Aghevli, Bijan B., “Money, Prices and the Balance of Payments: Indonesia, 1968-73,” Journal of Development Studies, Vol. 13 (January 1977), pp. 38–57.
Aghevli, Bijan B, and Mohsin S. Khan (1977), “Inflationary Finance and the Dynamics of Inflation: Indonesia, 1951-72,” American Economic Review, Vol. 67 (June 1977), pp. 390–403.
Aghevli, Bijan B (1978), “Government Deficits and the Inflationary Process in Developing Countries,” Staff Papers, Vol. 25 (September 1978), pp. 383–416.
Aghevli, Bijan B (1980), “Credit Policy and the Balance of Payments in Developing Countries,” in Money and Monetary Policy in Less Developed Countries: A Survey of Issues and Evidence, ed. by Warren L. Coats, Jr., and Deena R. Khatkhate (Oxford, 1980), pp. 685–711.
- Search Google Scholar
- Export Citation
)| false ( Aghevli, Bijan B 1980), “ Credit Policy and the Balance of Payments in Developing Countries,” in Money and Monetary Policy in Less Developed Countries: A Survey of Issues and Evidence, ed.by ( Warren L. Coats, Jr., and Deena R. Khatkhate Oxford, 1980), pp. 685– 711.
Aghevli, Bijan B P.R. Narvekar, and Brock K. Short, “Monetary Policy in Selected Asian Countries,” Staff Papers, Vol. 26 (December 1979), pp. 775–824.
Barro, Robert J. (1977), “Unanticipated Money Growth and Unemployment in the United States,” American Economic Review, Vol. 67 (March 1977), pp. 101–15.
Barro, Robert J. (1978), “Unanticipated Money, Output, and the Price Level in the United States,” Journal of Political Economy, Vol. 86 (August 1978), pp. 549–80.
Blejèr, Mario I., “The Short-Run Dynamics of Prices and the Balance of Payments,” American Economic Review, Vol. 67 (June 1977), pp. 419–28.
Blejèr, 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, Vol. 13 (February 1980), pp. 82–95.
Cagan, Phillip, “The Monetary Dynamics of Hyperinflation,” in Studies in the Quantity Theory of Money, ed. by Milton Friedman (University of Chicago Press, 1956), pp. 25–117.
Clements, Kenneth W., “A General Equilibrium Econometric Model of the Open Economy,” International Economic Review, Vol. 21 (June 1980), pp. 469–88.
Clements, Kenneth W.,, and Peter D. Jonson, “Unanticipated Money, ‘Disequilibrium’ Modelling and Rational Expectations,” Economics Letters, Vol. 2 (No. 4, 1979), pp. 303–308.
Dutton, Dean S., “A Model of Self-Generating Inflation: The Argentine Case,” Journal of Money, Credit and Banking, Vol. 3 (May 1971, Part 1), pp. 245–62.
Goldman, Steven M., “Hyperinflation and the Rate of Growth in the Money Supply,” Journal of Economic Theory, Vol. 5 (October 1972), pp. 250–57.
International Monetary Fund, The Monetary Approach to the Balance of Payments: A Collection of Research Papers by Members of the Staff of the International Monetary Fund (Washington, 1977).
Keller, Peter M., “Implications of Credit Policies for Output and the Balance of Payments,” Staff Papers, Vol. 27 (September 1980), pp. 451–77.
Khan, Mohsin S. (1976), “A Monetary Model of Balance of Payments: The Case of Venezuela,” Journal of Monetary Economics, Vol. 2 (July 1976), pp. 311–32.
Khan, Mohsin S. (1977), “Variable Expectations and the Demand for Money in High-Inflation Countries,” Manchester School of Economics and Social Studies, Vol. 45 (September 1977), pp. 270–93.
Knight, Malcolm D., and Clifford R. Wymer, “A Macroeconomic Model of the United Kingdom,” Staff Papers, Vol. 25 (December 1978), pp. 742–78.
Knight, Malcolm D., and Donald J. Mathieson, “Economic Change and Policy Response in Canada Under Fixed and Flexible Exchange Rates.” (This is scheduled for publication in The International Transmission of Economic Disturbances, ed. by Jagdeep Bhandari and others (MIT Press, 1982).)
- Search Google Scholar
- Export Citation
)| false , “ Knight, Malcolm D., and Donald J. Mathieson Economic Change and Policy Response in Canada Under Fixed and Flexible Exchange Rates.” (This is scheduled for publication in The International Transmission of Economic Disturbances, ed.by and others ( Jagdeep Bhandari MIT Press, 1982).)
Laidler, David E.W. (1980), “The Demand for Money in the United States—Yet Again,” in On the State of Macro-Economics, ed. by Karl Brunner and Allan H. Meltzer, Carnegie-Rochester Conference Series on Public Policy, A Supplementary Series to the Journal of Monetary Economics, Vol. 12 (Amsterdam, 1980), pp. 219–71.
- Search Google Scholar
- Export Citation
)| false ( Laidler, David E.W. 1980), “ The Demand for Money in the United States—Yet Again,” in On the State of Macro-Economics, ed.by , Carnegie-Rochester Conference Series on Public Policy, A Supplementary Series to the Karl Brunnerand Allan H. Meltzer Journal of Monetary Economics, Vol. 12( Amsterdam, 1980), pp. 219– 71.
Laidler, David E.W., and Patrick O’Shea, “An Empirical Macro-model of an Open Economy under Fixed Exchange Rates: The United Kingdom, 1954-1970,” Economica, Vol. 47 (May 1980), pp. 141–58.
Magee, Stephen P., “The Empirical Evidence on the Monetary Approach to the Balance of Payments and Exchange Rates,” American Economic Review, Vol. 66 (May 1976), pp. 163–70.
Mathieson, Donald J., “Interest Rates and Monetary Aggregates During a Financial Reform” (unpublished, International Monetary Fund, December 26, 1979).
Olivera, Julio H.G., “Money, Prices and Fiscal Lags: A Note on the Dynamics of Inflation,” Banca Nazionale del Lavoro, Quarterly Review, Vol. 20 (September 1967), pp. 258–67.
Reichmann, Thomas M., and Richard T. Stillson, “Experience with Balance of Payments Adjustment: Stand-By Arrangements in the Higher Credit Tranches, 1963-72,” Staff Papers, Vol. 25 (June 1978), pp. 293–309.
Robichek, E. Walter (1967), “Financial Programming Exercises of the International Monetary Fund in Latin America,” address to a seminar of Brazilian professors of economics, Rio de Janeiro, September 20, 1967.
Robichek, E. Walter (1971), “Financial Programming, Stand-By Arrangements, and Stabilization Programs” (unpublished, International Monetary Fund, 1971).
Sargent, Thomas J., and Neil Wallace, “Rational Expectations and the Dynamics of Hyperinflation,” International Economic Review, Vol. 14 (June 1973), pp. 328–50.
Tanzi, Vito, “Inflation, Real Tax Revenue, and the Case for Inflationary Finance: Theory with an Application to Argentina,” Staff Papers, Vol. 25 (September 1978), pp. 417–51.
Vogel, Robert C., “The Dynamics of Inflation in Latin America, 1950-1969,” American Economic Review, Vol. 64 (March 1974), pp. 102–14.
von Furstenberg, George M., “The Effect of the Changing Size and Composition of Government Purchases on Potential Output,” Review of Economics and Statistics, Vol. 62 (February 1980), pp. 74–80.
White, William H., “The Importance of ‘Blocked’ Compensating Deposit Balances for Setting Stand-By Credit Ceilings and Monetary Targets in LDCs” (unpublished, International Monetary Fund, >February 27, 1980).
Williamson, John, “Economic Theory and International Monetary Fund Policies,” in Monetary Institutions and the Policy Process, ed. by Karl Brunner and Allan H. Meltzer, Carnegie-Rochester Conference Series on Public Policy, A Supplementary Series to the Journal of Monetary Economics, Vol. 13 (Amsterdam, 1980), pp. 255–78.
- Search Google Scholar
- Export Citation
)| false , “ Williamson, John Economic Theory and International Monetary Fund Policies,” in Monetary Institutions and the Policy Process, ed.by , Carnegie-Rochester Conference Series on Public Policy, A Supplementary Series to the Karl Brunnerand Allan H. Meltzer Journal of Monetary Economics, Vol. 13( Amsterdam, 1980), pp. 255– 78.
Wymer, Clifford R., “Continuous Time Models in Macro-Economics: Specification and Estimation,” paper presented at SSRC-Ford Foundation Conference on Macroeconomic Policy and Adjustment in Open Economies, Ware, England (April 28-May 1, 1976).
Mr. Khan, Assistant Chief of the Financial Studies Division of the Research Department, is a graduate of Columbia University and the London School of Economics and Political Science.
Mr. Knight, Assistant Chief of the External Adjustment Division of the Research Department, is a graduate of the University of Toronto and the London School of Economics and Political Science, where he also served as a member of the Economics Department from 1972 to 1975.
Apart from colleagues in the Fund, the authors are grateful to Vittorio Corbo, Rudiger Dornbusch, Michael Mussa, and John Williamson for helpful comments on the paper.
One previous study, by Aghevli and Khan (1980), does try to generalize by using the same model for eight developing countries.
Such stickiness could arise from the existence of prior contracts, or simply because inflation is driven by expectations that are slow to be revised.
See Frenkel and Johnson (1976) and IMF (1977). Such generalizations have been made by Blejèr (1977) for Mexico, Knight and Wymer (1978) for the United Kingdom, and Knight and Mathieson (1982) for Canada.
Careful study of the individual characteristics of a specific country would obviously be required before a stabilization program could be tailored to its particular circumstances.
This does not mean that the exchange rate cannot be altered, but only that it is policy determined. Indeed, an exchange rate change may well be one of the policy actions included in a stabilization package. It is recognized that a few developing countries have a floating exchange rate, and that a larger number follow some variation of a crawling-peg system. The present model explicitly allows an exchange rate change to affect domestic prices, and it could easily be extended to a crawling-peg regime.
Financial reform policies in recent years in some Latin American and Asian countries have resulted in a fairly rapid development of domestic capital and financial markets. See, for example, Mathieson (1980). For such countries, it is possible that this model would involve some misspecification. However, the experience of these countries is quite recent and not representative of developing countries in general.
In the steady state, λ1 = λ1λ4g, where γ4 is the income elasticity of the demand for money and g ≠ 0 is the rate of growth of capacity output. This ensures that domestic prices are at their equilibrium level relative to foreign prices.
Here, β0 represents the equilibrium ratio of domestic prices to prices in the rest of the world. This ratio depends on such factors as domestic and foreign tastes and levels of productivity.
This assumption of γ3 = 1 is, of course, one of the main features of the monetary approach to the balance of payments.
For a discussion of the role of this variable in the inflationary process, see Knight and Mathieson (1982).
Furthermore, because of controls imposed by the authorities, the interest rates that are available show very little variation over time. This makes it difficult to detect empirically any systematic relationship between money holdings and interest rates. For a discussion of the interest rate data that are available for some developing countries, see White (1980).
This has to be done because such valuation changes do not affect the domestic money stock or the excess demand for money. If F is the stock of reserves valued in foreign currency, then R = ϵF. It is ΔlogF that is related to the excess demand for money, and ΔlogF = ΔlogR - Δlogϵ.
The demand for nominal money balances is simply logMd = logmd + logP.
The Aghevli-Khan expenditure function is cast in real terms, that is, desired real expenditure is related to the level of real income. In combination with a nominal revenue formulation, this implies asymmetric behavior in the components of the deficit. In the model here, both expenditure and revenues are written in nominal terms.
If government expenditure and revenues both grow at the same rate as nominal income in the long run, then it would imply that γ9= γ11 = 1. Starting from an equilibrium position, this would ensure a balanced budget in the steady state. In the short run, however, even with the condition being satisfied that the income elasticities equal unity, one could observe a divergence between expenditure and revenues that would result from differences in the values of the adjustment parameters γ8 and γ10.
See Knight and Wymer (1978) for an example of such a model. In a recent paper, Keller (1980) also examines theoretically the relationship between monetary factors and the supply side of the economy in developing countries.
In principle, one would also like to include the effects of changes in fiscal policy and relative prices on the flows of real aggregate demand and output. To determine the direct impact on output of a change in the relation between domestic and foreign prices, the term −
To catch the stimulative effect of an increase in real government spending on output,
In a growing economy where g ± 0, λ2 must be equal to (1 + λ4λ12-λ13)g for current output to increase at the same rate as capacity output in the steady
At the same time, the increase in the expected rate of inflation would tend to lower demand.
The countries are Argentina, Brazil, Chile, Colombia, the Dominican Republic, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Nicaragua, Panama, Paraguay, Uruguay, Jamaica, Jordan, Sri Lanka, India, Korea, Malaysia, Nepal, the Philippines, Singapore, Thailand, Burundi, Ghana, Kenya, Malawi, and Zambia.
In each estimated equation, the constant term is a combination of an adjustment parameter and the basic ratios, such as those of domestic to foreign prices, money to income, and government spending and taxes to income. The dummy variables that are introduced into each equation standardize the sample. Thus, allowance is made for the fact that these ratios differ widely from one country to another, while adjustment parameters and the elasticities are still restricted to be the same across countries.
The computer program employed to calculate the estimates is entitled RESIMUL and was written by Clifford R. Wymer.
This approximation method automatically adjusts the domestic currency value of international reserves to offset the valuation effects of exchange rate changes. See Appendix III.
Because of the presence of these dummies, equations (22) and (23) were treated as stochastic, although with the values for γ15 to γ23 from the linearization imposed. This effectively leaves the identity for real money balances as the sole nonstochastic equation.
Since none of the countries in our sample have freely floating exchange rates, Aloge is generally zero, and this variable was omitted from equation (1) during estimation. Since
These are denoted as “t-values,” even though, strictly speaking, this ratio has an asymptotic normal distribution. Hypothesis testing would thus have to be based on the normal distribution rather than the t-distribution. In this case, with a sample size of 232 observations, however, there is obviously no distinction.
The existence of a wide variety of close financial substitutes for money in those countries also allows for economies of scale in holding money, thereby giving rise to the possibility that the income elasticity may be less than unity. See Laidler (1977).
Khan’s (1980) estimates for 11 developing countries tend to cluster around a value of two, using quarterly data.
It would have made it more nonlinear in parameters. The alternative of searching for γ14, since it is bounded (0, 1), would have been fairly time consuming. The estimation model has 208 parameters (including those of the country dummies) and 232 observations, so that even a single FIML estimate takes a considerable amount of computer time.
The elasticity is significantly greater than unity, which would mean that government revenues rise secularly as a proportion of nominal income. Of course, since the revenue data have not been adjusted for discretionary tax changes, the elasticity could be biased upward.
This result can be shown to be similar to that emerging from models of the rational expectations variety, where only unanticipated monetary changes affect output. For a discussion of the relationship between the specification in this paper and the models of Sargent and Wallace (1973) and Barro (1977; 1978), see Clements and Jonson (1979).
The equation can be interpreted in a partial-adjustment framework where the rate of growth of real income responds proportionally to the difference between suppliers’ “desired” level of real output, as represented by the capacity level, and actual real output of the previous period. In this case, the parameter γ13 would represent the coefficient of adjustment, with the expression 1/γ13 measuring the average time lag.
A value of unity would mean that in the absence of any monetary disequilibrium, real income would always be at its trend value.
Such a model could be derived by relating domestic expenditure to the excess demand for real balances and utilizing the national income identity. See Laidler and O’Shea (1980).
This result is consistent with the well-known empirical observation that the elasticities of export supply and import demand differ widely from one developing country to another. Furthermore, the inclusion of this variable affected other parameters in the system. For these reasons, the current specification was chosen.
The expression [1 -(MSE/
While the coefficients in the domestic credit and money supply equations were imposed by the linearization procedure, as mentioned earlier, these equations were actually treated as stochastic in the estimation.
Even though the theoretical model can be considered linear in logarithms, the size of the matrix of endogenous variables makes it impossible to evaluate the stability of the model analytically. It is thus necessary to determine stability through numerical means.
The effect of a change in the relative price of domestic versus foreign goods (for example, an oil-price shock) could also be simulated by changing the level of β0. but that experiment is somewhat tangential to the present paper.
As already noted, the fact that no direct effect of government spending on real output could be detected empirically means that only the monetary effects of changes in fiscal policy are taken into account in the model. In these circumstances, it makes no difference whether the present stochastic shock initially hits domestic credit, government spending, or taxes, since the time path traced by the model will be the same in all cases.
The model is constructed in such a way that the reserve leakages associated with the balance of payments deficit begin in the period after the monetary expansion that induces it. Thus, the monetary shock is assumed to take place right at the end of period one, and the reserve leakages start from the beginning of period two. Since no leakages occur during the first period, the money stock initially rises by the full extent of the increase in domestic credit.
The simple model assumes that a partial-adjustment process determines holdings of real money balances and imposes the same restrictions on the expectations mechanism as the model in the paper. The reduced form of the simple model was estimated for the pooled sample by the ordinary least-squares method. For details, see Appendix V.
The short-run responses to a change in nominal income are estimated from the sample as γ8γ9= 0.775 for nominal government expenditure, and γ10γ11 = 0.837 for tax revenue.
As noted earlier, λ1 = γ1γ4g and λ2 = (1 +γ4γ12-γ13)g.
The analysis could also be cast in terms of a flow target: namely, a desired balance of payments position, or target reserves-to-imports ratio. While making the simulations somewhat different, the results should be qualitatively similar to the experiment performed here.
For this analysis, the target level of international reserves is taken as exogenous; this means that one equation must be eliminated from the model. We have chosen to drop the government-spending equation, so that the level of public expenditure in nominal terms is now determined by the domestic credit identity.
It is certainly possible that with a target that is defined in flow terms, the pattern for domestic credit would be quite different. This possibility should be kept in mind when examining the present simulations.
The fluctuating pattern is essentially the consequence of the built-in inertia in the model. We are indebted to Michael Mussa for pointing this out.
The costs of underemployment are universally acknowledged, but overemployment may also cause serious externalities in a developing economy, especially when it is concentrated in the industrial sector. Even if job prospects in this sector are only temporary, overemployment may induce a significant increase in migration to the cities, exacerbating urban problems and stretching public services beyond capacity.
In principle, a benevolent government that was certain to retain office forever would apply a social discount rate of zero. Obviously, most real-world governments can be presumed to have a shorter time horizon, so that they regard immediate employment losses as more costly than future losses.
For a theoretical analysis of the relation between government fiscal policy and potential output in a developed economy, see von Furstenberg (1980).
This is in the context of a model where real capacity output is constant over time. An analogous restriction in a growth context would obviously be the rate of domestic credit expansion.
Obviously, the concept of real income is complicated when the relative price of traded and nontraded goods is allowed to change. However, this problem is of only limited relevance to the empirical results. The theoretical and empirical aspects of this problem are discussed in more detail in Knight and Mathieson (1982).
If the supply of nontraded goods were made a function of capacity rather than current output, a term representing a Phillips curve effect would appear in the price equation (equation 32)). We are indebted to Rudiger Dornbusch for emphasizing this point. This specification, however, did not prove to be empirically robust.
If αj is complex, that is, αj = a + bi, then the modulus of αj is given by
Since γ3 is a coefficient solely of an exogenous variable, its partial derivatives are all necessarily zero.
The t-values are reported in parentheses below the coefficients;