Macroeconomics in Emerging Markets

Cover......Page 1
Half-title......Page 3
Dedication......Page 4
Title......Page 5
Copyright......Page 6
Contents......Page 7
Preface......Page 9
PART 1 Overview......Page 13
1 Macroeconomics and Development......Page 15
a. Complete Specialization and the Aggregate Production Function......Page 16
b. Short Run and Long Run in Macroeconomics......Page 18
II. MACROECONOMIC STABILITY AND LONG-RUN GROWTH: THEORY......Page 19
a. Macroeconomic Instability, Total Factor Productivity, and Capital Accumulation......Page 20
3. Financial Sector Fragility......Page 22
III. MACROECONOMIC STABILITY AND LONG-RUN GROWTH: EVIDENCE......Page 23
a. Cross-Country Evidence......Page 24
b. Cross-Country Growth Regressions......Page 26
c. Evaluating the Evidence......Page 28
IV. SUMMARY......Page 29
b. Graphing Functions......Page 30
PART 2 A Benchmar Macroeconomic Modelfor an Emerging Economy......Page 33
2 Equilibrium in the Domestic Labor and Goods Markets......Page 35
1. The Demand for Labor......Page 36
2. The Supply of Labor......Page 37
3. Labor Market Equilibrium......Page 38
b. Output of Domestic Goods......Page 40
a. Aggregate Expenditure......Page 41
b. Aggregate Demand for Domestic Goods......Page 42
c. Net Exports......Page 43
d. The Aggregate Demand Curve......Page 44
III. EQUILIBRIUM IN THE MARKET FOR DOMESTIC GOODS......Page 46
IV. ANTICIPATED SHOCKS......Page 48
V. THE GM CURVE......Page 50
VI. SUMMARY......Page 53
3 Equilibrium in Financial Markets......Page 54
a. The Domestic Private Sector’s Balance Sheet and Asset Demand Functions......Page 55
b. Public Sector Balance Sheets......Page 58
d. Balance Sheet and Asset Demands of the Rest of the World......Page 59
II. ASSET SUPPLIES......Page 60
b. The Supply of Money......Page 61
3. Domestic Credit Targeting......Page 62
5. Perfect Capital Mobility......Page 65
6. Summary......Page 66
b. Money Market Equilibrium......Page 67
1. A Change in the Domestic Price Level......Page 68
2. Expansionary Monetary Policy......Page 71
3. A Change in the Country’s Net Creditor Position......Page 72
4. A Change in the Foreign Interest Rate......Page 74
5. A Change in the Nominal Exchange Rate......Page 76
IV. SUMMARY......Page 77
APPENDIX 3.1: BALANCE SHEET CONSTRAINTS AND ASSET MARKET EQUILIBRIUM CONDITIONS......Page 78
APPENDIX 3.2: MONETIZATION AND REVALUATION ACCOUNTS......Page 79
b. Monetization......Page 80
c. Monetization with Credit Expansion......Page 81
I. THE FM CURVE......Page 82
II. SHORT-RUN MACROECONOMIC EQUILIBRIUM......Page 86
a. Expansionary Fiscal Policy......Page 87
b. Expansionary Monetary Policy......Page 89
c. Nominal Devaluation......Page 91
d. A Domestic Supply Shock......Page 92
e. A Reduction in the Foreign Interest Rate......Page 94
f. An Increase in Partner-Country Incomes......Page 95
III. APPLICATION: MACROECONOMIC INSTABILITY IN EMERGING ECONOMIES......Page 96
b. Changes in the International Environment......Page 97
IV. SUMMARY......Page 98
5 Medium-Term Macroeconomic Equilibrium......Page 100
I. SOURCES OF MACROECONOMIC DYNAMICS......Page 101
II. MEDIUM-TERM EQUILIBRIUM UNDER FINANCIAL AUTARKY......Page 103
a. An Increase in Domestic Credit......Page 105
b. A Nominal Devaluation......Page 107
III. MEDIUM-TERM EQUILIBRIUM UNDER PERFECT CAPITAL MOBILITY......Page 108
IV. MEDIUM-TERM EQUILIBRIUM UNDER IMPERFECT CAPITAL MOBILITY......Page 109
a. Effects of a Domestic Credit Expansion......Page 111
b. Effects of a Nominal Devaluation......Page 112
V. SUMMARY......Page 113
PART 3 Public Finance and Macroeconomic Performance......Page 115
6 The Intertemporal Budget Constraint of the Public Sector......Page 117
a. The Budget Constraint of the Consolidated Public Sector......Page 118
b. Interest Rate Differentials......Page 120
c. Determinants of Money Supply Growth......Page 122
II. THE PUBLIC SECTOR’S INTERTEMPORAL BUDGET CONSTRAINT......Page 123
III. MONETARY STABILIZATION AND FISCAL ADJUSTMENT......Page 130
IV. THE SIZE OF THE REQUIRED FISCAL ADJUSTMENT......Page 132
V. SUMMARY......Page 134
7 Consequences of Insolvency I: High Inflation......Page 136
I. INFLATION AND LONG-RUN GROWTH: THEORY......Page 137
d. High RealInterest Rates......Page 138
f. Working Capital......Page 139
II. INFLATION AND LONG-RUN GROWTH: EVIDENCE......Page 140
a. Costs of Inflation Stabilization......Page 143
b. Modeling Inflation Stabilization......Page 144
c. Stabilization Strategies......Page 151
IV. INFLATION STABILIZATION: EVIDENCE......Page 152
a. Cross-Country Evidence......Page 153
b. Case Study Evidence: Stabilization Programs......Page 154
1. Hyperinflation......Page 155
2. Chronic Inflation......Page 156
V. SUMMARY......Page 157
I. THE DEBT “OVERHANG”......Page 159
b. Macroeconomic Effects of the Debt Overhang......Page 160
II. THE DEBT CRISIS OF THE EIGHTIES......Page 163
a. Run-up to the Debt Crisis......Page 164
b. Triggering Events......Page 165
c. Policy Responses......Page 166
d. Macroeconomic Outcomes......Page 168
III. SUMMARY......Page 170
9 Measures for Achieving Fiscal Credibility I: Central Bank Independence......Page 172
I. ACHIEVING FISCAL CREDIBILITY......Page 173
b. Tying One’s Hands......Page 174
d. “Signaling” by Breaking Taboos......Page 175
II. TYING THE GOVERNMENT’S HANDS BY RESTRICTING ACCESS TO SEIGNORAGE......Page 176
III. CENTRAL BANK INDEPENDENCE AND INFLATION: THEORY......Page 178
a. FormalIndicators of Independence......Page 182
4. Lending to Government......Page 183
c. Relationship Between Independence and Price Stability......Page 184
 V. SUMMARY......Page 185
I. ECONOMIC ROLE OF STATE-OWNED ENTERPRISES......Page 187
II. THE FISCAL EFFECTS OF PRIVATIZATION......Page 189
a. Evidence on State-Owned Enterprise Performance......Page 192
1. Privatization......Page 193
2. Enterprise Reform......Page 194
IV. SUMMARY......Page 195
PART 4 The Financial Sector and Macroeconomic Performance......Page 197
11 Finance, Welfare, and Growth......Page 199
I. FINANCIAL TRANSACTIONS AND FINANCIAL MARKETS......Page 200
a. Risk Reduction......Page 201
b. Intertemporal Reallocation of Consumption......Page 202
c. Financing Investment......Page 203
II. FINANCIAL MARKET EQUILIBRIUM IN AN IDEAL WORLD......Page 204
III. THE REAL WORLD: IMPERFECT INFORMATION AND OPPORTUNISTIC BEHAVIOR......Page 205
a. Financial Intermediation as a Costly Activity......Page 206
b. The External Finance Premium......Page 209
a. What Do Banks Do?......Page 210
b. Capital Markets......Page 212
a. Policies to Promote an Enabling Environment......Page 214
c. Policies to Deal with Financial Sector Instability......Page 216
a. Effects of Growth on Financial Development......Page 217
b. Effects of Financial Development on Growth: Theory......Page 220
c. Effects of Financial Development on Growth: Evidence......Page 221
VII. SUMMARY......Page 223
b. Gambia......Page 224
f. Tanzania......Page 225
12 Financial Repression......Page 226
I. THE INGREDIENTS OF FINANCIAL REPRESSION......Page 227
a. Financial Repression as a Fiscal Phenomenon......Page 229
b. Financial Repression and Seignorage......Page 230
c. Fiscal Revenues from Financial Repression......Page 232
1. Effects on Efficiency of Allocation......Page 235
2. Effects on the Costs of Intermediation......Page 236
b. Financial Repression and Growth: Evidence......Page 237
a. Financial Policies in the Asian “Miracle” Economies......Page 238
b. Financial Repression and Growth in East Asia: Hypotheses......Page 241
2. Financial Policy and Saving Rates......Page 243
4. Financial Policies and the Efficiency of Investment......Page 245
5. Management of Directed Credit Policies......Page 248
V. SUMMARY......Page 249
13 Financial Reform, Public Policy, and Financial Crises......Page 251
I. VULNERABILITY OF A LIBERALIZED BANKING SECTOR......Page 252
a. Banking Crises......Page 253
b. Bank Panics......Page 254
a. The Lender of Last Resort and Deposit Insurance......Page 256
b. Bank Regulation and Supervision......Page 258
III. BANKING CRISES: THEORY......Page 260
IV. BANKING CRISES: EVIDENCE......Page 263
1. Demigurc-Kunt and Detragiache (1998)......Page 264
b. Case Study Evidence......Page 265
2. The Nordic Crises of the Early 1990s......Page 266
3. Seven Developing Countries......Page 267
4. Chile (1982)......Page 268
5. Mexico (1994)......Page 269
V. SUMMARY......Page 270
14 Financial Openness and the Sequencing of Financial Reform......Page 273
a. The Effectiveness of Capital Controls......Page 274
b. Optimality of Capital Account Restrictions......Page 279
II. THE SEQUENCING OF FINANCIAL REFORM......Page 281
a. The Sequencing of the Broad Components of Reform......Page 282
b. Specific Reform Measures......Page 284
III. COUNTRY CASE STUDIES......Page 285
a. Financial Reform Among Asian Economies......Page 286
b. Financial Reform in Sub-Saharan Africa......Page 288
APPENDIX 14.1: OBSERVATIONS ON SEQUENCING OF FINANCIAL REFORM......Page 290
b. McKinnon (1992)......Page 291
c. Williamson (1991)......Page 292
15 Coping with Capital Inflows......Page 294
a. Characteristics of Capital Flows to Emerging Economies in the Early 1990s......Page 295
b. “Pull” Factors, “Push” Factors, and Changes in Financial Integration......Page 296
II. WELFARE IMPLICATIONS OF ‘‘PUSH” VERSUS ‘‘PULL”......Page 298
III. MACROECONOMIC OVERHEATING: DESTABILIZING INFLOWS......Page 300
b. Policy Intervention: A Menu......Page 301
c. Restrictions on the Magnitude of Gross Inflows......Page 302
d. Encouragement of Gross Outflows......Page 303
e. Trade Liberalization......Page 304
f. Exchange Rate Flexibility......Page 305
g. Sterilization......Page 306
i. Fiscal Contraction......Page 308
j. Policy Strategies......Page 310
a. Sources of Vulnerability......Page 311
b. Sources of Vulnerability: Evidence......Page 313
V. SUMMARY......Page 314
a. Calvo, Leiderman, and Reinhart (1993)......Page 316
c. Fernandez-Arias (1994)......Page 317
f. Hernandez and Rudolf (1994)......Page 318
h. World Bank (1997)......Page 319
PART 5 Exchange Rate Management......Page 321
16 Equilibrium Real Exchange Rates......Page 323
a. Analytical Issues......Page 324
3. Dependent-Economy (Swan-Salter) Models......Page 325
b. Measurement Issues......Page 326
II. THE LONG-RUN EQUILIBRIUM REAL EXCHANGE RATE: CONCEPTUAL ISSUES......Page 327
a. Defining “Equilibrium”......Page 328
2. The Long-Run Equilibrium Real Exchange Rate (LRER)......Page 329
b. Misalignment......Page 330
III. HOW LONG IS THE “LONG RUN”?......Page 333
IV. A MODEL OF THE LONG-RUN EQUILIBRIUM REAL EXCHANGE RATE......Page 334
a. The Purchasing Power Parity Approach......Page 337
b. The “Trade Elasticities” Approach......Page 338
c. General-Equilibrium Model Simulation......Page 339
d. Single-Equation Reduced-Form Estimation......Page 340
e. An Evaluation......Page 342
VI. SUMMARY......Page 343
17 Exchange Rate Regimes......Page 345
I. FOREIGN EXCHANGE REGIMES, EXCHANGE RATE MANAGEMENT, AND MONETARY POLICY......Page 346
1. Nominal Anchors in Open Economies......Page 348
2. Monetary Neutrality......Page 349
3. Fiscal Solvency......Page 350
b. A Short-Run Constraint: The “Impossible Trinity”......Page 351
a. Exchange Regimes and Transactions Costs......Page 352
IV. EXCHANGE RATE REGIMES AND LONG-RUN INFLATION STABILIZATION......Page 353
a. Time Inconsistency Once Again......Page 354
b. Characteristics of Commitment Mechanisms......Page 355
c. Exchange Rate Announcements as Commitment Mechanisms......Page 356
d. Money Supply Announcements as Commitment Mechanisms......Page 357
e. Exchange Rate Regimes and Price Stability: Evidence......Page 358
f. Inflation Targeting......Page 359
a. An Example: Adjustment to a Permanent Real Shock......Page 360
1. Consequences of Macroeconomic Shocks......Page 362
2. Availability of Macroeconomic Instruments......Page 363
a. Currency Boards......Page 364
b. Floating Exchange Rates......Page 366
VII. SUMMARY......Page 369
18 Managing an Officially Determined Exchange Rate......Page 371
I. WHY MANAGE THE EXCHANGE RATE?......Page 372
a. Self-Fulfilling Speculative Attacks......Page 373
b. The Role of Fundamentals......Page 375
III. HOW TO MANAGE AN OFFICIALLY DETERMINED EXCHANGE RATE: FIXING THE CENTRAL PARITY......Page 378
b. Choosing the Peg......Page 379
c. Targeting the Real Exchange Rate......Page 380
a. Announcing the Band Width......Page 382
1. The Degree of Fiscal Flexibility......Page 383
4. The Cost of Maintaining Foreign Exchange Reserves......Page 384
V. HOW TO MANAGE AN OFFICIALLY DETERMINED EXCHANGE RATE: INTERVENTION WITHIN THE BAND......Page 385
VI. SUMMARY......Page 386
I. MACROECONOMIC POLICIES AND VULNERABILITY: THEORY......Page 388
a. Public Sector Debt Runs......Page 389
b. Private Sector Debt Runs......Page 390
II. VULNERABILITY IN PRACTICE: MEXICO......Page 394
III. VULNERABILITY IN PRACTICE: THAILAND......Page 399
a. Pre-Crisis Developments......Page 400
1. Real Exchange Rate Misalignment in Thailand......Page 401
2. inancial Sector Vulnerability in Southeast Asia......Page 406
b. Macroeconomic Policies in 1995–96......Page 407
c. Outbreak of the Crisis in Thailand......Page 409
IV. SUMMARY......Page 413
20 Domestic Macroeconomic Management in Emerging Economies: Lessons from the Crises of the Nineties......Page 417
1. Importance of External Financial Shocks......Page 418
2. Domestic Distortions and Financial Integration......Page 420
3. Factors Driving Capital Flows......Page 421
1. Multiplicity of Causes......Page 422
2. Traditional Recipes......Page 423
3. The Role of Debt Composition......Page 424
1. Capital Controls......Page 426
2. Exchange Rate Policy......Page 427
3. Monetary Policy......Page 430
4. Fiscal Policy......Page 434
1. Structural Reforms......Page 435
3. Sources of Currency Mismatches......Page 436
4. Monetary and Fiscal Responses to Crises......Page 437
III. CONCLUSION......Page 438
References......Page 441
Index......Page 447