Journal Issue


International Monetary Fund. External Relations Dept.
Published Date:
September 1984
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Rudiger Dornbusch and Mario Henrique Simonsen (editors)

Inflation, Debt, and Indexation

The MIT Press, Cambridge, MA, USA, 1983, xiii + 334 pp., $25.

Before the first oil shock, widespread indexation was often praised as a second best to price stability. A number of countries have adopted comprehensive indexation schemes for wages, bonds, and taxes to minimize the welfare losses caused by chronic and uncertain inflation rates, and they have been reasonably successful in this regard. But indexation represents an obstacle to relative price changes, specifically changes in real factor rewards. Any arrangement that weakens an existing brake on price changes increases the sensitivity of the general price level to any type of shock. And when an economy must adjust to internal or external supply shocks, the more widespread the indexation, the higher the rate of inflation must be if the loss is to be imposed via an inflation tax. Indexation may also reduce the political will to fight inflation, since it makes rising prices easier to live with.

These considerations have cooled the initial enthusiasm for indexation among economists and policymakers. They have also led to a variety of modifications in existing indexation schemes—adaptations designed to avoid passing on, into factor incomes, unavoidable terms-of-trade losses and to allow other necessary adjustments in income distribution or tax structure without causing extra inflation.

The chapters and discussions in this book are in part theoretical but also include considerable analysis of the experience with widespread indexation and inflation stabilization. Originally presented as papers at a conference in Rio de Janeiro in December 1981, they have been edited by two leading macroeconomists—Rudiger Dornbusch, from MIT, and Mario Henrique Simonsen, of the Getulio Vargas Foundation (which sponsored the conference). Brazil’s system of indexation is one of the most complete anywhere, and Professor Simonsen has had considerable practical experience in dealing with it, having been Minister of Finance and later Planning after the first oil shock during the 1970s. Professor Dornbusch has spent some months teaching in Brazil for the past several years.

The chapters are organized in four parts covering: (1) wages, prices, and inflation stabilization; (2) indexation experience; (3) indexation and assets markets; and (4) the panel discussion. Policymakers and other practitioners will no doubt find the chapters by Simonsen and Roberto Macedo on the Brazilian experience and that by Michael Emerson on the European experience most useful. The editors’ introduction is also very helpful. The chapter on stopping moderate inflation by Thomas J. Sargent (which compares the methods used by Raymond Poincaré in France in the 1920s and Margaret Thatcher in the United Kingdom in the 1980s) provides an insightful critique of gradualism from a rational expectations viewpoint, and that by Stanley Fischer includes a good summary of the arguments for and against the indexation of government bonds. Other chapters also include some analysis or useful insights for the practitioner but are more notable for their theoretical elegance.

This book, which includes a useful index and ample bibliographical references at the end of each chapter, is essential reading for those concerned with indexation and economic stabilization issues. While the debate on indexation and deindexation continues, this single volume provides the “state of the art” of a much debated issue. If it has a deficiency, it is in not including more analysis of the experience of the other Latin American countries (such as Chile, Argentina, and Colombia) and Israel with indexation.

Peter T. Knight

Robert Millward, David Parker, Leslie Rosenthal, Michael T. Sumner, and Neville Topham

Public Sector Economics

Longman, Inc., New York, 1983, ix + 283 pp., $18.95.

In surveying the primary literature of public sector economics this book covers four important topics: the incentive effects of taxation; economic relationships between central and local government; subsidies to the household sector; and the comparative efficiency of public and private enterprise. These are important topics, but practicing economists in government, faced with making difficult fiscal choices from a range of decidedly suboptimal choices, may not find the up-to-date review of the theoretical and empirical literature very useful.

On each of the four topics, the theoretical issues are outlined briefly and the relevant empirical literature is reviewed, based primarily on data from the United Kingdom. The interesting, if inconclusive, section concerning the relative efficiency of public and private enterprises also includes results from Canada, Australia, and the United States. Economists looking for policy implications will generally be disappointed; the conclusions more often relate to problems of estimation than to the nature of the phenomena measured.

One cannot, of course, fairly reproach the authors for the failure of their surveys to reveal operational concepts; they are simply the bearers of the bad news. There are two obvious reasons why the academic public finance literature is not moving in directions more helpful to the practitioner. First, as Sumner points out with respect to taxation:

theoretical results have been far more powerful in their negative role of demonstrating that much of the conventional wisdom rests on special assumptions, than in any more positive respect. When the special assumptions necessary for simple prescriptions are not fulfilled, optimal tax formulae require empirical magnitudes for their implementation.

This survey shows that the measurement of these empirical magnitudes lags far behind the corresponding theoretical advances. This gap between theory and measurement becomes even more hopeless for policy-making in the nonindustrial countries.

Second, because recent advances in the study of public sector economics tend to in corporate the political process in the analysis, the role of the economist becomes that of predicting the outcome of the dynamics of political and economic interaction. Thus, subsidy policy is assessed within the context of interdependent utility functions; local government is discussed in the context of the theory of clubs, social welfare functions, and median voter models; and the comparison of public and private enterprise is addressed, in part at least, through property rights analysis and ballot-box models. The contribution of this research is likely to be realized only in the long run when, hopefully, it will contribute to desirable institutional changes. In the short run, unfortunately, much of this research shares with recent advances in seismic research the doubtful utility of improving our ability to predict disasters, while doing little to help prevent them.

Robert Roy Schneider

Arjo Klamer

Conversations with Economists

Rowman & Allanheld, Totowa, NJ, USA, 1984, xii + 265 pp, $18.95 (cloth), $9.95 (paper).

This book’s main purpose is to evaluate the distinctive contribution of the new classical economics. The author interviews a number of economists, including the school’s main proponents, Robert Lucas, Thomas Sargent, and Robert Townsend, and lets them talk about the new classical approach in relation to Keynesian, monetarist, and other approaches. Other participants are drawn from different persuasions: there are neo-Keynesians such as James Tobin, Franco Modigliani, and Robert Solow of the “older” generation, and Alan Blinder and John Taylor of the “newer”; monetarist Karl Brunner; and nonconventional and pro-Marxian David Gordon and Leonard Rapping. The author includes a helpful introduction and a concluding interpretation.

As is perhaps to be expected from such a heterogeneous group, no consensus emerges. But the rational expectations view—namely, that people use all available information and their knowledge of how the economy works to determine their expectations—comes out relatively unscathed. Most participants would have no quarrel with grounding macroeconomic assumptions in the traditional microeconomic postulate of optimizing behavior. As Barro has put it in a recent article, the appropriation of the term “rational” forces opponents of this approach into an uncomfortable defensive position of either being irrational or modeling others as irrational. It seems to be generally agreed, however, that the new classical economics can be separated from rational expectations, since a macroeconomic model with rational expectations can lead to Keynesian conclusions.

The proposition of new classical models that active stabilization policies are altogether ineffective (the neutrality proposition) comes not from the hypothesis of rational expectations but from that of market clearing by prices. These models, in fact, set out to interpret the contemporary world as a moving Walrasian equilibrium. But are business cycles compatible with perpetual equilibrium? Lucas and Sargent explain business cycles solely as problems of information, such as asymmetries and imperfections in the information that agents have. The neo-Keynesians retort that this assumption is just as arbitrary as that of the institutional rigidities to which Lucas and Sargent object. Moreover, how does one reconcile market clearing with such observable problems as changes in inventories, middlemen, order backlogs, contracts in nominal terms, and so on?

What, then, is the essential ingredient of the new classical economics? Is it the neutrality proposition? To one’s surprise, both Lucas and Sargent downplay its importance. Is it their belief in the fundamental stability of the market? But then this is hardly a novel idea. Sargent explains that the key thing about the new classical economics is a commitment to some notion of general equilibrium and some notion of optimizing behavior. Put this way, these very broad notions can accommodate all sorts of models. It would appear, as the author is forced to conclude in the final chapter, that the distinctive claim of new classical economists concerns style, not substance.

I hope this brief review indicates how entertaining and informative the book is, even though it leaves the reader with a sense of the essential imprecision of economics itself. The conversational format inevitably lends more emphasis to rhetoric than to substance, but it does offer interesting insights into the personalities of some of today’s leading economic thinkers.

Subimal Mookerjee

David Worswick and James Trevithick (editors)

Keynes and the Modern World

Cambridge University Press, New York, 1983, xii + 269 pp., $37.50.

By any definition, Keynes was one of the greatest economists of all time. The centenary of his birth appropriately prompted a great deal of commemorative activity (Alexandre Kafka wrote an appreciation in the December 1983 issue of Finance & Development). King’s College, Cambridge, his alma mater, held a conference in July 1983 and this book presents its papers and an account of the discussions.

The anniversary comes at a time when, for over a decade, Keynesian economics has found itself under concerted attack by monetarists and supply-siders. If the latter have been riding the wave of the so-called counter-revolution with all the zeal of a newly discovered gospel, the adherents of Keynes have at times tended to be disorganized and defensive. The intellectual battle has been fought on several fronts: one has been on the contention that Keynesian policies no longer work, and that indeed they must be held accountable for many of the problems faced today; another, more speculative, has been focused on what Keynes meant in his writings and what he would have said if faced with current problems.

This debate has been frequently arid, sometimes confusing, occasionally instructive, and now and then amusing. It shows no sign of abating and some of the issues may still form the basis of learned papers on the bicentennial of the great man’s birth!

What of this volume? The conference was about the relevance of Keynes’ ideas for this world today. The authors are eminent economists and for the most part their papers are lucid and informative. The main benefit of this book is that it brings together many strands of the debate surrounding the economic thinking of Keynes. Nothing, however, is settled definitively and, as already indicated, the debate will continue. The reader would have gained by a greater contribution from the editors. A more comprehensive overview—not so much of the conference but of subject matter itself, setting forth clearly the areas of agreement, those of contention, and so on—would have been most useful especially if, as the editors claim, the book is aimed at laymen as well as economists.

Included in the volume are a number of memoirs by Keynes’ contemporaries. The most eloquent is the one by Sir Austin Robinson. In his deep appreciation of Keynes he writes: “The uniqueness of Keynes lay in the fact that he was three persons in one. He was a very great applied economist with extreme sensitivity as to how institutions and markets worked. He was a very great, and extremely original and innovative theoretical economist. He was an economist statesman with remarkable gifts of leadership and persuasion. His special greatness lay in the combination of the three.”

Bahram Nowzad

Robert J. Flanagan, David W. Soskice, and Lloyd Ulman

Unionism, Economic Stabilization, and Incomes Policies

European Experience

The Brookings Institution, Washington, DC, 1983, xviii + 705 pp., $28.95 (cloth), $18.95 (paper).

This study describes and evaluates the experience that several Western European countries had with incomes policy between the end of World War II and the late 1970s. Its opening chapter covers the general trends in the motivation and conduct of incomes policies, and provides a brief exposition on the theoretical bases of such incomes policies. The main body of the book, however, is a thorough analysis of the changing characteristics of collective bargaining in Austria, Denmark, France, Germany, Italy, the Netherlands, Norway, Sweden, and the United Kingdom. Against this background, the authors review the attempts of governments to mold, through incomes policy, the results of collective bargaining to the prevailing macroeconomic circumstances. Particular attention is paid to the substantially different experiences of these countries and to the institutional, social, and economic factors behind these differences. Through this emphasis, the book succeeds in providing a deeper understanding of the motives, constraints, and nature of the incomes policy measures undertaken. Going beyond a mere inspection of the macroeconomic variables permits the analysis to provide greater insight into the consistency, or lack of consistency, of these measures.

The discussion of the dependence of policy choices on specific political, social, and economic factors, however, does not fully consider the interaction between incomes policy and the monetary and fiscal policy stance. While occasional individual country studies refer to fiscal and monetary policies, a more comprehensive discussion of the macroeconomic policies that were followed in conjunction with incomes policy might have afforded additional insight into the latter’s effective potential and might have uncovered more information on the limitations of incomes policy.

The review of the European experience refers to the period before the 1980s. This is somewhat unfortunate, given the recent sharp deterioration in the public finances of most countries and the growing commitment of governments to restrictive financial policies. Much more than in the 1970s, incomes policy in the 1980s has been seen, therefore, not as an alternative but as a complement to fiscal and monetary restraint. Although the value of the book is not diminished by the limitations in its coverage, its usefulness for present-day policy-making is less explicit.

All in all, the authors provide a wealth of information on developments in collective bargaining in each of the countries analyzed, and on the manner in which governments have been able, or unable, to implement an incomes policy within the framework of collective bargaining.

Jozef Van’t dack

John Cornwall

The Conditions for Economic Recovery

A Post-Keynesian Analysis

M.E. Sharpe, Inc., Armonk, NY, USA, 1983, xi + 361 pp., $35 (cloth), $18.95 (paper).

Restrictive demand policies cannot succeed in curing stagflation, this book argues, they can only perpetuate stagnation. Any reduction they may bring in inflation will be short-lived. Cornwall faults the analytical basis of the anti-inflationary policies pursued by major capitalist economies, charging that they ignore institutional realities which prevent the realization of social benefits through market forces. He suggests instead a policy package to end stagflation—one that consists of stimulating demand, instituting industrial policies to foster productivity growth and structural adjustments, introducing permanent incomes policies, and simultaneously developing cooperative institutions to transform industrial relations. The impact of this package upon monetary developments, balance of payments, and exchange rates is touched on, but superficially. While the book is clearly written, it is highly repetitive and constantly switches between technical and nontechnical arguments. It contains an interesting review of developments in inflation and unemployment theory but ends on the unduly harsh note that “this kind of analysis contributes to economic breakdown” besides being bad science.

David Bigman and Teizo Taya (editors)

Exchange Rate and Trade Instability

Causes, Consequences, and Remedies

Ballinger Publishing Co., Cambridge, MA., USA, 1983, 340 pp., $35.

Concerned with the causes, effects, and some possible remedies for exchange rate and trade instability, this book is not intended as a unified or comprehensive appraisal of experience with managed floating. Rather, it consists of a collection of 13 essays by specialists, each focusing on some set of empirical characteristics of exchange rates (those by Frenkel, Bigman and Lee, Dooley and Shafer), on the theory of exchange rate determination (by Bigman, McKinnon, McNelis and Condon), on some aspect of trade instability (by Knudsen and Harbert, Kawai, and Chu et al.), or an individual-country experience (by Taya, von Furstenberg, Michaely, and Otani). The quality of these essays varies considerably and the coverage of topics is quite uneven—there is little discussion of why exchange rate and trade instability is costly or of what an equilibrium exchange rate is—but there are enough good pieces to make the book a useful supplementary source for graduate students.

Andre Martens

L’économie des pays árabes

Econimica, Paris, 1983, 199 pp., FF 95.

Contrasts could not be greater between the oil rich and labor-deficit economies of the Gulf countries and the labor-surplus economy of Egypt, not to mention the indigent smaller countries of the Yemens, Mauritania, or Somalia. Yet the book, quite rightly, finds homogeneity in this diversity and attempts to describe common conditions prevailing in the 20-odd Arab countries and their largely unfulfilled efforts at integration. With the exception of a few peripheral places, the core of the Arab world was, Martens believes, not truly colonized. He describes, however, as a perfect exploitation the system of “unequal trade” perpetrated by monetary unions such as the franc zone, and notes the deleterious effect on the area’s development of the free trade imposed on it in the nineteenth century through the tenuous Ottoman connection. The book’s excursions into explaining Islamic economics or analytical themes, such as the notion that the cost of extracting oil should contain an element of user cost are, however, sketchy and generally less successful.

David Gowland

International Economics

Bames & Noble Books, Totowa, NJ, USA, 1984, 193 pp., $25.75.

Strictly as a primer on international economics, this small book should appeal to a large audience. It is clearly written and covers the main theoretical aspects of the subdiscipline. It also has sections on policy aspects of the subject and discusses a few issues in their empirical setting (although mainly in terms of U.K. experience). But in a book on international economics originally published in 1983, and one that purports to be up-to-date, it is somewhat surprising to find no entry under “external debt,” given that this topic has dominated international economic discussion for the past several years. Otherwise, a good, concise introduction to an important, and increasingly complex, branch of economics.

Michael Stewart

The Age of Interdependence

Economic Policy in a Shrinking World

MIT Press, Cambridge, MA, USA, 1984, ix + 192 pp., $15.

A political economist’s view of growing international economic interdependence, this book is critical of policy-making in the major countries, which he believes to be based largely on perceptions of domestic needs. The author also sees a deflationary bias in national policies that creates a similar trend in the global economy. To reduce the economic and social costs of this bias in OECD countries—costs that, according to him, include huge unemployment and long-term environmental damage caused by short-term energy and economic policies—he advocates greater coordination of national economic policies and longer-term structural adjustment. The latter, he feels, will also pull the developing countries out of their current difficulties.

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