The authors are grateful to Nadeem Haque, Guillermo Le Fort, Tony Lanyi, Saul Lizondo, Carmen Reinhart, Carlos Vegh, Danny Villanueva, and David Vines for helpful comments.
See Khan and Knight (1985) for a survey of selected macroeconomic models for developing countries.
The monetary approach to the balance of payments plays a key role in the formulation of Fund financial programs (IMF (1977) and (1987)), and the World Bank uses a two-gap growth model to establish external financing needs and consistent projections across countries (World Bank (1980)).
See Corden (1987) for a discussion of the relevance of current macro-economic theories to developing economies.
For simplicity we assume that the private sector cannot borrow abroad, and that domestic interest rates are zero. While the introduction of private capital flows and domestic interest payments would complicate the analysis, it would be unlikely to alter the conclusions.
Since the model described in this sector is formulated in discrete time, the symbol “d” will be used below to denote the change in a variable from the last period (0) to the present.
We assume that there is no public investment so that all investment in the economy is undertaken by the private sector.
In this model it is assumed that only the government can borrow abroad.
Capital gains from devaluation are assumed to be retained by the central bank.
See World Bank (1980). In practice Bank programs go well beyond what is implied by RMSM. For an extended discussion of the economics of Bank programs for adjustment and growth, see Michalopoulos (1987).
Lower-case letters will denote real variables throughout.
Recall that F = F0 + dF and R = R0 + dR.
Using a more general formulation for the demand for money would not alter the analysis appreciably as long as the function was stable with respect to the explanatory variables.
This assumes that the factor α1(s + b) is less than unity, a condition which is very unlikely to be violated empirically.
This is simply a slightly modified version of the familiar Marshall-Lerner condition.
In the Polak model the endogenous variables are the balance of payments and nominal output. Assuming real output exogenous, the Polak model then determines the change in reserves and prices.
This means that all the increase in domestic credit goes to the private sector.
We assume that in the absence of the devaluation, the balance of payments would have been in equilibrium. If not, the change in the domestic currency value of the flow of foreign exchange reserves would also exert monetary effects.
We again ignore the changes in the slope of GG.