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Professor Edwards was a consultant with the Research Department when this paper was written. He is currently with the University of California, Los Angeles, and with the National Bureau of Economic Research. He is a graduate of the Universidad Catolica de Chile and of the University of Chicago.
Mr. Montiel is Assistant Division Chief of the Developing Country Studies Division of the Research Department. He is a graduate of Yale University and the Massachusetts Institute of Technology.
Several authors have investigated the process of macroeconomic adjustment in developing countries. Most studies, however, have focused on a particular aspect of the adjustment process, without providing a general and integrated picture that “fits” (or is consistent with) the more salient stylized facts. See, for example, Blanco and Garber (1986), Connolly and others (1987), Rodriguez (1978), Khan and Lizondo (1987), Krugman (1979), and Edwards (1983).
Extreme care should be taken when using “control groups” to perform macroeconomic empirical studies. See Goldstein and Montiel (1986) and Edwards (1989b). The countries that constituted the control group in this analysis were Côte d’Ivoire, Dominican Republic, Ecuador, Egypt, El Salvador, Ethiopia, Greece, Guatemala, Honduras, the Islamic Republic of Iran, Iraq, Jordan, Malaysia, Mexico, Nicaragua, Nigeria, Panama, Paraguay, Singapore, Sudan, Thailand, Tunisia, Venezuela, and Zambia. See Edwards and Montiel (1989) for the specific periods considered for each of these countries.
The values of the x2 statistics ranged from 9.1 to 14.6. This statistic has two degrees of freedom.
We have arbitrarily defined “significant” as a decline in the terms of trade of at least 5 percent.
Note that these are net foreign assets of the monetary system; thus, the change in this variable is influenced by private capital movements, including capital flight.
Naturally, to the extent that there have not been changes in the equilibrium real exchange rates, these appreciations reflect disequilibrium situations (that is, real overvaluations). Note that the extent of real exchange rate appreciation before the crisis not only varied across countries, but also was more marked in recent years (the 1980s). This has been the case particularly for the countries that adopted a crawling peg after the devaluation.
This model is partially based on Khan and Montiel (1987). It differs in that the present version incorporates a dual exchange rate market and ignores the bond market. Kiguel and Lizondo (1986) and Edwards (1988) have presented models somewhat similar to the one developed here.
The initial steady state around which the model will be solved below will have the property that y2 = 0. This will be the case when the country is initially neither a net international debtor nor creditor, since in this case (1 -%)y = yNle (see Khan and Montiel (1987)).
Of course, in this case the increase in gN will have to be temporary.
Note that m + v rises up to point D. Although e falls, if 1- θ is small, equation (8) indicates that a will increase. Since by equation (7) y is unaffected by changes in e, the behavior of c will depend on that of a.
Note that, if the economy jumped above C, the new path would intersect LL to the southwest of D. Since the increase in v along this path (call it C’D’) is smaller than that along CD, and since for each value of v on this path
We are here considering an adverse terms of trade shock that takes the form of a reduction in
The initial point C must be below
That the paths such as GH, located below CD, require more time to traverse than CD follows from the fact that, for each m, the trade deficit on CD exceeds that on GH, yet the cumulative deficit along GH (the reduction in m) exceeds that along CD. It follows that, in the case of prolonged adjustment, the initial jump from point A must be to a path below CD, rather than to one above it.
In particular, adding endogenous capital flows triggered by perceived interest rate differentials would result in a system with three state variables.