Chapter

2 The Forward-Looking IMF Analytical Work Program on Macroeconomic Issues

Author(s):
International Monetary Fund
Published Date:
January 2004
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The IMF is carrying out an extensive research program to examine key macroeconomic issues that confront low-income countries in the design and implementation of their national poverty reduction strategies. Drawing on findings from the 2002 joint World Bank-IMF review of the Poverty Reduction Strategy Paper approach and the IMF review of the Poverty Reduction Growth Facility, research projects are planned and under way in five priority areas:

  • Improving growth outcomes,

  • Assessing the macroeconomic impact of larger aid flows,

  • Addressing vulnerability and exogenous shocks,

  • Assessing debt sustainability,

  • Accessing private capital markets.

Improving Growth Outcomes

Increasing and sustaining growth is essential for poverty reduction. The research program will look into the role of macroeconomic policies in generating growth, as well as specific channels that transmit macroeconomic policies into growth.

Sources of and Obstacles to Growth

Four studies will examine sources of and obstacles to growth. First, “Sources of Growth in Sub-Saharan African Countries, 1970–2002” will analyze sub-Saharan African countries using a growth accounting framework. The paper will investigate stylized facts about factor accumulation versus productivity growth. Literature on the sources of growth in developing countries has focused primarily on Asia and Latin America. This study will attempt to fill the knowledge gap concerning sub-Saharan African countries.

  • African Department

    Dhaneshwar Ghura (dghura@imf.org)

Following sharp declines in activity during the early years of transition, many low-income Commonwealth of Independent States (CIS) countries recorded rapid growth. “Explaining the Growth Surge in the CIS-7” will detail the sources of each country’s recent growth from both the supply- and the demand-side perspectives. A traditional growth accounting framework points to sharp turnaround in total factor productivity. Does this indicate a fundamental improvement in productivity in response to structural reforms, or is the surge explained through specific factors, such as linkages to the booming oil-exporting economies in the region?

  • European Department

    David O. Robinson (drobinson2@imf.org)

    Elena Loukoianova (eloukoianova@imf.org)

“Achieving Sustainable Growth and Poverty Reduction in Nicaragua” will comprise several self-contained substudies on policies leading to sustainable growth and poverty reduction in Nicaragua, including sources of growth, fiscal sustainability, external and domestic debt sustainability, financial sector reform, and others.

  • Western Hemisphere Department

    Marco Piñón (mpinonfarah@imf.org)

“Is There Hope for a Poor Country? The Case of Nicaragua” will focus on structural barriers to growth in Nicaragua, including institutional weaknesses and the role of external aid. The paper will address the question: Why is Nicaragua still among the poorest of countries in the Americas despite generous support from the donor community?

  • Western Hemisphere Department

    Oscar Melhado (omelhado@imf.org)

Transmission Channels Through Which Macroeconomic Policies Influence Growth

Five studies will explore the specific transmission channels through which key macroeconomic policies influence growth. “Fiscal Policy and Growth in Low-Income Countries: An Examination of Transmission Channels” will scrutinize the links between fiscal stance and growth. Fiscal consolidation has been demonstrated in general to be good for growth in the short and long run; this study will examine the channels through which such growth occurs. Is the impact of fiscal consolidation on growth due to its impact on inflation? Does fiscal consolidation have favorable effects on interest rates and the availability of credit to the private sector, thereby triggering higher private investment?

  • Fiscal Affairs Department

    Arye Hillman (ahillman@imf.org)

    Emanuele Baldacci (ebaldacci@imf.org)

    Naoko Kojo (nkojo@imf.org)

A companion study, “Impact of Tax Policy on Growth in Low-Income Countries,” will explore several questions. Does a shift from trade to domestic taxes spur growth? Does a change in the composition of taxes from direct to indirect taxation have a positive or negative effect? What is the relationship between tax effort and growth? Do distortionary tax systems, as measured by the number of exemptions and the level of marginal tax rates, hamper growth? Does administrative simplicity of the tax system—proxied, for example, by the number of income tax rates—have a bearing on growth? These and related questions will be addressed by regressing the annual rate of real per capita GDP growth on a set of regressors, including variables measuring the composition of revenues and other control variables.

  • Fiscal Affairs Department

    Benedict Clements (bclements@imf.org)

“External Public Debt and Growth in Low-Income Countries” will assess the debt-growth nexus in low-income countries, including heavily indebted poor countries (HIPCs). Recent work by IMF staff suggests that excessive external debt may hamper growth, yet little evidence has been provided on the transmission channels. For example, does public debt service divert budgetary resources from the public investment necessary to stimulate growth? Is it debt service that matters in explaining the relationship between debt and growth, or the net present value (NPV) of debt? These and related questions will be explored through a structural econometric model.

  • Fiscal Affairs Department

    Benedict Clements (bclements@imf.org)

    Rina Bhattacharya (rbhattacharya@imf.org)

“Channels Through Which External Debt Affects Growth” will explore empirically the extent to which external debt affects growth through capital accumulation or total factor productivity (TFP) growth. Following up on earlier research, this project will examine whether debt has nonlinear impacts on capital accumulation or TFP growth. Next, the project will examine the main channels for the impact of debt on income, capital, or TFP growth—for example, whether external debt affects these variables by influencing the stance of policies, levels of corruption, infrastructure, or the public/private investment mix. The study will explore such questions using panel data for a large set of developing countries.

  • Research Department

    Catherine Pattillo (cpattillo@imf.org)

Finally, “IMF Financial Programs and Economic Growth: What Is the Link?” will examine whether achievement of the policy targets will lead to the growth and inflation outcomes that underpin those targets within the financial programming framework. By showing which policy targets matter and how, the results could have important implications for policy design. This analysis will also illuminate factors behind debt unsustainability and IMF lending (see “Assessing Debt Sustainability,” below).

  • Research Department

    Rodney Ramcharan (rramcharan@imf.org)

    Ratna Sahay (rsahay@imf.org)

    Reza Baqir (rbaqir@imf.org)

Assessing the Macroeconomic Consequences of Aid

Countries with sound poverty reduction strategies and public expenditure management systems should benefit from these flows under the PRSP approach. In most countries, greater aid flows can easily be absorbed. However, rapidly increased concessional flows sometimes have negative macroeconomic consequences. Research in this area will therefore assess how monetary and exchange rate policies should respond to increased aid inflows and the effects of debt and grant aid on key macroeconomic variables.

Foreign aid inflows affect the growth of a recipient economy through various channels. “How Monetary and Exchange Rate Policy Should Respond (or Not) to Increased Aid Inflows” will develop a framework that accounts for both productivity-enhancing effects (such as human capital formation) and adverse effects (“Dutch disease”) of official development assistance. The framework takes into account the timing of disbursements and the composition of aid. The project will discuss whether sterilizing the monetary impact of aid inflows is appropriate and how this policy should take into account the degree of concessionality of aid flows and the possible crowding out of investment. A novel measure of real exchange rates—based on black-market rates—is used. Preliminary results suggest, first, that large foreign aid inflows are generally associated with real exchange rate appreciation and, second, that the appreciation takes place mainly in the parallel exchange market. The findings also show that sterilization significantly reduces the real exchange rate appreciation associated with foreign aid inflows.

  • Research Department

    Alessandro Prati (aprati@imf.org)

    Ratna Sahay (rsahay@imf.org)

    Thierry Tressel (ttressel@imf.org)

“Exchange Rate Flexibility and the Monetary Management of Aid Flows in Africa” will focus on selected African countries where money-based stabilization programs in the 1990s succeeded in bringing inflation to relatively low levels while maintaining a market-determined exchange rate. The paper focuses on highly persistent shocks to aid flows, including PRSP-related increases in net flows. Such shocks have beneficent long-run effects; but when the substitutability between domestic and foreign currencies is relatively high, they can produce dramatic, short-run macroeconomic management problems. The question, then, is: What is the appropriate mix of money and exchange rate targeting and the role of temporary sterilization? The study develops an intertemporal optimizing model in which the budgetary contribution of aid may be partly spent and partly devoted to reducing the government’s seigniorage requirement. Preliminary results indicate that when the credibility of policymakers’ commitment to low inflation is firm, the most attractive short-run approach appears to be some degree of “dirty floating” along with partial sterilization of increases in the monetary base.

  • Research Department

    Catherine Pattillo (cpattillo@imf.org)

“Debt Relief, Additionality, and Aid Allocation in Low-Income Countries” will provide empirical analysis on whether debt relief crowds out other aid flows. It asks whether debt relief has had a significant impact on the overall level of resource transfers from official donors as a group. Using an aid allocation model, the paper compares the experiences of countries receiving debt relief from IDA-only with countries that have not.

  • African Department

    Robert Powell (rpowell@imf.org)

“Grants Versus Loans” will analyze the trade-offs faced by international development agencies when determining the grant component of an aid package. The project will assess how recipient countries’ characteristics and policy environments influence the relative effectiveness of grants versus loans in promoting growth.

  • Research Department

    Tito Cordelia (tcordella@imf.org)

    Ratna Sahay (rsahay@imf.org)

    Hulya Ulku (hulku@imf.org)

“Conditional Aid, Sovereign Debt, and Debt Relief” asks whether debt relief is the best instrument for raising consumption by the poor in HIPCs. To answer this question, the project will develop a model of conditional aid based on a “contract” between altruistic donors concerned with consumption by the poor and recipient governments representing the interests of those who are well off. This implicit contract is played out over an infinite horizon and is supported by threats of punishment for deviation. The research will examine how debt relief in an optimal conditional-aid relationship can reduce the welfare of the poor. The framework will offer new explanations of why aid flows can be procyclical and why donors who are themselves debt-holders continue to provide aid without granting debt relief.

  • Research Department

    Tito Cordelia (tcordella@imf.org)

    Giovanni Dell’Ariccia (gdellariccia@imf.org)

    Ken Kletzer (University of California at Santa Barbara)

Addressing Vulnerability and Exogenous Shocks

Macroeconomic research in this area examines how commodity prices affect exchange rate fluctuations and the design of inflation targets in commodity-dependent low-income countries. “How Monetary and Exchange Rate Policies Should Take Into Account Commodity Prices and Terms of Trade Shocks” has thus far focused on identifying countries with “commodity currencies”—meaning countries where real exchange rates are chiefly determined by movements in the real prices of their commodity exports. For countries with commodity currencies—most of which are low-income countries—commodity prices can be a useful benchmark signaling that exchange rates have deviated excessively from their equilibrium value. In addition, policymakers in commodity-currency countries can use information on spot or futures prices to guide monetary policy. Subsequent research on commodity-dependent countries will examine the efficacy of alternative nominal exchange rate anchors, especially the use of spot (world) commodity prices, and the role of commodity prices in inflation targeting when commodity-dependent countries wish to move toward greater flexibility in their nominal exchange rates.

  • Research Department

    Paul Cashin (pcashin@imf.org)

“Identifying Vulnerabilities in CIS Countries” will take stock of the peculiar features of the CIS economies and will identify their vulnerabilities to specific shocks. The emphasis in the general literature on volatile short-term capital flows and banking sector fragility is less relevant in CIS countries because of their typically small banking sectors and the absence of links to the international capital market. Instead, these countries are prone to commodity-price shocks (especially oil), economic downturn in Russia, and domestic shocks related to political crisis, the weather, and so forth, which are exacerbated by their structural and institutional rigidities. The impact of the 1998 Russian crisis will be explored and might provide useful evidence. The study may also construct hypothetical scenarios of the processes that lead to full-blown crises.

  • Research Department and European Department

    Ratna Sahay (rsahay@imf.org)

    José Fajgenbaum (jfajgenbaum@imf.org)

    Francesco Luna (fluna@imf.org)

Assessing Debt Sustainability

Higher aid flows in support of poverty reduction can affect the debt sustainability of low-income countries, and overly optimistic projections regarding growth and export can paint a distorted picture of whether it can be sustained. The IMF research program in this area will develop a debt sustainability framework and will assess overoptimism in the projections that underpin sustainability analyses.

“Debt Sustainability in Low-Income Countries” will discuss how the framework recently adopted by the IMF for middle-and upper-income countries can be adapted to low-income countries. The framework for low-income countries will cover issues of both external sector sustainability and fiscal sustainability, examining how sustainability can be achieved on both fronts. Creating such a framework presents a number of analytical challenges, considering the marked differences between low- and middle-income economies. The former are characterized by limited access to private capital markets, highly concessional debt that is usually at interest rates far below projected growth, and heavy reliance on primary commodities exports. Consequently, debt sustainability analysis for low-income countries should cover a longer projection period in order to capture the implications of future graduation from highly concessional assistance. The study will apply the new framework to several countries. Stress tests will be used to demonstrate the effects of shocks (for example, lower-than-expected commodity prices or economic growth) on external and fiscal sustainability. The paper will also discuss how official financing in a post-HIPC setting could broadly affect debt sustainability.

  • Fiscal Affairs Department

    Emanuele Baldacci (ebaldacci@imf.org)

    Kevin Fletcher (kfletcher2@imf.org)

Accessing Private Capital Markets

The ability to tap into private credit markets is decisively determined by a country’s vulnerability to shocks and the perceived quality of its policies. IMF research on accessing private capital markets will examine these key determinants of low-income countries’ access to credit markets.

“Private Capital Market Access by Developing Countries: The Role of Policies and Vulnerability” will employ detailed data on sovereign bond issuances and public syndicated bank loans since the outset of the Latin American debt crisis in 1982. In addition to covering factors traditionally in the literature, this project will investigate the importance of vulnerability—with regard to terms-of-trade shacks, for example—in determining credit constraints. In examining the role of government policies, this study will go beyond previous research by using, first, a comprehensive, detailed data set on the quality of government policies and, second, a panel approach that controls for fixed country characteristics and time-varying global conditions.

  • Research Department

    Gaston Gelos (ggelos@imf.org)

    Ratna Sahay (rsahay@imf.org)

“Overcoming Financial Market Deficiencies in Sub-Saharan Africa” will look at financial market deficiencies in sub-Saharan Africa. The paper will examine efforts worldwide to overcome institutional and regulatory hindrances to financial services in rural areas and access to credit by small and medium-sized enterprises.

  • African Department

    Lelde Schmitz (lschmitz@imf.org)

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