparing countries’ performance, the levels or rates of change of individual indicators, such as economic growth, should not be presented in isolation for countries within a group, but should be accompanied by the relevant set of financial indicators. There is a particular need for caution when presenting changes in individual indicators which occur in the context of economic adjustment efforts. It is not meaningful, for example, to compare in isolation changes in the current account/GDP ratio of different countries and to assume that the larger the reduction, the better the performance. In fact, the reverse could be true—a reduced deficit may signal a loss of external confidence, leading to a reduction in capital inflows, while a larger deficit may imply the opposite. The former case may well be associated with a tightening of import restrictions that will have adverse effects on economic growth and the rate of inflation.

Given these limitations, does it follow that all quantitative comparisons between countries are largely meaningless, and that there should be no attempt to provide comparative quantitative indicators? The answer is that a proper assessment of performance should not, in practice, rely solely (or perhaps even largely) on aggregate indicators but rather must involve important additional elements of qualitative judgment.

Assessing policies

Whether one is considering economic performance at an intercountry or intra-country level, attention must be paid to the policies which underlie movements in aggregate indicators of the type discussed already. Thus, from a macroeconomic viewpoint, at any given time a government will have a measure of flexibility in choosing different combinations of targets for economic growth, domestic inflation, and the external deficit. How to assess the government’s choice involves not only looking at the actual outcome during the relevant time period but also what it implies for the future path of the economy. Especially for developing countries, the policies that underlie a growth rate target and, in particular, the composition and the financing of investment expenditures, will have an important bearing on the consistency and sustainability of an overall economic growth plan.

One criterion for consistency between investment-led growth and an external financial constraint is that investment financed by foreign borrowing should be increased to the point where the expected marginal rate of return (after allowance for the uncertainty elements present) just equals the cost of borrowing. In principle, any less investment would be conservative, while any more would involve borrowing that will not earn additional resources sufficient for its repayment, and thus would be unsustainable.

Applying such a criterion requires sufficient information on the expected returns to investments funded by external borrowing as well as the margin of uncertainty involved. For political and social reasons, governments often make many investments that do not produce, even ex ante, returns that match the cost of their financing. However, to be able to assess the meaning of high recorded rates of investment and economic growth properly, it is important to have some idea of the size of the disparity that may be involved and how, for example, it may change over time. In addition, there is fairly widespread agreement that some policies, such as the use of external borrowing on a sustained basis to finance an excess of current (as opposed to investment) expenditure over current revenue, constitute unequivocally “bad” economic performance. However, in this connection, it is important to bear in mind that very often expenditures officially classified as “current” include outlays on education and health which augment the country’s stock of human capital.

It is similarly appropriate to examine the policies underlying movements in inflation and external current account indicators. If the rate of increase in prices, for example, is suppressed by wage and price controls that are not accompanied by measures to relieve excess demand pressures, then the measured “improvement” in inflation can at best represent a statistical phenomenon without an economic basis, as “unofficial” prices will, in any event, tend to rise. Such suppression will merely tend to postpone recorded inflation, rather than deal with inflation itself.

The assessment of external deficits is complex. There is no simple answer to the question of how to assess a “small” recorded deficit in comparison to a “large” one. From the perspective of the external constraint discussed above, a current account deficit can be viewed as optimal up to the point where externally borrowed resources are used most productively, and is suboptimal both before and after that point. Given this criterion, a “large” deficit may be optimal for one country and sub-optimal in another. Moreover, as already mentioned, the existence of a “small” deficit may reflect, for instance, an inability to find sufficient foreign exchange financing—normally not an appropriate situation for any developing country.

From another perspective, economic performance can be assessed in light of whether economic resources are mobilized and allocated most effectively. For example, the case of an unsustainable external deficit just cited involves an inefficient use of borrowed resources: the same problem arises in the case of a misuse of domestic savings. An approach such as this would imply less emphasis on the measurement of short-run aggregate macroeconomic indicators (such as balance of payments deficits or the inflation rate) and rather more on the quality of policy decisionmaking and, in particular, the extent to which policies directly support efficiency in production and consumption, especially over a longer time period. In practice, however, quantifying the extent to which resources in production are allocated efficiently is by no means an easy task. It involves considering the degree to which the prevailing price structure (be it a market price structure in a fully capitalist economy or an implicit shadow price system in a centrally planned economy) reflects relative scarcities. For an individual country, one useful quantitative approach to this question lies in a comparison of the level and structure of internal and world prices.

On the question of efficiency in the allocation of consumption, how to measure and compare the costs and benefits of consumption taxes and subsidies is undoubtedly controversial. But there is widespread agreement that subsidies impede the efficient allocation of resources and that, considered in isolation, they tend to impair aggregate economic performance. Moreover, their perceived benefits to consumers may be overestimated if the real prices of the subsidized commodities (that is, their officially measured prices adjusted for the possible scarcity costs involved, such as waiting in line for items) are much higher than indicated by published price indices. However, it must be borne in mind that in some circumstances, the removal of subsidies may involve—apart from possible social and political costs—some direct economic costs; strikes may occur, labor productivity may be reduced with adverse consequences on the growth of output, and so on. How to weigh these different considerations inevitably requires, in addition to an examination of measured indicators, substantial elements of qualitative judgment.

In summary, a quantitative assessment of overall macroeconomic performance should ensure consistency between a country’s growth objectives and the internal and external financial constraints it faces. Thus, in the first place, in addition to economic growth rates, the assessment should include a simultaneous examination of a comprehensive range of financial indicators. Second, comparisons of measured performance must be based on criteria that embody a realistic assessment of the alternative options available both now and in the future. Finally and perhaps most important, quantitative assessments must be supplemented by an appropriate qualitative evaluation, especially of the policies that underlie the movements in measured indicators. In a fundamental sense, the availability of indicators cannot supersede the need for human judgment.


Occasional Paper No. 17

Aspects of the International Banking Safety Net

by G.G. Johnson, with Richard K. Abrams

During the 1970s, international lending by banks came to play a dominant role in the flow of international finance. In the early 1980s, banks have continued to play a major role, but the recent evidence of strains in international banking has raised questions about the prospects for continuity of international intermediation by banks.

This paper focuses on one aspect of banks’ willingness and ability to continue international intermediation. Banking history up to the 1930s was replete with crises that entailed a disruption of banking activity, drastically altering the volume, direction, and terms of the flow of funds within and among national economies. Could such a disruption occur today? The paper provides a qualitative assessment of the strengths and weaknesses of the existing safeguards for the continuity of international intermediation by banks. As background to that discussion, it also presents, in general terms, some conceivable origins of banking problems and some of the possible consequences of such problems for the international economy.

Advice on payment in currencies other than the U.S. dollar will be given on request.

Copies of these publications are available from:

Publications Unit

International Monetary Fund

Box A-102

Washington, DC 20431 USA

Occasional Paper No. 18

Oil Exporters’ Development in an Interdependent World

by Jahangir Amuzegar

Not unpredictably, there is a complex energy bind as we approach the end of the twentieth century. The oil importing industrial countries have anchored their whole energy-dependent lifestyle on hydrocarbon fuels. The major international hydrocarbon suppliers are limited to a relatively small group of oil exporting developing countries, most of whom are members of the Organization of Petroleum Exporting Countries (OPEC).

This study examines the role of the oil exporting developing countries in meeting their own economic development needs and their appropriate contribution to the international adjustment process. It focuses on the near-term problems and policies of the oil exporting developing countries within a global framework and briefly looks at world energy development and the role of petroleum in the future. The study is devoted mainly to a search for an appropriate national economic framework within which oil revenues can best be managed by the major oil exporting countries—a framework that, it is hoped, can relate domestic development strategies and policies to the exigencies of the international adjustment process. A concluding section attempts to outline the essentials of global cooperation designed to satisfy simultaneously the oil exporting developing countries and the energy-deficient countries.

Price of Occasional Papers: US$5 each (US$3 for university libraries, faculty, and students).

Other Resources Citing This Publication