Abstract

There are several reasons why cross-country and time-series studies can yield conflicting results for the effects of Fund programs on economic growth. First, the conflict may simply arise from differences in the methodology and empirical criteria employed by the two types of studies. The time-series studies, for example, are based on formal statistical tests, while the cross-country studies rely on a less formal and more judgmental approach to determining the effects of programs. Comparing the results across studies that employ different criteria for testing the effects of policies can, as such, be quite difficult. Second, the time period over which the effects on growth are measured can be an issue. While the time-series evidence in Section III is restricted to comparisons over a one-year period, the cross-country studies often look at longer (three-year) periods. This difference in time horizons for the tests could also explain part of the inconsistency that arises between the results of these studies.

There are several reasons why cross-country and time-series studies can yield conflicting results for the effects of Fund programs on economic growth. First, the conflict may simply arise from differences in the methodology and empirical criteria employed by the two types of studies. The time-series studies, for example, are based on formal statistical tests, while the cross-country studies rely on a less formal and more judgmental approach to determining the effects of programs. Comparing the results across studies that employ different criteria for testing the effects of policies can, as such, be quite difficult. Second, the time period over which the effects on growth are measured can be an issue. While the time-series evidence in Section III is restricted to comparisons over a one-year period, the cross-country studies often look at longer (three-year) periods. This difference in time horizons for the tests could also explain part of the inconsistency that arises between the results of these studies.

Third (and this is perhaps the most important factor), while the time-series studies are concerned with assessing a single policy, and mainly a demand-oriented policy, the cross-country studies examine the effects of the whole package of policies implemented in the course of a Fund program. Whereas demand-management policies by themselves may cause the rate of growth of output to decline, other policies, particularly those stressing supply-side aspects, could work toward improving the growth picture. Furthermore, the adoption of a Fund-supported program may alter expectations, so that the effects on the ultimate objectives cannot be precisely determined a priori. Expectations are inherently non-quantifiable and thus cannot be easily incorporated into the time-series framework. Nor do these time-series studies reflect the positive growth effects of increased inflows of capital that may result both directly and indirectly from the implementation of a Fund-supported adjustment program, unless they focus explicitly on this question. Since cross-country studies concentrate solely on comparing the outcome of programs (with the historical pattern or with some control group performance) and attribute all changes that occur to the program, they automatically incorporate the effects of all factors, including expectations and increased external finance, that have a bearing on the outcome.

Clearly, it would be useful if the main advantages of the two approaches could be combined in some way. In other words, it would be worthwhile to incorporate a range of policies into the analysis, while at the same time abstracting from factors that influence growth but are exogenous to the program. One way to do so would be to expand the models underlying the time-series studies to handle a variety of both demand-side and supply-side measures and to use the resulting model to perform controlled experiments corresponding to alternative policy combinations. This type of simulation exercise might help to reconcile the observed inconsistency between results and could also provide insight on the main issue of the growth effects of Fund programs.

For this purpose, however, it is necessary to have at hand a structural model that incorporates the relations between various policies and certain macroeconomic variables, including in particular the level or rate of growth of output. No single model can generally cover the whole range of policy measures contained in a typical Fund program, although some small-scale models incorporate certain of the major policy instruments. One such model, developed by Khan and Knight (1981), satisfies the requirement of being able to handle several policies simultaneously, particularly those involving the control of aggregate demand and the exchange rate, and of assessing their effects on the main macroeconomic variables—growth, inflation, and the balance of payments. Furthermore, the parameters embedded in this model, estimated from a sample of 29 developing countries, are broadly consistent with those obtained in the studies cited in Section III. For present purposes, a slightly expanded version of this model, including certain explicit supply-side aspects, is used. With this model, described in the Appendix, the effects of different combinations of policies on growth can be studied by performing hypothetical simulation experiments.

The simulation experiments conducted here are, of course, purely illustrative and are not intended to reflect all the complexities surrounding a program. Formal models of any type are clearly unable to analyze all questions relating to Fund programs, and in particular they do not capture the complex ways in which policy variables are related to ultimate objectives. The model used here is highly aggregative and thus focuses only on what are considered the most important macroeconomic relationships. Also, while expectations are included, they are treated in a very simple fashion. Finally, although the parameters of the model reflect empirical estimates, the changes in policy and the combination of policies studied here are entirely arbitrary. These various reservations should be kept in mind in considering the simulation results.

The simulations conducted with this model start with the assumption that the authorities wish to achieve an (arbitrarily defined) increase in the stock of international reserves in a period of one year. To hit this target, it is possible to use demand-management policies alone or some combination of demand-side and supply-side measures. Since the time horizon is restricted to one year, supply-side measures alone cannot be used, as they tend to operate with a significant lag. This lag in the effect of supply-side policies is built explicitly into the model.

Specifically, the simulations trace out the effects on the growth of real GDP of the following:48

  1. A set of demand-management policies, defined as a once-for-all 10 percentage point reduction in the rates of growth of nominal domestic credit and nominal government expenditures, and a 10 percent devaluation.49 Since prices do not adjust immediately in the model, these policies translate into real changes in the short run.

  2. The above demand-management policies, combined with a set of supply-side policies that would raise the rate of growth of capacity output by 0.5 percentage point a year over a period of four years. In the context of the model this requires an increase in the investment-income ratio of about 2–3 percentage points a year for the same four-year period.50 No attempt, however, has been made to specify exactly the measures that would produce this result. As discussed in Section III, the increase in the investment-income ratio would have to be achieved by a combination of supply-side measures geared to the productive structure of the country under consideration.51

The results of the simulations are presented in Chart 1. Assume that the economy is initially growing at some arbitrary constant rate (equal to 5 percent a year) and that a stabilization program is introduced in the third period (year).52 If the policy package consisted solely of demand-side measures (Simulation a), the rate of growth would decline at the beginning of the program, as the tighter credit and fiscal policies reduced aggregate demand. The expansionary effect of devaluation is insufficient to offset these developments, and altogether the growth rate in this simulation falls by about 1.5 percentage points in the first year, but then starts to rise as inflation declines, raising real domestic credit and real government expenditures. The general improvement persists for about two years, and eventually the growth rate approaches its original level. The international reserves target is achieved with a pure demand-oriented policy package, but at the price of a transitory drop in the growth rate.

Chart 1.
Chart 1.

Effect on Growth Rate of Demand-Management and Supply-Side Policies

The output costs can be reduced significantly if appropriate supply-side measures are introduced simultaneously with the demand-management package. Assuming that these supply-side policies raise investment and thereby the economy’s trend growth rate of capacity output (in the present illustration by 0.5 percentage point a year), the actual growth rate would also start to rise.53 The combined package of demand- and supply-oriented policies (Simulation b) would still result in a decline in the growth rate in the first period, but now the negative impact of the demand-management policies is partially offset by the positive effect of the increase in the growth of capacity. Since the supply-side policies are assumed to raise the growth rate permanently by increasing capacity growth, the overall package succeeds in putting the economy on a higher secular growth path.

Despite being only illustrative, these simulation experiments yield three particular insights into the effects of Fund programs, as well as into reconciling the conflicting evidence produced by the time-series and cross-country studies. First, the combined effect of several policies implemented simultaneously turns out to be different from the effect of such policies enacted individually. Second, it is clear that suitable supply-side policies can help to offset, at least partially, any adverse short-term effects on growth that may result from demand restraint. Since the time-series studies look mainly at the demand-side policies, it is understandable why they reach the conclusion that certain policies included in Fund programs reduce the growth rate in the short run. Cross-country studies are arguably more ambiguous on this issue because they implicitly incorporate supply-side policies into the analysis. Third, it is clear that in judging the effects of programs, care has to be exercised with regard to the time period in question. In the present example, if one makes only one-year comparisons, the results in Figure 1 would imply that the stabilization program had significant costs, irrespective of the of policies it contained. In contrast, if the period of comparison were extended to, say, three years, the conclusion would be quite different.

  • View in gallery

    Effect on Growth Rate of Demand-Management and Supply-Side Policies

  • Aghevli, Bijan B., and Mohsin S. Khan, “Credit Policy and the Balance of Payments in Developing Countries,” in W.L. Coats, and D. R. Khatkhate, (eds.), Money and Monetary Policy in Less Developed Countries (Oxford: Pergamon, 1980), pp. 685 –711.

    • Search Google Scholar
    • Export Citation
  • Balassa, Bela, Exports and Economic Growth: Further Evidence,Journal of Development Economics (Amsterdam),Vol. 5 (June 1978),pp. 181 –89.

    • Search Google Scholar
    • Export Citation
  • Balassa, Bela, The Process of Industrial Development and Alternative Development Strategies, Essays in International Finance No. 141 (Princeton, New Jersey: Princeton University, 1980).

    • Search Google Scholar
    • Export Citation
  • Barro, Robert J., “Money and Output in Mexico, Colombia, and Brazil,” in J. Behrman, and J. A. Hanson (eds.), Short-Term Macroeconomic Policy in Latin America (Cambridge, Massachusetts: National Bureau of Economic Research, 1979), pp. 177 –200.

    • Search Google Scholar
    • Export Citation
  • Bhagwati, Jagdish N., and T. N. Srinivasan, “Trade Policy and Development,” in Rudiger Dornbusch and Jacob A. Frenkel (eds.), International Economic Policy: Theory and Evidence (Baltimore: Johns Hopkins University, 1979), pp. 1 –35.

    • Search Google Scholar
    • Export Citation
  • Blejer, Mario I., and Roque B. Fernandez,The Effects of Unanticipated Money Growth on Prices and on Output and Its Composition in a Fixed-Exchange Rate Open Economy,Canadian Journal of Economics (Toronto), Vol. 13 (February 1980), pp. 82 –95.

    • Search Google Scholar
    • Export Citation
  • Blejer, Mario I., Mohsin S. Khan,Government Policy and Private Investment in Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 31 (June 1984), pp. 379 –403.

    • Search Google Scholar
    • Export Citation
  • Bond, Marian E., Agricultural Responses to Prices in Sub-Saharan African Countries,Staff Papers, International Monetary Fund (Washington), Vol. 30 (December 1983), pp. 703 –26.

    • Search Google Scholar
    • Export Citation
  • Branson, William H., Stabilization, Stagflation, and Investment Incentives: The Case of Kenya, 1979—80, Woodrow Wilson School of Public and International Affairs Discussion Papers in Economics No. 89 (Princeton, New Jersey: Princeton University, 1985).

    • Search Google Scholar
    • Export Citation
  • Cline, William R., Sidney Weintraub, eds., Economic Stabilization in Developing Countries (Washington: The Brookings Institution, 1981).

  • Connors, Thomas A., The Apparent Effects of Recent IMF Stabilization Programs, International Finance Discussion Papers, No. 135 (Washington: U. S. Board of Governors of the Federal Reserve System, International Finance Division, April 1979), pp. 1 –15.

    • Search Google Scholar
    • Export Citation
  • Cooper, Richard N., Currency Devaluation in Developing Countries, Essays in International Finance No. 86 (Princeton, New Jersey: Princeton University, 1971).

    • Search Google Scholar
    • Export Citation
  • Crockett, Andrew D., Stabilization Policies in Developing Countries: Some Policy Considerations,Staff Papers, International Monetary Fund (Washington), Vol. 28 (March 1981), pp. 54 –79.

    • Search Google Scholar
    • Export Citation
  • Diaz-Alejandro, Carlos, Exchange Rate Devaluation in a Semi-Industrialized Economy: The Experience of Argentina 1955–1961 (Cambridge, Massachusetts: Massachusetts Institute of Technology, 1965).,

    • Search Google Scholar
    • Export Citation
  • Diaz-Alejandro, Carlos, IMF Conditionality: What Kind?”PIDE Tidings (Islamabad), No. 4 (January–February 1984), pp. 7 –9.

  • Donovan, Donal J., Real Responses Associated with Exchange Rate Action in Selected Upper Credit Tranche Stabilization Programs,Staff Papers, International Monetary Fund (Washington), Vol. 28 (December 1981), pp. 698 –727.,

    • Search Google Scholar
    • Export Citation
  • Donovan, Donal J., Macroeconomic Performance and Adjustment Under Fund-Supported Programs: The Experience of the Seventies,Staff Papers, International Monetary Fund (Washington), Vol. 29 (June 1982), pp. 171 –203.

    • Search Google Scholar
    • Export Citation
  • Dornbusch, Rudiger, Open Economy Macroeconomics (New York: Basic Books, 1981).

  • Ebrill, Liam P., The Effects of Taxation on Labor Supply, Savings, and Investment in Developing Countries: A Survey of the Empirical Literature” (unpublished, Washington: International Monetary Fund, April 1984).

    • Search Google Scholar
    • Export Citation
  • Edwards, Sebastian (1983a),The Short-Run Relation Between Growth and Inflation in Latin America: Comment,American Economic Review (Nashville, Tennessee), Vol. 73 (June 1983), pp. 477 –82.

    • Search Google Scholar
    • Export Citation
  • Edwards, Sebastian (1983b),The Relation Between Money and Growth Under Alternative Exchange Rate Arrangements: Some Evidence from Latin-American Countries,” paper presented at the Econometric Society Meetings, San Francisco, December 1983.

    • Search Google Scholar
    • Export Citation
  • Fry, Maxwell J., Saving, Investment, Growth and the Cost of Financial Repression,World Development (Oxford), Vol. 8 (April 1980), pp. 317 –27.,

    • Search Google Scholar
    • Export Citation
  • Fry, Maxwell J., Saving, Investment, Growth and the Terms of Trade in Asia(February 1984), unpublished, Irvine, California.

  • Giovannini, Alberto, The Interest Elasticity of Savings in Developing Countries: The Existing Evidence,World Development (Oxford), Vol. 11 (July 1983), pp. 601 –07.

    • Search Google Scholar
    • Export Citation
  • Guitian, Manuel, The Effects of Changes in the Exchange Rate on Output, Prices, and the Balance of Payments,Journal of International Economics (Amsterdam), Vol. 6 (February 1976), pp. 65 –74.,

    • Search Google Scholar
    • Export Citation
  • Guitian, Manuel, Fund Conditionality: Evolution of Principles and Practices, IMF Pamphlet Series No. 38 (Washington: International Monetary Fund, 1981).

    • Search Google Scholar
    • Export Citation
  • Gylfason, T., Credit Policy and Economic Activity in Developing Countries: An Evaluation of Stand-By Programs, 1977–79,” Institute for International Economic Studies, Seminar Paper No. 268 (Stockholm: University of Stockholm, December 1983).,

    • Search Google Scholar
    • Export Citation
  • Gylfason, T., Michael Schmid, Do Devaluations Cause Stagflation?” Institute for International Economic Studies, Seminar Paper No. 201 (Stockholm: University of Stockholm, April 1982).

    • Search Google Scholar
    • Export Citation
  • Hanson, James A., The Short-Run Relation Between Growth and Inflation in Latin America,American Economic Review (Nashville, Tennessee), Vol. 70 (December 1980), pp. 972 –89.,

    • Search Google Scholar
    • Export Citation
  • Hanson, James A., Contractionary Devaluation, Substitution in Production and Consumption, and the Role of the Labor Market,Journal of International Economics (Amsterdam), Vol. 14 (February 1983), pp. 179 –89.

    • Search Google Scholar
    • Export Citation
  • Harberger, Arnold C., Sebastian Edwards, Causes of Inflation in Developing Countries: Some New Evidence,” paper presented at the American Economics Association Meetings, December 1982.

    • Search Google Scholar
    • Export Citation
  • Kelly, Margaret R., Fiscal Adjustment and Fund-Supported Programs, 1971–80,Staff Papers, International Monetary Fund (Washington), Vol. 29 (December 1982), pp. 561 –602.

    • Search Google Scholar
    • Export Citation
  • Khan, Mohsin S., Import and Export Demand in Developing Countries,Staff Papers, International Monetary Fund (Washington), Vol. 21 (November 1974), pp. 678 –93.,

    • Search Google Scholar
    • Export Citation
  • Khan, Mohsin S., and Malcolm D. Knight, Stabilization Programs in Developing Countries: A Formal Framework,Staff Papers, International Monetary Fund (Washington), Vol. 28 (March 1981), pp. 1 –53.,

    • Search Google Scholar
    • Export Citation
  • Khan, Mohsin S., and Malcolm D. Knight, Some Theoretical and Empirical Issues Relating to Economic Stabilization in Developing Countries,World Development (Oxford), Vol. 10 (September 1982), pp. 709 –30.

    • Search Google Scholar
    • Export Citation
  • Khan, Mohsin S., and Malcolm D. Knight, Determinants of the Current Account Balances of Non-Oil Developing Countries in the 1970s: An Empirical Analysis,Staff Papers, International Monetary Fund (Washington), Vol. 30 (December 1983), pp. 819 –42.

    • Search Google Scholar
    • Export Citation
  • Killick, TonyThe Impact of Fund Stabilization Programs,” Chapter 6 in T. Killick (ed.), The Quest for Economic Stabilization: The IMF and the Third World (London: Heinemann, 1984), pp. 227 –69.

    • Search Google Scholar
    • Export Citation
  • Killick, Tony and others,Towards a Real Economy Approach,” Chapter 7 in T. Killick (ed.), The Quest for Economic Stabilization: The IMF and the Third World (London: Heinemann, 1984), pp. 270 –320.

    • Search Google Scholar
    • Export Citation
  • Krueger, Anne O., others (eds.), Trade and Employment in Developing Countries: Vol. I—Individual Studies (Chicago: University of Chicago, 1981).

    • Search Google Scholar
    • Export Citation
  • Krugman, Paul, and Lance Taylor,Contractionary Effects of Devaluation,Journal of International Economics (Amsterdam), Vol. 8 (August 1978), pp. 445 –56.

    • Search Google Scholar
    • Export Citation
  • Leiderman, Leonardo, On the Monetary-Macro Dynamics of Colombia and Mexico,Journal of Development Economics (Amsterdam), Vol. 14 (May 1984), pp. 183 –201.

    • Search Google Scholar
    • Export Citation
  • Lipschitz, Leslie, Domestic Credit and Exchange Rates in Developing Countries: Some Policy Experiments with Korean Data,Staff Papers, International Monetary Fund (Washington), Vol. 31 (December 1984), pp. 595 –635.

    • Search Google Scholar
    • Export Citation
  • McDonald, Donogh, “The Determinants of Saving Behavior in Latin America” (unpublished, Washington: International Monetary Fund, April 1983).

    • Search Google Scholar
    • Export Citation
  • Michalopoulos, Constantine and Keith Jay, Growth of Exports and Income in the Developing World: A Neoclassical View,” U.S. AID Discussion Paper No. 28 (Washington: U.S. Agency for International Development, November 1973).

    • Search Google Scholar
    • Export Citation
  • Nashashibi, Karim, A Supply Framework for Exchange Reform in Developing Countries: The Experience of Sudan,Staff Papers, International Monetary Fund (Washington), Vol. 27 (March 1980), pp. 24 –79.

    • Search Google Scholar
    • Export Citation
  • Nowzad, Bahram, The IMF and its Critics, Essays in International Finance No. 146 (Princeton, New Jersey: Princeton University, 1981).

  • Nugent, Jeffrey B., Constantine Glezakos,Phillips Curves in Developing Countries: The Latin American Case,Economic Development and Cultural Change (Chicago), Vol. 30 (January 1982), pp. 321 –34.

    • Search Google Scholar
    • Export Citation
  • Reichmann, Thomas M., Richard T. Stillson, Experience with Programs of Balance of Payments Adjustment: Stand-By Arrangements in the Higher Tranches 1963–72,Staff Papers, International Monetary Fund (Washington), Vol. 25 (June 1978), pp. 293 –309.

    • Search Google Scholar
    • Export Citation
  • Robinson, ShermanSources of Growth in Less Developed Countries: A Cross-Section Study,Quarterly Journal of Economics (Cambridge, Massachusetts), Vol. 85 (August 1971), pp. 391 –408.

    • Search Google Scholar
    • Export Citation
  • Sundararajan, V., Subhash Thakur, Public Investment, Crowding Out, and Growth: A Dynamic Model Applied to India and Korea,Staff Papers, International Monetary Fund (Washington), Vol. 27 (December 1980), pp. 814 –55.

    • Search Google Scholar
    • Export Citation
  • Taylor, Lance, “IS/LM in the Tropics: Diagrammatics of the New Structuralist Macro Critique,” in W. R. Cline and S. Weintraub (eds.), Economic Stabilization in Developing Countries (Washington: The Brookings Institution, 1981), pp. 465 –502.

    • Search Google Scholar
    • Export Citation
  • Taylor, Lance, Jeffrey A. Rosensweig, “Devaluation, Capital Flows and Crowding-Out: A Computable General Equilibrium Model with Portfolio Choice for Thailand” (unpublished, Washington: International Bank for Reconstruction and Development, November 1984).

    • Search Google Scholar
    • Export Citation
  • Tun Wai, U., and C. Wong,Determinants of Private Investment in Developing Countries,Journal of Development Studies (London), Vol. 19 (October 1982), pp. 19 –36.

    • Search Google Scholar
    • Export Citation
  • Tyler, William G., Growth and Export Expansion in Developing Countries: Some Empirical Evidence,Journal of Development Economics (Amsterdam), Vol. 9 (August 1981), pp. 121 –30.

    • Search Google Scholar
    • Export Citation
  • United Nations Conference on Trade and Development, “Survey of Commodity Demand and Supply Elasticities,” Research Memorandum No. 48 (Geneva: UNCTAD, March 1974).

    • Search Google Scholar
    • Export Citation
  • van Wijnbergen, Sweder, Stagflationary Effects of Monetary Stabilization Policies: A Quantitative Analysis of South Korea,Journal of Development Economics (Amsterdam), Vol. 10 (April 1982), pp. 133 –69.

    • Search Google Scholar
    • Export Citation
  • Williamson, John, ed., IMF Conditionality (Washington: Institute for International Economics, 1983).