APPENDIX I Structure of the Dynamic Model
APPENDIX II Structure of the Steady-state Model
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The authors are grateful to Mohsin Khan for helpful comments, and to Ravina Malkani for excellent research assistance.
The best-known macroeconomic simulation model for developing countries is by Khan and Knight (1981). That model is estimated and simulated with adaptive expectations. Haque, Montiel, and Symanski (1989) construct a developing-country simulation model and use it to examine the dynamic effects of several policy and external shocks with forward-looking expectations. Recently Agenor (1990) has estimated and simulated a small developing-country rational-expectations model.
The model is presented in Appendix I, which also contains variable definitions. The parameters reported in Appendix I were estimated empirically, using an error-components three-stage least squares technique, for a pooled cross section-time series sample of 31 developing countries. Details of the estimation, including diagnostic statistics, are provided in Haque, Lahiri, and Montiel (1990). That paper also contains a detailed equation-by-equation description of the model, so the exposition in this section will be brief.
As of June 30, 1989, 84 developing-country members of the International Monetary Fund defended an exchange parity for their currencies; see IMF (1989).
The roots were computed through the subroutine LIMO in TROLL.
The symbol “^” denotes a proportionate rate of change.
For an analysis of the aggregate demand effects of import restrictions in developing countries, see Ocampo (1987).
The Marshall-Lerner condition is satisfied by the model of Appendix I. Notice that the perfect capital mobility assumption implies that the higher domestic price level results in a capital inflow and a substantial reserve gain. While this operates to ease import restrictions and increase the trade deficit, this effect appears with a one-period lag.
This result is sensitive to the assumptions of perfect wage-price flexibility and perfect capital mobility. For an analysis directed specifically to these issues, see Haque and Montiel (1990).
Under perfect capital mobility, one might question why they should do so, since a reserve target could readily be attained by altering the stock of domestic credit, thereby inducing private capital flows that would permit achievement of a reserve target. Implicitly, it is assumed that the authorities face constraints—perhaps in the form of imperfect control over the supply of domestic credit—that do not permit credit policy to be flexibly adjusted to this end. An alternative specification—in which import restrictions depend on the sum of the foreign exchange held by the central bank and the private sector (which might be more reasonable when capital mobility is high)—is explored in a separate paper (see Haque and Montiel (1990)).
A third link to the rest of the world, through foreign prices, is also present in the model. To save space, however, we will not describe the effect of shocks to this variable.