Adjustment and Economic Growth: Their Fundamental Complementarity

Mohsin Khan, Morris Goldstein, and Vittorio Corbo
Published Date:
September 1987
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Manuel Guitián
Deputy Director

Exchange and Trade Relations Department

International Monetary Fund

The purpose of this paper is to provide an overview of the direct role of the International Monetary Fund in support of economic adjustment efforts and the consequent attainment of economic growth. To this end, the paper will address a variety of issues that revolve around the essential characteristics of the relationship between the processes of adjustment and growth. As the title of the paper indicates, the analysis will stress particularly the fundamental complementarity that binds these two processes together. This property of their relationship, of course, constitutes a basic principle underlying the approach of the Fund to the issues of adjustment and growth. In the process, the analysis will also seek to bring forth the opportunities that the complementarity between adjustment and growth opens as well as the limitations that it imposes for economic policy formulation.

This paper is concerned mainly with the adjustment policies of members seeking access to Fund resources. Therefore, its scope does not extend to an examination of other important aspects of the role of the institution in the international adjustment process. The broad dimensions of the responsibilities of the Fund in this area, including its provision of financial support, reflect the universal character of its membership as well as the ample realm of its mandate. The membership encompasses a variety of countries, developing and developed, debtor and creditor alike. The mandate includes responsibility for surveillance over member economic and financial policies as a means to foster orderly economic growth with a measure of price stability in a setting of liberal and open exchange of goods, services, and capital among countries.1 Through the exercise of surveillance, the Fund seeks to establish in the international economy conditions that are supportive of the balance of payments adjustment efforts of individual members. Surveillance can enhance the effectiveness of those efforts and therefore, it constitutes another of the important contributions of the Fund toward the improvement of the functioning of the adjustment process. But to yield results, the implementation of surveillance requires consistency with other Fund policies in support of adjustment, including, in particular, those discussed in this paper.

The focus of the paper will be on policy issues that arise in the specific context of adjustment and growth and that appear of particular relevance from the perspective of the Fund and its relationship with members that seek use of Fund resources as well as with the membership as a whole. The examination of these issues can hardly be expected to cover the complexities of the subject in their entirety; rather, the intention is to shed light on certain critical aspects of the choices that have to be made in the economic policy decision-making process as they emerge in the context of Fund operations with members.

The plan of the paper is as follows: the analysis will first focus on the nature and characteristics of the imbalances that typically confront member country economies. Second, the paper will examine the various objectives of adjustment, their interrelationship and the implications for the Fund’s operations of the priorities that members set with regard to the scope and speed of achievement of the various goals. Third, the analysis in the paper will discuss the realities of adjustment and how these are influenced by the requirements of growth. Against this background, the paper will then outline a broad framework for the design of adjustment and the attainment of growth. Such a framework will permit an examination of the broad domestic and external policy areas, as well as their interplay, that are generally involved in the formulation of an adjustment plan. Given the specific requirements of the attainment of growth as a concrete objective, this examination will widen the analysis to include among the possible policy actions the need for supporting measures in concrete sectoral domains. On the basis of this framework, the paper will then discuss issues, choices and constraints that the pursuit of adjustment and growth pose for the Fund and for member countries. Finally, the paper will close with some brief remarks concerning areas where scope for further action on the part of the Fund may be warranted to strengthen the positive interaction between adjustment and growth.

Nature and Characteristics of Adjustment Need

An important element for purposes of the design of an adjustment and growth strategy is an assessment of the nature and characteristics of the imbalance that needs to be redressed. On the most general level, an actual or a potential need for adjustment may arise in a variety of manners and for a variety of reasons. It can develop because the sum total of demands for resources that develop in an economy exceeds the global amount of resources that can be made available internally and those that can be obtained from abroad on an appropriate scale and on sustainable terms. But it can also emerge on account of inefficiencies in the use of available resources or other distortions that constrain the level or the rate of expansion of aggregate supply—most likely, both of them—and therefore keep the economy operating under its capacity and below its potential rate of growth. Actual or potential aggregate imbalances that conform to this general description recur in all economies, albeit with a varying degree of frequency. For purposes of addressing such recurring imbalances, it is also important to ascertain other of their specific characteristics. This will require, for example, an assessment of the origin of the imbalances—that is, whether they are the result of external or internal factors—and of their nature—that is, whether they reflect exogenous or endogenous causes and, more important, whether they are transitory or permanent.2

An accurate assessment of the various features of the imbalance in need of adjustment can contribute greatly to the quality of the design of the required adjustment effort. For example, the particular mix of policies will of course be influenced by whether the imbalance is the result of demand or supply factors, or by whether it reflects external or internal events, or by whether or not it is attributable to domestic policy developments. Important though these features are, they are not as critical, for purposes of policy decision making, as the evaluation of the temporary or permanent character of the imbalance, which besides affecting the policy mix, will determine the strength and pace of the adjustment effort required for its elimination.

The characteristics of the adjustment need, therefore, have clear implications for the design of the adjustment effort. In addition, an issue that needs to be kept under close examination is the correspondence that has been established over time between the development of an adjustment need and the consequent formulation and implementation of an adjustment effort (both of them flow concepts). 3 The extent to which need and effort are commensurate with each other in scale and timeliness will determine whether or not the imbalance in one period is being passed on to the next. These considerations interact with the distinctions outlined above concerning the characteristics of an imbalance, which, in this context, may lose some of their initial relevance. For example, a temporary imbalance which is not corrected opportunely may prove to be less transitory than it seemed originally.4 Similarly, an exogenously created imbalance, unless corrected promptly, can give rise to endogenous developments that compound it.

This line of reasoning cannot be overstressed in present circumstances in the international economy. Instances abound in recent years of imbalances accumulated over a relatively long period of time (a stock concept) which have led to a distribution of liabilities and assets across countries, the characteristics of which have exacerbated the difficulties typically associated with the adjustment process. Rapid accumulation of external debt and payments arrears have constrained the scope for economic policy management in debtor countries. It has also led to a slowdown, indeed, a virtual interruption of capital flows from creditor countries along their historically normal patterns. As a result, severe constraints have arisen for the adjustment process and the attainment of economic objectives, in particular, economic growth.

Objectives of Adjustment

Economic policies in general, and adjustment policies in particular seek a broad range of objectives of a diverse but generally interrelated nature. From the standpoint of member countries, the choice among those objectives is based not only on economic criteria but also on other considerations. Objectives that are selected mainly on economic grounds include: the achievement of a sound growth rate and the maintenance of an appropriate level of employment, a measure of domestic price and exchange rate stability, and a viable balance of payments position. Among the various economic policy goals, these are the most often mentioned in the international context because, besides their clear importance for each particular economy, they are most relevant for the interrelationship among national economies.

There are also economic policy objectives the selection of which reflects a mixture of economic and other criteria and that are of importance mainly (though by no means solely) in a domestic context. The pursuit of these objectives is based on a combination of economic, social, and political considerations and frequently responds to concerns about the equity and the distributional consequences of economic policies. Thus, besides the growth, price, and balance of payments objectives outlined above, country governments often seek the establishment of standards of welfare through the pursuit of equity-oriented goals in a diversity of domains, such as income distribution, education, and nutrition.

Clearly, the scope for the attainment of the full spectrum of such varied economic policy aims is bound inevitably by the relationship that prevails between required and available resources. The setting of priorities, therefore, involves choices with regard to the mix of objectives as well as with regard to the speed of their relative attainment and constitutes an integral part of the process of economic policy formulation and decision making. Indeed, the appropriateness of those choices can be a critical factor for the sustained implementation of economic policies, which in turn is often a necessary condition for the attainment of the objectives. Alternatively, evidence of progress in the adjustment effort, which is often measured by the appropriateness in the balance in selection of economic aims and by the record of proximity toward their attainment, can provide the strongest grounds for its sustainability.

On the part of the Fund, its broad purposes are described in the basic charter of the institution, the Articles of Agreement. They call for the expansion and balanced growth of world trade as a means toward the promotion and maintenance of high employment and real income levels as well as toward the development of the productive resources of all members. The institution seeks to fulfill its purposes by fostering economic and financial cooperation among member countries in a setting of exchange stability and orderly exchange arrangements and in the context of a liberal system of multilateral payments. To this end, it is well known that the Fund stands ready to make resources temporarily available to members in support of their efforts to correct maladjustments in their balance of payments. The basic aim is to shorten the duration and lessen the degree of the imbalance in the payments positions of members through the adoption of policy measures compatible with individual member interests as well as with those of the membership as a whole.5

In the provision of financial support to members’ adjustment efforts, the Fund needs to be assured that their policies are consistent with the code of conduct embodied in the institution’s charter and it must also establish adequate safeguards to ensure that the use of the resources will be temporary.6 It is, thus, clear that the Articles of Agreement call upon the Fund, in a particularly direct fashion, to support members in balance of payments need that are willing to adopt corrective policies that conform to the agreed code of conduct and that give assurances that the specific objective of balance of payments recovery will be achieved over a foreseeable period.7

In its financial relationship with individual members, therefore, the Fund stresses the attainment of balance of payments objectives as the domain in which the interests of each member and those of the membership as a whole intersect and coincide. Of course, this does not mean that the institution is indifferent or oblivious to the achievement of other objectives. In particular, sound rates of economic activity, employment, and growth as well as price stability are objectives shared by the Fund and its membership. From the perspective of the institution, attainment of these other policy objectives cannot but strengthen the recovery of the balance of payments and make it durable. But it must be stressed that the Fund’s concern with these policy aims is based on their complementarity with the strengthening of the external payments position. Members naturally seek to attain them for this as well as for other reasons of possibly more importance domestically.

Besides the safeguard and promotion of the interests of the membership, in its financial operations with individual countries8 the Fund aims at keeping an important measure of circumspection in its interaction with members in the area of policy formulation. Such circumspection is required to avert undue international interference in domestic policy decisions. It is manifest in the priority the institution accords to external objectives—for example, balance of payments, exchange restrictions, external payments arrears—and the latitude its policies allow members to retain with regard to other domestic economic objectives—e.g., growth, price stability. The observance of what might be termed a principle of political neutrality is required to an even larger extent with respect to domestic policy objectives that are pursued for equity, social, or political considerations.9 The exercise of discretion on these fronts, however, is not an indication of disregard or indifference. The establishment of social or political priorities, even when they overlap with economic considerations, is part of the domain of independent national policy decision making. International circumspection, therefore, is only a reflection of respect for such independence. Noninterference, of course, does not preclude the Fund, whenever necessary, from assessing the claims that domestic priorities put on available resources and from pointing out their economic implications and in particular any resulting balance of payments pressures.

Realities of Adjustment and Requirements of Growth

As made abundantly clear by developments in the international economy in recent years, a feature of the international adjustment process that cannot be overstressed is that external payments imbalances can prevail only for as long as they can be financed.10 Thereafter, adjustment will occur, and claims on resources will be confined to those that are domestically available, whether or not specific policy actions are undertaken. Consequently, a key reality to keep in mind when confronting an external imbalance is that the issue is not whether it will be adjusted, because it will be, but rather, how it will be adjusted, efficiently or otherwise.

Another important reality that warrants attention in this general context concerns the relationship between adjustment and financing11 and its implications for the design of a strategy to redress an external payments imbalance. The issues that arise in this regard involve intertemporal trade-offs and serve to illustrate the connection between a flow (initial) imbalance with a stock (accumulated) disequilibrium that was mentioned earlier. Financing and adjustment can substitute for or complement one another as an external imbalance develops. The possibility of relying on foreign borrowing or on international reserve use (financing) rather than on policy action (adjustment) is a course of action that, as noted above, can only be pursued temporarily. Such a strategy basically transfers and adds the imbalances from one period to the next until the cumulative adjustment need surfaces abruptly, often when no more financing is available and the scope for the incurrence of payments arrears is exhausted. At that moment, the burden of adjustment is to correct the existing flow imbalance that remains together with previous imbalances that were allowed by means of the accumulation of external liabilities on unsustainable scale and terms.

But financing can instead be used in conjunction with adjustment policies to tide the economy over the period required for the policies to yield their results. The mix of adjustment and financing required by this alternative strategy can vary depending on the strength of the policies and the speed with which they are adopted. Other things equal, the stronger the policy measures are, and the faster their implementation is, the lesser will be the associated need for financing.12

The characteristics of the particular blend of adjustment and financing are among the factors that influence the specific constellation of objectives achieved over time in the process of adjustment. For example, the particular path of the balance of payments during the period of adjustment and beyond will be affected, among other things, by the amount and terms of the financing that has been used in the process. The larger the magnitude of financing and the harder its terms, the higher will be the claims placed on future resources, and therefore the stronger will have to be the balance of payments results to be attained by policy action.13

This line of reasoning leads directly into the relationship between adjustment, financing and policy objectives, and in particular, economic growth. Emphasis on economic growth in the adjustment process does not run counter to the objective of balance of payments viability. It is important, however, to stress that although normally the attainment of both objectives goes hand in hand, whenever the imbalances to be corrected have led to or were associated with unsustainable growth rates in the economy, the restoration of growth to a sustained, even though lower, path represents an element of the solution rather than being a manifestation of a problem.14

It is conceivable that for a given amount of external and internal resources, concentration on achieving growth will constrain the range of the policy mixes that otherwise would be compatible with a viable balance of payments. To an extent, such constraints may reflect trade-offs between growth and other domestic policy objectives (particularly those of a distributional character) more than trade-offs between growth and balance of payments outcomes per se.

When correction of a balance of payments imbalance is to be undertaken, growth considerations are also raised to influence the choice of the mix between adjustment and financing. In this context, it is often argued that a bias in favor of financing is appropriate whenever growth objectives are part of the policy strategy. As developed more fully later, however, the issue at stake here tends to revolve more frequently around the efficiency of resource use than around the amount of resources. If efficiency requirements are met, the choice of the adjustment financing mix has to be guided by the relationship on the margin, between the rate of return and the cost of the foreign resources. Use of foreign financing beyond the point where their yield covers their cost would not be advisable either from the perspective of growth or the balance of payments. Another way in which this argument can be put is the following: the more foreign financing is resorted to, the more resources will have to be devoted in the future to its servicing. Consequently, unless the growth associated with such financing reflects its efficient use, it will not be sustained. Indeed, growth in the future may have been mortgaged if financing was undertaken in excess of the economy’s absorptive and productive capacities.

Broad Framework for Adjustment and Growth

Programs of adjustment are typically required to bring aggregate demand in an economy in line with its productive capacity or, for a given global demand, to bring such productive capacity to its potential level.15 Among their various goals, the programs include a strengthening of the balance of payments, a measure of price stability, and an improvement in growth performance. It is important to stress, at the outset, that in exact parallel with adjustment, the attainment of a sound rate of growth depends on two critical factors: the amount of resources available to an economy; and the efficiency with which it uses those resources. Consequently, adjustment programs contain an important array of policies and measures that besides restoring balance to the economy, are aimed at the mobilization and efficient use of resources, and in particular at an increase in savings and, as a result, in the potential for investment.

Policies of adjustment can be classified in accordance with a variety of criteria, but such classifications are rarely clearcut because sectors and economies are interdependent and therefore the effects of policy actions are pervasive. It is useful nevertheless to group the various policy measures according to the variables on which they exert their strongest (though not their only) impact. From this standpoint, policies and measures that influence in a relatively straightforward manner the level and composition of aggregate demand are often distinguished from policies and measures that seek to affect directly the rate and structure of production in the economy. The underlying rationale of the distinction is that among the variety of factors behind the emergence of a global imbalance in an economy, there is frequently an unsustainable expansion in aggregate demand and expenditure, and consequently, its elimination will entail a reduction in the level or the rate of growth of demand. At the early stages of the process, it is not always easy to provide an unambiguous diagnosis that such an expansion in demand is an indication of a developing imbalance that requires correction. This is particularly the case when the combination of its effects gives grounds for diverse, if not conflicting, assessments. In specific terms, incipient increases in global demand and expenditure can—and often do—give rise to developments in certain areas (e.g., employment, output) that are generally perceived as favorable. These perceptions are not always sufficiently tempered by concurrent developments in other domains (e.g., prices, balance of payments) even though these rarely can be described as positive.

There is a variety of reasons why reactions may be biased in favor of the areas with favorable effects. To begin with, pressures on domestic prices and the balance of payments may not manifest themselves immediately, as some of the effects of the expansion in demand can be masked by borrowing abroad or by utilization of international reserves or both. Even where the resulting increases in external debt and declines in foreign assets are viewed with a measure of concern, these developments may be considered at the time to be a reasonable price to pay for the positive events elsewhere in the economy. As the process develops, however, the scope for increases in external debt and declines in international reserves becomes progressively limited. At this point, the adverse price and balance of payments performance becomes increasingly evident, often at a time when the initially positive developments in the employment and output fields either begin to falter or have already disappeared.

Amount of Resources and Macroeconomic Balance

For these reasons, a key function of economic management is to keep the level and the rate of growth of aggregate demand in a sound relationship with the level and growth prospects of the economy’s productive capacity. For a given level of such capacity and a given structure of relative prices and costs (including exchange rates and interest rates), this will entail the prevalence of domestic financial policies that are consistent with macroeconomic balance in the economy. This is a first broad area of interest in the context of the relationship between the Fund and its members.

Investigation of the sources of expansion in aggregate demand frequently indicates that they are directly associated with imbalances in the fiscal accounts or more broadly in the public sector finances. Such imbalances, not surprisingly, are typically the outcome of the pursuit of objectives requiring levels of public sector expenditure that exceed the sector’s willingness or ability to raise and collect revenues.

The correction of imbalances that originate in the public sector finances encompasses a variety of policy actions that constitute what may be labeled the fiscal aspect of macroeconomic management. All of these actions ultimately consist of measures that specifically seek to curtail fiscal spending or to raise additional fiscal revenues in order to bring the resulting public sector balance to a sustainable position. The particular mix of measures chosen to correct a fiscal disequilibrium will, of course, influence the general performance of the rest of the economy. For example, the implications for the private economy will vary depending on whether the fiscal strategy focuses on measures to control outlays or whether it stresses instead revenue-raising actions. At a first approximation, an approach based on reduction of public sector spending seeks to restore balance in the economy by directly lowering the participation or weight of the public sector in aggregate demand. In contrast, the balance that would obtain from an approach based instead on raising domestic fiscal revenues would tend to be accompanied, other things equal, by a reduction in private demand. The consequences across the economy of different fiscal policy mixes are therefore diverse, but they also vary over time as they influence differently the incentives and signals they provide for economic decisions.16 Not only do fiscal policy packages differ in impact; they also differ in the certainty and speed with which they yield results. For example, an action to curtail spending and an action to raise revenue do not carry necessarily the same probability with regard to the magnitude and the timing of their respective results. Among other reasons, this is because the scope for a government to control its spending generally exceeds its ability to ensure that its receipts will rise.

There is, of course, a close relationship between fiscal policies—interpreted, as already noted, to mean actions that influence the flows of public sector outlays and revenues, and the broader sphere of financial policies, that is, those related to developments in credit, money and borrowing flows in an economy. In a domestic context, this relationship has been investigated extensively, among other things, to establish the relative role of fiscal and monetary policies in macroeconomic management.17 Difficulties have been encountered in making an unambiguous distinction between them if only because public sector spending or revenue measures—fiscal policy—influence strongly the public sector borrowing requirement in general and its need for domestic bank financing in particular—monetary policy.18

These considerations underscore that the maintenance of aggregate demand on a sustainable path calls for a measure of control over the flows of domestic financing and specifically over the rates of monetary and domestic credit expansion. These constitute what might be called the monetary aspect of macroeconomic management and stress as a key element the relationship that exists between the rate of domestic credit expansion and money supply increases, on the one hand, and among these and the levels of aggregate demand and expenditure, on the other. The other element to underscore in this general context is the important and well-established relationship that prevails under most circumstances between the demand for money balances and the level of global income in an economy. The combination of these two elements serves to bring to the surface the notion that, under most circumstances, a discrepancy between the supply and demand for money (an imbalance in the money market) has as a counterpart an imbalance between expenditure and income (an imbalance in the market for goods and services).19 Therefore, the process of restoring a sound relationship between expenditure and income will also entail keeping domestic credit expansion in an appropriate balance with the prospective path of desired money holdings in the economy. Generally, although they can be influenced by policy actions, the behavior of these holdings is determined by the public.20 Consequently, policy formulation in this area focuses mainly on the rate of domestic credit expansion to ensure that sustained balance prevails or is brought to the money market, in the sense that it is not bought at the expense of the balance of payments (e.g., international reserve losses, excessive foreign borrowing) or of price and exchange rate stability.

These general considerations provide the rationale for the particular importance attached to domestic credit expansion as a policy instrument in the context of Fund policies.21 From the specific perspective of the Fund, this is perhaps best explained by stressing the close relationship that exists between this policy variable and the balance of payments. Under most circumstances, such relationship is relatively more direct that the one between monetary expansion and the external accounts, as made evident by the possibility of coexistence of a given stock of money with markedly different balance of payments outcomes. Given the need to protect the temporariness of the use of Fund resources, it is imperative that policy be formulated in a manner that does not permit, even over the limited periods in which they can occur, trade-offs among economic policy objectives that endanger balance of payments prospects and weaken international reserve positions, as would be the case if inflation or growth targets were to be pursued at the expense of international reserve losses.

Consistency in macroeconomic management requires that its fiscal and monetary aspects be complemented by supportive foreign borrowing policies—the external debt aspect of macroeconomic management.22 The macroeconomic implications of external debt management policies derive from the direct influence that they can exert on the expenditure-income flow and from the substitutability that exists between foreign and domestic credit. In general, given an economy’s productive and absorptive capacities, there is a level of aggregate demand and expenditure that is consistent with sustained growth, price stability and a viable, and therefore, sustainable, balance of payments position. In effect, the key aspects of macroeconomic management include monitoring the global (e.g., foreign and domestic) flow of financial resources available to the economy to ensure its compatibility with a pattern of expenditure and income that can be sustained.

From a different vantage point, the relationship between domestic financial and external debt policies also manifests itself in the latter’s influence on international reserve and overall balance of payments developments as well as on the inflation and growth fronts. Put in a nutshell, in the presence of an imbalance (as defined earlier in the paper), foreign borrowing can make it temporarily possible for domestic demand and the rate of growth to reach levels beyond those that the economy can sustain. In these circumstances, the accumulation of external debt has in effect substituted for the price pressures and the international reserve losses that would have surfaced in its absence.

Efficiency in Resource Use and Economic Incentives

Until now, the discussion of macroeconomic management has proceeded on the assumption that the economy’s productive capacity and the structure of relative prices and costs were given. Therefore it concentrated on key macroeconomic policies where attention has to focus to ensure that aggregate demand is kept in line with the economy’s productive and external debt-carrying capacity at the prevailing relative cost-price structure. But the economy’s productive potential and its capacity to service debt are influenced directly by macroeconomic policy actions as well as indirectly via their impact on relative prices and costs.

In general, the borrowing process transfers command over resources from surplus to deficit sectors or economies. In a closed economy context, with a given resource and technology endowment, output and growth will depend on the economy’s propensity to save and the efficiency of its investment. The domestic borrowing process, by channeling resources from savers to investors, helps the economy with its given resource base to attain its potential level and rate of growth of production. An open economy, in contrast, has an additional source of resources, the use of foreign savings, for which the accumulation of external debt provides an important channel. Thus, aside from its already discussed macroeconomic impact, foreign borrowing adds directly to the resources available to the economy. If utilized efficiently, such borrowing can allow the economy not only to reach higher expenditure levels as noted above, but also to grow at higher sustained rates than otherwise.

These considerations highlight the link that exists, via the current account of the balance of payments, between domestic macroeconomic management, external debt policies, the saving-investment process, and the long-run evolution of the economy. They also make clear that a medium-term horizon is required for the formulation and assessment of policies, and this is also the appropriate timeframe for the achievement of objectives like growth and external payments viability.

A sustained adjustment effort, particularly where growth is an especially important objective in addition to the balance of payments, requires that macroeconomic balance be attained in a setting of appropriate incentives and signals to guide decisions to allocate and use resources efficiently in the economy. The adequacy of structure of relative prices and costs is critical in this regard. Imbalances, especially when they are allowed to persist, often result in relative price-cost misalignments both among sectors in the economy and between the economy as a whole and the rest of the world. In these circumstances, the conduct of macroeconomic policy in the various areas already discussed often needs to be supported by suitable adjustments in key prices and costs for progress in the attainment of macroeconomic balance to be durable.

This is one of the domains of economic policy where macroeconomic management blends with structural adjustment and the scope for action is indeed ample. In the realm of fiscal policy, particularly in the area of expenditure management, a key issue relates to the efficiency and composition of spending. The durability of an effort to control demand and public sector expenditure will depend, inter alia, on the curtailment of unproductive spending and in particular, on the protection of productive investment outlays. In the area of fiscal revenues, improvements in the structure of tax rates can also contribute to enhance productivity in the economy, thus underpinning the quality of global fiscal management.23 Other possible supporting actions of equivalent importance encompass the broad realm of public sector enterprise pricing policy, including sectoral producer and consumer prices and the related question of subsidies. More generally, the maintenance of an appropriate structure of relative prices is required to promote efficiency in the allocation and use of resources among sectors in the economy. At times, for reasons often associated with distributional aims, prices of goods and services of importance from an economywide standpoint are allowed to become unrealistic, despite adverse allocative and financial consequences. In those circumstances, a critical element for adjustment will be the restoration of adequate prices relativities.24

In the sphere of monetary and credit policies, these must lead to appropriate domestic interest rates, which are critical to ensure efficiency in the allocation and use of financial resources in the economy. Consequently, they are also of primary importance for growth and balance of payments viability. On a general level, these objectives call for domestic interest rates that help mobilize domestic savings, that is, interest rates that are appropriate in real terms. They also call for those interest rates to be competitive internationally so as to retain savings internally and encourage foreign capital inflows.25 This is yet another perspective from which the policies required for purposes of growth and the balance of payments coincide, although it may be pointed out that examples abound where interest rates have been kept uneconomically low, even negative in real terms, on the grounds that high interest rates adversely affect investment and growth.

Another area the importance of which for growth and external payments viability cannot be overstressed concerns exchange rates and competitiveness. Persistent imbalances in an economy typically result in patterns and movements of domestic prices and costs that diverge significantly from those that prevail abroad. Resource allocation is distorted and competitiveness is impaired in the process and so are the growth and balance of payments performance of the economy.26 In these circumstances, exchange rate adjustments or flexibility in exchange rate management, or both, supported by appropriate macroeconomic policies, can be crucial to restore competitiveness and balance to the economy by helping to bring factor prices, including wages, and absorption, particularly consumption, to realistic levels. In broad terms, the usefulness of exchange rate adjustments and more generally of exchange rate policy lies in their widespread effects on the economy. When competitiveness has been eroded and balance of payments pressures prevail, exchange rate action helps to shift demand from international goods to domestic goods. In the process, it also causes variations in the real value of nominal assets and as a result influences the level or rate of growth of global demand and expenditure. Therefore exchange rate policy contributes to balance the external accounts directly by containing domestic absorption and indirectly by improving resource allocation between the internal and external sectors.

But in order to improve incentives and yield results, macroeconomic policies, as well as domestic price and cost adjustments, need to be supported by the opening up of the economy. The efficiency of pricing signals in imparting information among sectors and among economies concerning their respective relative resource scarcities and demand patterns can be seriously impaired by the presence of restrictions and controls. Therefore another important and desirable component of an adjustment strategy is the liberalization of exchange and trade regimes to ensure that economic incentives and pricing signals fulfill their functions.

Specific Sectoral Measures

The attainment and maintenance of an economy’s growth potential often call for other specific actions to eliminate inefficiencies in the economy as a whole or in concrete sectors within the economy. These sectoral policy domains are of particular importance in the context of structural adjustment. The liberalization of trade and exchange restrictions already noted constitutes a necessary complement to policy measures in the macroeconomic and pricing spheres for the attainment of sustained growth and balance of payments viability. From a logical perspective, an adequate adjustment effort would include among its various aims the elimination of restrictions maintained for balance of payments reasons because absence of the need for such restrictions is one of the characteristics of external viability.

Besides the external sector, there are other domains for action of a specific character that include the following: the public sector enterprises where issues of efficiency typically arise in connection with pricing, employment, investment, and financial management decisions; domestic financial sector reform, where the issues to be resolved can span from the viability of the sector to its ability and efficiency in mobilizing savings; labor market conditions, where the issues often include, besides the appropriateness of wage rates, rigidities in sectoral mobility and the realism of labor legislation; and capital markets, their adequacy and accessibility, including prospects to foster direct investment flows.27 In this context, the importance of open capital markets in creditor and debtor countries alike cannot be overstressed because it is critical for the restoration and maintenance of balance in the structure and level of capital movements.

The measures most closely related to the broad policy areas discussed earlier are those in connection with the liberalization of exchange regimes, which fall within the direct competence and responsibility of the Fund, and of trade systems, where the Fund shares its interest with the General Agreement on Tariffs and Trade (GATT) and the World Bank.28 Through its regular consultation as well as its technical assistance mission work with member countries, the Fund has been actively involved in the process of reform of specific economic sectors. These activities have included the development of central banking and money market institutions; the improvement of exchange market arrangements; and the establishment of adequate institutional machinery for coordination of policy decision making as well as for monitoring economic performance, particularly in the fiscal and external debt management areas. A number of these activities fall within the domain of common interest to the Fund and the Bank and the two institutions collaborate closely in the exercise of their respective roles in these areas.29 The issues that arise in connection with such institutional reforms are not generally perceived as an integral part of the broad realm of global economic management, but they can be critical for the efficient operation of the economy and therefore are important in the context of the design of a growth-oriented adjustment strategy.

Issues in the Context of Adjustment and Growth

A major aspect of the role of the Fund in adjustment consists of the provision of resources to members that are not only in need of balance of payments support but also willing to undertake policies appropriate to correct their external imbalance. As has been often remarked, the policies and conditions attached to the assistance provided by the Fund have helped to catalyze financial resources from other sources. From this standpoint, it can be said that the Fund helps to oversee the distribution of capital flows among member countries so that it contributes to the effectiveness of adjustment and thus proves beneficial to each member and the membership as a whole.30 On this front, the institution’s approach underscores that from an economic perspective, key determinants of the flow of capital include the prospects concerning its rate of return and the probability of its continued service. Only on this basis can sustainability of capital flows be postulated. Consequently, policies in borrowing countries have to provide assurances with regard to the return and servicing of capital flows in order to attract external savings on a sustained basis. In recent years, the movement of capital across countries has been severely curtailed. In the circumstances, the Fund has had to develop increasingly active procedures in an attempt to ensure that external assistance in support of adjustment efforts actually flows on the required scale. These procedures were built around members’ financial arrangements with the Fund. Besides being the main vehicles for the provision of Fund resources, these arrangements became the pivot around which the institution organized its efforts to elicit support from major creditor countries and from main sources of private capital, including in particular, the commercial banks. In this manner, at a time when capital movements had virtually ceased, the Fund played an increasingly important role as a catalyst for capital flows to strengthen adjustment.31 An important factor, therefore, for purposes of adjustment and growth in borrowing countries will be the continued ability of the Fund to muster external resources as well as to elicit responsible actions on the part of creditors and capital exporting countries to allow capital to flow efficiently.

The temporariness in the use of Fund resources prescribed by the Articles of Agreement constitutes a specific form of recognition that balance of payments problems have to be corrected to permit, at a minimum, timely repayment of the resources drawn from the institution. The elimination of the external imbalance will require actions to reduce the excess of absorption over production of resources supplemented in most circumstances by measures to induce a reallocation of those resources in order to ease the foreign exchange constraint and also to increase output. The general characteristics of the main policies that will be necessary to these ends have already been discussed. But the scope and variety of possible policy packages is ample and therefore choices have to be made which, in turn, give rise to a number of issues.

From the standpoint of the member country, key decisions are required with regard to the specific mix and strength of the policies to be pursued. These decisions bear importantly on the time horizon over which the adjustment is to be made and on the constellation of objectives to be pursued, besides those related to the balance of payments. In general, the availability of choices on these various fronts is constrained by the resources that are likely to be available during the period of policy implementation. Typically, the longer the imbalance has been allowed to prevail, and therefore, the larger its magnitude has become, the tighter the constraint is and as a result, the more limited are the possible courses of action. Therefore a critical factor to take into account in the process of policy formulation is resource availability.

Given the resource constraint, emphasis in the selection of the policy mix must be placed on efficiency in resource use. This is possibly the most crucial consideration from the standpoint of policy selection, because it can help release the resource constraint directly by eliminating inefficiencies and indirectly by stimulating resource mobilization both internally and externally. Thus, although resource availability can pose a constraint on policy choices, the quality of those policies can influence the availability of resources and therefore ease the constraint.

Besides available resources, another factor that typically influences the policy formulation process is the combination of objectives that are pursued. One of the reasons for such influence is the perception of the existence of trade-offs among policy objectives. Arguments abound to the effect that growth in an open economy is subject to a foreign exchange constraint.32 These arguments highlight the possibilities of conflict between growth and the balance of payments. Trade-offs are also often perceived between inflation and growth as well as between inflation and the balance of payments. There is a limit, however, to the lid that can be put on inflation by incurring balance of payments deficits, as there is to the growth in demand that can be fostered either by inflationary means, by excessive external borrowing, or by international reserve losses. Despite these considerations, the perception of such trade-offs often influences the choice and mix of policies.

The fundamental point that needs to be underlined is that tradeoffs among policy objectives are more apparent than real. Under most circumstances, the only trade-offs that exist are intertemporal and these depend on the scope that is available for allocating policy decisions over time. It is clearly possible for a limited period—and examples abound to this effect—for an economy to grow at an unsustainable rate and maintain a measure of price stability at the expense of deficits in the current account and the overall balance of payments. But this possibility is only a reflection of the choice that can be made between growth today versus growth tomorrow and of the trade-off of price stability today for inflation tomorrow.

A broader set of considerations apply to the relationship of growth, price, and balance of payments objectives to other aims simultaneously sought on account of a combination of economic, social, and political factors. These aims reflect, among other aspects, equity standards and focus particularly on the distributional effects of economic policy actions.33 From the vantage point of economic efficiency, the scope for trade-offs between these two sets of objectives is limited. In the context of a relatively open environment, social and political aims can rarely be pursued, on a sustained basis, at the expense of the efficient operation of the economy. In this context, it is generally futile to argue that there can be a sustained conflict between the criterion of economic efficiency and equity considerations; on the contrary, it is inefficiency and waste that run counter to equity.

These considerations, however, do not go as far as saying that economic objectives can be pursued without regard being paid to social and political aims. On the contrary, awareness and sensitivity toward these latter aims are essential to govern effectively and they can enhance a government’s ability to carry out the necessary economic measures and reforms. The important question here is not that social and political considerations are to be altogether disregarded; the critical issue is rather to prevent the regard for such considerations from running counter to the requirements of efficiency in the use of scarce resources. In general, there can hardly be any question that the pursuit of goals for equity, social, or political reasons influences the performance of the economy. In general, the attainment of such goals places a claim on available resources, which therefore, become unavailable for other purposes. In this sense, trade-offs do exist between policy objectives, but as long as efficiency in resource use is not impaired and as long as choices conform to the economy’s preferences, conflicts need not arise.

These relationships between policy objectives and the criteria for their selection are but aspects of a broader link that binds the political environment with economic policy implementation. The latter two are interdependent and interact in numerous ways. In general, a stable political environment is essential for the effective and sustained implementation of economic policies required in most circumstances to bring an adjustment effort to fruition.

A specific area that often arises in the context of discussions between the Fund and its members can be used to illustrate some of these issues and choices. It concerns the relative role of the public and private sectors in the economy. In the discussion of global imbalances in an economy earlier on, it was noted that the factors behind their emergence frequently included pressures coming from the public sector finances. Such pressures tend to arise from the pursuit by the public sector of a variety of aims requiring resources in excess of those the economy (or the rest of the world, for that matter) is willing to provide. The process of redressing the imbalance may entail decisions to abandon or postpone some of the aims on the part of the public sector (e.g., a reduction in its claims on resources) or decisions to raise additional revenues (e.g., an increase in the resources available to the sector) or both. As already argued, the nature and mix of those decisions will influence the performance of the economy in terms of growth, price, and balance of payments performance. Their sustainability, however, will depend on the accuracy with which they reflect preferences in the economy with regard to the priority being given to the various policy objectives as well as on the efficiency that they display to attain those objectives.

From the standpoint of the Fund, its options must conform to the code of conduct laid out in the Articles of Agreement. This code eschews certain courses of action as means of dealing with balance of payments problems (e.g., exchange restrictions, discriminatory practices). Instead, it advocates policy courses that lead to openness in the economies of members and to their progressive integration in the international economic system. There is a clear mandate for the institution in this code of conduct with regard to balance of payments and exchange matters which it must observe in the exercise of its role in the adjustment process.

Despite the interdependence among economic policies and their objectives, the mandate of the Fund focuses mainly on external objectives, in particular on balance of payments viability. To the extent that other economic objectives contribute to balance of payments viability (e.g., price stability, growth), however, the Fund argues forcefully for the adoption of policies to promote their achievement. Indeed, a key message of the argument made earlier has been that there are no sustained trade-offs between the attainment of these objectives and balance of payments recovery.

While the mandate of the Fund does not extend to policies and objectives that reflect mainly social or political considerations, the Articles of Agreement enjoin the institution to pay due regard to them in connection with its exercise of surveillance over exchange rate arrangements.34 Therefore, the institution has striven to abide by this prescription in its relationship with members. In particular, it has sought to observe a principle of political neutrality and to minimize the degree of its participation in domestic policy decision making.35 Observance of this broad principle not only has kept the Fund from entering into areas that require judgment of social or political priorities; it has also led the institution to seek that they are generally taken into account and that, in its negotiations with members, policy discussions and understandings be cast in terms of aggregate variables to keep its distance from specific decisions required for policy implementation.

An essential consideration behind this institutional principle of political neutrality has been the need to maintain an acceptable balance between the protection of the interests of an individual member and the safeguard of the interests of the membership as a whole. By distancing itself from specific economic policy decisions, the Fund acknowledges a member’s independence in policy decision making. In turn, the institution’s emphasis on the external objectives and consequences of members’ economic policies helps protect the membership’s collective interests and is based on a broad consensus among members that those are subjects of legitimate international concern. Were the Fund to widen its focus to include, besides the external area, domains with respect to which the grounds for international concern are less firm, the general acceptance of the priority that the Fund accords to external objectives would be less assured, if not contested.

Concluding Remarks

The thrust of argumentation in this paper has stressed the fundamental complementarity between adjustment and growth. Indeed, by removing distortions and impediments to efficiency, adjustment is necessary for the attainment of sound growth. In the presence of imbalances, the choice that policymakers confront is adjustment now versus often harder adjustment later. The notion that adjustment is inimical to growth only serves to conceal that without adjustment, growth today is at the expense of often significantly less growth tomorrow.

These points bear importantly on the role of the Fund in the promotion of growth-oriented adjustment. Its support of policies to restore viability to balance of payments, therefore, represents also support for growth on two counts: first, because those policies typically promote efficiency in resource use, and second, because the direct financial support from the Fund as well as the assistance from other sources that the institution catalyzes in effect add, often significantly, to the resources at the disposal of member countries undertaking adjustment.

The Fund has refrained from entering into policy decisions that would take the institution toward areas outside its mandate. It has also refrained from seeking understandings on policies and objectives calling for judgments that fall in the social and political sphere and therefore belong with the national authorities. Even in those policy domains that are clearly linked to balance of payments objectives, the Fund has sought to reach understandings with members that could be formulated in terms of global instruments, thereby providing member authorities with ample choices on the specific ways of observing those understandings. In its choice of aggregate policy instruments, however, the Fund has aimed to select those that focus attention on the decisions that need to be made. In general, the combination of possible decisions is varied and the choice of the one to be adopted is left to the member.

Over time, a delicate system of checks and balances has been developed to guide the financial operations of the Fund with its members. These checks and balances are derived from the direct link established in Fund arrangements with member countries between performance under a quantitative economic policy program and the actual disbursement of Fund resources. Normally, the program is designed in terms of only those policy instruments necessary to provide an assurance of the achievement of its objectives. The number of instruments is typically limited, which thus provides the member with broad scope to select and undertake its own policy actions. In turn, the likely attainment of the program’s objectives, which include balance of payments recovery, tends to preserve the revolving nature of Fund resources. Therefore, this system of checks and balances contributes to safeguarding the monetary character of the institution as well as protecting the member’s independence in policy decision making. The ability of the Fund and this system of checks and balances to promote adjustment and growth to a large extent depends on its accuracy in outlining the choices available and the constraints that confront policy decision makers.

From the viewpoint of the Fund, there are a number of issues that warrant consideration for purposes of the promotion of growth-oriented adjustment in current circumstances. There is scope within the system of checks and balances for seeking that more progress in dismantling exchange and other restrictions maintained for balance of payments reasons be made by members during the process of adjustment. Indeed, as noted earlier, the continued prevalence of such impediments not only tends to impair efficiency and growth but consequently it also casts a heavy shadow over external payments viability. This is, therefore, an area where strengthened efforts to speed up liberalization and economic openness can contribute significantly to both the adjustment and growth processes.

Another related issue worthy of particular attention concerns the rising incidence of external payments arrears. Decisive action toward an orderly settlement of those arrears with a view to eliminating them within an appropriate period of time also appears called for in the context of adjustment, particularly in present circumstances in the international economy. Arrears typically result in both higher costs and in curtailment of normal trade financing flows. In addition, in common with restrictive practices, arrears generally contribute to the reluctance of capital movements, and given the environment that prevails currently in international capital markets, their continued presence cannot but compound such reluctance.

With regard to capital flows, their contribution to ease the adjustment process and to foster growth across the international system has long been recognized. Nevertheless, at present international capital movements have yet to resume their historical pattern, with regard both to their level and their composition. Indeed, the resumption of capital flows on their normal scale is proving to be a particularly protracted process. Progress has been made in the last few years toward restoring a measure of normality, but it has been limited and severe problems remain in this area. Continued efforts to find solutions to the payments difficulties confronting many countries yet will be required, including, where appropriate, external assistance in amounts and on terms consistent with the nature and magnitude of the required internal adjustment effort. But such efforts will need to be accompanied by an increasing commitment of all members, creditors and debtors alike, to the adoption of consistent and mutually supporting adjustment measures in order to lay the grounds for a timely and sustained resumption of international capital flows.


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Note: The views expressed in this paper are the author’s and not necessarily those of the International Monetary Fund.


See Article IV of the Articles of Agreement of the International Monetary Fund, International Monetary Fund (1978).


A more extensive discussion of these issues can be found, for example, in Manuel Guitián (1981), Bahram Nowzad (1981), and Vito Tanzi (1987). In addition to the specific features of the imbalance, the characteristics of the country’s economy are important for the design of an adjustment strategy. In the context of Fund operations with members, consideration of these diverse individual country characteristics calls for a measure of flexibility which has to be balanced against the institutional requirement of uniformity of treatment. These issues, of course, are country specific and have not been pursued here because this paper focuses on the general aspects of adjustment and growth. Further discussion of these subjects, however, can be found in Manuel Guitián (1983a).


In the context of policies on the use of Fund resources and in particular, of the Guidelines on Conditionality, this is a key notion behind guideline No. 1 that encourages members to adopt corrective measures at an early stage of their external difficulties. See International Monetary Fund (1986a).


In this argument, the concept of temporariness is to be distinguished from the notion of reversibility. A transitory and reversible imbalance does not generally call for policy action if resources exist (reserves) or can be found (borrowing) to finance it for the duration or if the distortions (restrictions, price, and output variations) to which it can otherwise give rise are considered acceptable.


See Article I of the Articles of Agreement, International Monetary Fund (1978).


See, in particular, Article I(v) and Article V, Section 3(a) of the Articles of Agreement, International Monetary Fund (1978).


The Fund makes resources available to members through a variety of instruments, including stand-by and extended arrangements. For a discussion of those instruments, see Joseph Gold (1980) and Manuel Guitián (1981). In 1986, the Fund established a Structural Adjustment Facility to provide concessional assistance to low-income countries with protracted balance of payments problems. See International Monetary Fund (1986a).


As noted at the outset, the Fund supports adjustment directly through provision of financial resources and of policy advice in the context of annual consultations with individual members as well as through the promotion of a stable and favorable environment by the exercise of surveillance. In addition, the Fund carries out a number of other tasks in the financing sphere, including the provision of direct liquidity through SDR allocations and of temporary financing under the Compensatory Financing and Buffer Stock Financing Facilities.


For an ample discussion of these issues, see C. David Finch (1983).


The norm used in this paper to measure an external payments imbalance is whether it requires foreign financing on a scale and on terms incompatible with the economy’s growth and development prospects and therefore, unsustainable. See in this context, Manuel Guitián (1983a).


For a recent general discussion of the subject of adjustment and financing and the role of the Fund, see Peter B. Kenen (1986).


A point that may be advanced here is that the adoption and sustained pursuit of adjustment measures not only reduce the need for resources but they are also instrumental in raising their availability. This argument is elaborated further in later sections of the paper.


These considerations are related to the question of the relative merits of a gradual versus a rapid adjustment effort which revolve around the choice between current and future absorption levels in the economy.


For discussions of the impact on growth of a variety of economic policy measures, see, for example, Mohsin S. Khan and Malcolm D. Knight (1985) and Mohsin S. Khan (1986).


The discussion in this section, and in the paper in general, refers specifically to policies typically supported by the Fund, but the analysis is of a general character and it applies to any given economy confronting an imbalance.


For a general discussion of fiscal policy issues in the adjustment process, see Vito Tanzi and Mario Blejer (1984).


For a discussion of this subject in the context of an open economy, see Jacob A. Frenkel and Michael L. Mussa (1981).


For a recent discussion of this subject, see Mohsin S. Khan (1986).


The argument abstracts from the existence of borrowing and capital movements, an assumption that does not affect the analysis at this level. A fuller treatment of these issues can be found in the collection of articles in Jacob A. Frenkel and Harry G. Johnson (1976) and in International Monetary Fund (1977).


Strictly speaking, the public determines its real money holdings, which can vary with changes in the price level or in the nominal quantity of money or both. In a closed economy, money market imbalances lead fundamentally to price level variations while in an open economy they lead to a combination of these with exchange rate and balance of payments changes; by means of the latter, the nominal quantity of money in the economy changes. See in this context, Manuel Guitián (1973) and Peter M. Keller (1980).


Further discussion of this issue can be found in Manuel Guitián (1973 and 1985b) and in William H. L. Day (1979).


A general discussion of external debt management issues can be found in Claudio M. Loser (1977), K. Burke Dillon and David Lipton (1985), Vito Tanzi (1985), and Manuel Guitián (1987).


For an extensive discussion of these issues, see Vito Tanzi (1987).


On the subject of the role of economy-wide prices in adjustment, see Claudio M. Loser (1984); see also Rudiger Dornbusch (1985).


Interest rate policies are discussed in some detail in International Monetary Fund (1983).


For a discussion of the relationship between the exchange rate and financial policies as well as their implications for growth and the balance of payments, see Manuel Guitián (1976 and 1985b); see also, G. G. Johnson (1985), Rudiger Dornbusch (1986), and Morris Goldstein (1986).


On the specific subject of foreign private investment flows, see International Monetary Fund (1985).


A brief discussion of these institutional relationships can be found in Manuel Guitián (1985a). For an examination of the World Bank financing of structural adjustment, see Ernest Stern (1983).


Issues of Fund-Bank collaboration, important though they are, fall outside the scope of this paper. For treatments of this subject, see Joseph Gold (1981-82), P. R. Narvekar (1983), and Hiroyuki Hino (1986).


See C. David Finch (1983) where this particular dimension of the role of the Fund in adjustment has been stressed.


Besides devising procedures to unlock capital flows, the Fund also adapted its policies on access to its own resources, including the continuation of the enlarged access policy. For an examination of these topics, see Manuel Guitián (1985a and 1987).


A similar argument can of course be made in a closed economy to the effect that growth is subject to a domestic resource constraint. In this context, the argument underscores directly the importance of efficiency for the attainment of growth. As noted earlier, the opening of the economy, if efficiency prevails, can allow it to sustain a higher growth rate than otherwise.


A discussion of distributional issues in the context of adjustment policies can be found in Omotunde Johnson and Joanne Salop (1980) and in International Monetary Fund (1986b).


See Article IV, Section 3(b) of the Articles of Agreement, International Monetary Fund (1978). In the area of adjustment policies, a similar principle is contained in guideline No. 4 of the Guidelines of Conditionality, which draws attention to the domestic political and social aims of members as well as to their economic priorities. See International Monetary Fund (1986a).


As already noted, in the context of policies on the use of Fund resources, these concerns are reflected in the Guidelines on Conditionality, most particularly, in the already cited guideline No. 4 and in guideline No. 9, which deals with the number and content of policy instruments (performance criteria) in Fund arrangements. See International Monetary Fund (1986a).

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