Despite the increased attention that macroeconomic management in developing countries has received during the past decade, no consensus has emerged on the appropriate analytical framework for the study of developing country macroeconomic issues. Instead, individual models suitable for different tasks have proliferated with different, and often conflicting, assumptions about a wide range of crucial aspects of these economies, such as the nature of financial markets, the degree of capital mobility, the form and functioning of the exchange rate regime, the degree of wage-price flexibility, the determination of aggregate supply, the extent to which agents’ expectations are forward-looking, and so on.
This lack of consensus on analytical macroeconomic models for developing countries is even more pronounced at the empirical level. Substantial disagreement exists over the general specification of such models, as well as over the orders of magnitude of certain key macroeconomic parameters—for example, the interest responsiveness of saving and investment, the “offset coefficient” for monetary policy, the relative price elasticity of exports and imports, and the importance of “accelerator” mechanisms in the determination of investment, all of which have important implications for economic policy. Although estimates of macroeconomic parameters such as these are indeed available for developing countries, they differ greatly with regard to countries and periods covered, specifications of estimated equations, and—possibly most important—the empirical methodology employed in producing them. Consequently, generalizations across developing countries are virtually impossible to make.
The aim of this paper is to generate “representative” developing country estimates of a set of macroeconomic parameters that are considered important for policy, using a uniform data set for a relatively large group of countries and relying on appropriate empirical techniques to obtain these estimates. Because our interest is in providing reasonable empirical estimates of widely used parameters, we construct a fairly simple macroeconomic model using widely accepted developing country specifications for the key behavioral relationships wherever possible. The structural parameters are then estimated as a system.
Although, for the reason just explained, the behavioral relationships in our model are conventional, our work differs from existing developing country empirical macroeconomic models in two important ways. First, we assume that expectations are formed rationally by forward-looking economic agents. Second, we make explicit allowance for the presence of capital controls, the latter being a feature which, though pervasive in developing economies and often mentioned in policy discussions, is invariably neglected when it comes to empirical analysis.
The remainder of the paper is organized as follows. The model to be estimated is described in Section I. Section II describes the estimation procedure and presents the estimation results. The model estimates are discussed in Section III. The final section provides some brief comments on the specification of the model and the estimated relationships.
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Nadeem U. Haque, an Economist in the Developing Country Studies Division of the Research Department, holds degrees from the London School of Economics and Political Science and the University of Chicago.
Peter J. 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.
Kajal Lahiri, Professor of Economics at the State University of New York-Albany, was a Visiting Scholar in the Research Department when this paper was written. He was educated at Calcutta University and holds a Ph.D. from the University of Rochester.
The authors are grateful to Mohsin Khan for helpful comments.
Although a three-good (exportable-importable-nontraded) structure might be more appropriate for developing countries, data limitations make it infeasible to implement the estimation of a model with this structure across a large group of developing countries.
Few studies have found reliable or significant estimates of interest elasticities of consumption in developing countries. See, for example, Rossi (1988).
Note that the Mundell-Fleming structure of this model implies that exports and domestic output are perfect substitutes.
Once again, empirical applications of this specification are extensively discussed in Goldstein and Khan (1985).
We used the approximation
In our estimation the first-order term was found to be adequate.
The additional lagged term in Y permits the demand for money to adjust more slowly in response to changes in income than to changes in interest rates.
A negative value of FG,t denotes accumulated debt.
The countries in the sample are Brazil, Chile, Colombia, Costa Rica, Ecuador, Egypt, Ethiopia, Greece, Guatemala, India, Indonesia, Jamaica, Jordan, Kenya, the Republic of Korea, Malawi, Malaysia, Malta, Mexico, Morocco, Nigeria, Paraguay, the Philippines, South Africa, Sri Lanka, Tanzania, Thailand, Tunisia, Turkey, Venezuela, and Zambia.
For more detailed discussion of estimation with variance components see Balestra and Nerlove (1966), Hausman and Taylor (1981), Amemiya and McCurdy (1986), Breusch, Mizon, and Schmidt (1989, and Maddala (1988).
Before estimating the model, we tested our assumed error-components structure, and also conducted tests for serial correlation. These tests are described in Haque, Lahiri, and Montiel (1990), which also provides a detailed treatment of estimation issues. The results were consistent with the variance-components model, and no signs of serial correlation were detected in the residuals.
Note that our model formulation allows all the endogenous variables to be correlated with ηji and εji, in all equations. However, the exogenous variables are assumed to be uncorrelated with and Some of the exogenous variables, however, can be correlated with ηij, but uncorrelated εij. Cornwell, Schmidt, and Wyhowski (1988) refer to this latter group as “singly” exogenous variables. For consistent estimation, the country means of the singly exogenous variables (that is,
Since aggregate employment data are seldom available for developing countries, we used the population as a proxy for L.
Estimates of income elasticities of money demand substantially above unity are quite common in developing countries. See Khan (1980).
In view of this result, we re-estimated the model, imposing perfect capital mobility to see if the coefficients were altered in any significant manner. The results were essentially unchanged, with the exception of the consumption function. This function exhibited a substantially greater interest rate elasticity. The estimated fraction of liquidity-constrained households was about one third, a result which is much closer to the estimates in Haque and Montiel (1989).