APPENDIX: Data Description
All time series were obtained from International Financial Statistics (IPS). The individual time series used are described below. Lower case letters denote natural logarithms.
1. Real output (y): y = real GDP (IFS line 99b.p).
2. Money (m): m = money plus quasi-money (IFS lines 34 + 35). Quarterly end-of-period data were used to obtain annual averages.
3. Imports (z): z = import volume (IFS line 73).
4. Foreign prices (pF): pF = U.S. wholesale price index (IFS line 63), converted to peso terms using the peso/U.S. dollar exchange rate (IFS line rf).
5. Foreign real income (yF): yF = industrial country real income (IFS line 110.99bpx).
6. World money (WM2): WM2 = world money plus quasi-money (IFS line 001.351x).
7. International reserves (R): R = total reserves minus gold (IFS line 11.d).
8. Industrial country money (ICM2): ICM2 = industrial country money plus quasi-money (IFS line 110.351x).
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Mr. Chopra, an economist in the Exchange and Trade Relations Department, holds degrees from the University of Bombay and the University of Virginia. This paper was prepared while he was with the Developing Country Studies Division of the Research Department.
Mr. Montiel, an economist in the Developing Country Studies Division of the Research Department when this paper was written, is now in the Macroeconomics Division of the Development Research Department, The World Bank. He is a graduate of Yale University and the Massachusetts Institute of Technology.
Blejer and Fernandez (1980) are an exception. However, their mode! is somewhat unorthodox. For a further discussion, see Montiel (1987).
A Swan-Salter “dependent economy” version of this model is analyzed in Montiel (1987).
The results of this section would be unaffected by the explicit inclusion of the capital stock in equation (1). The assumption that the capital stock grows at a constant rate is needed only for the empirical implementation of the model, in the absence of capital stock series for most countries of interest.
It can readily be shown that the effective demand for labor given by equation (2) falls short of notional labor demand—that is, the amount of labor that would be employed in the absence of controls—when the foreign exchange constraint is binding.
In the Friedman-Phelps formulation, workers essentially negotiate a labor-supply schedule one period ahead based on the price level they expect to prevail during that period on the basis of current information. In contrast to the Lucas (1973) supply function, changes in current prices have real effects to the extent that they were unanticipated last period, not to the extent that they are unperceived this period.
See Montiel (1986).
In this connection, it is noteworthy that Edwards (1983b) had more success with the use of money than with domestic credit in his output equations for several Latin American countries.
See also Baldwin (1975), and the various issues of the Annual Report on Exchange Arrangements and Exchange Restrictions published by the International Monetary Fund.
International Bank for Reconstruction and Development, World Development Report (Washington, 1984), Tables 10–11, pp. 236–38.
The variable Xe in equation (14) may be taken to represent alternatively
It is interesting to note (see Table 2) that the coefficient of unanticipated money increases as additional open-economy variables are included. The closed-economy version is reasonably close to Hanson’s 10 percent rule for Latin American countries, but the final version is more than twice this large. Thus the weak output effects of monetary policy in developing countries uncovered in Khan and Knight’s (1985) survey may be related to misspecification of reduced-form output regressions in small, open economies.