Economics of Adjustment and Growth

Pierre-Richard Agénor is Hallsworth Professor of International Macroeconomics and Development Economics in the School of Social Sciences, and Co-Director of the Centre for Growth and Business Cycle Research, at the University of Manchester. His research interests include international macroeconomics, development economics, and growth theory.

The Economics of Adjustment and Growth is an exciting book, focusing on the challenges facing researchers and policymakers in the design and implementation of macroeconomic policies in developing countries. The book is very well written, with a nice balance between a clear exposition of models and an overview of their empirical applications. It summarizes the current state of knowledge and recent experience with policies. I highly recommended it to advanced undergraduate and graduate students interested in applied policy issues, as well as practitioners interested in gaining insight into current models and applications.

• Acknowledgments Introduction and Overview 1. BUDGET CONSTRAINTS AND AGGREGATE ACCOUNTS 1.1 Production, Income, and Expenditure 1.2 A Consistency Accounting Matrix 1.2.1 Current Account Transactions 1.2.2 Capital Account Transactions 1.3 Identities and Budget Constraints 1.3.1 Gross Domestic Product and Absorption 1.3.2 The Government Budget Constraint 1.3.3 The Private Sector Budget Constraint 1.3.4 The External Sector Budget Constraint 1.3.5 The Balance Sheet of the Financial System 1.3.6 The Savings-Investment Balance 1.4 Social Accounting Matrices 1.4.1 Activity, Commodity, and Factor Accounts 1.4.2 Institutions and the Capital Account 1.4.3 The Rest-of-the-World Account 1.4.4 SAMs and Economy-wide Models 1.5 Summary 2. CONSUMPTION, SAVING, AND INVESTMENT 2.1 Consumption and Saving 2.1.1 The Permanent Income Hypothesis 2.1.2 The Life-Cycle Model The Basic Framework Age and the Dependency Ratio 2.1.3 Other Determinants Income Levels and Income Uncertainty Intergenerational Links Liquidity Constraints Inflation and Macroeconomic Stability Government Saving Expectations, Taxation, and Debt Social Security, Pensions, and Insurance Changes in the Terms of Trade Financial Deepening Household and Corporate Saving 2.1.4 Empirical Evidence 2.2 Investment 2.2.1 The Flexible Accelerator 2.2.2 The User Cost of Capital 2.2.3 Uncertainty and Irreversibility 2.2.4 Other Determinants Credit Rationing Foreign Exchange Constraint The Real Exchange Rate Public Investment Macroeconomic Instability The Debt Burden Effect 2.2.5 Empirical Evidence 2.3 Summary Appendix - Income Uncertainty and Precautionary Saving 3. FISCAL DEFICITS, PUBLIC DEBT, AND THE CURRENT ACCOUNT 3.1 Structure of Public Finances 3.1.1 Conventional Sources of Revenue and Expenditure 3.1.2 Seigniorage and Inflationary Finance 3.1.3 Quasi-Fiscal Activities and Contingent Liabilities 3.2 The Government Budget Constraint 3.3 Assessing the Stance of Fiscal Policy 3.4 Deficit Rules, Budget Ceilings, and Fiscal Transparency 3.5 Fiscal Imbalances and External Deficits 3.6 Consistency and Sustainability 3.6.1 A Consistency Framework 3.6.2 Fiscal and External Sustainability 3.7 Sustainability and Solvency Constraints 3.8 Commodity Price Shocks and Deficits 3.9 Can Fiscal Austerity Be Expansionary? 3.10 Summary 4. THE FINANCIAL SYSTEM AND MONETARY POLICY 4.1 The Financial System 4.1.1 Financial Repression 4.1.2 Banks and Financial Intermediation 4.2 Money Demand 4.3 Indirect Instruments of Monetary Policy 4.4 Credit Rationing 4.5 The Transmission of Monetary Policy 4.5.1 Interest Rate Effects 4.5.2 Exchange Rate Effects 4.5.3 Asset Prices and Balance Sheet Effects Net Worth and the Finance Premium The Financial Accelerator 4.5.4 Credit Availability Effects 4.5.5 The Role of Expectations 4.6 Monetary Policy: Inflation Targeting 4.6.1 Strict Inflation Targeting 4.6.2 Policy Trade-offs and Flexible Inflation Targeting 4.6.3 Comparison with Intermediate Target Strategies Monetary vs. Inflation Targeting Exchange Rate vs. Inflation Targeting 4.6.4 Requirements for Inflation Targeting 4.7 Monetary Policy in a Dollarized Economy 4.7.1 Persistence of Dollarization 4.7.2 Implications of Dollarization 4.8 Summary Appendix - Inflation Targeting with Forward-Looking Expectations 5. EXCHANGE RATE REGIMES 5.1 The Nature of Exchange Rate Regimes 5.1.1 Pegged Exchange Rate Regimes 5.1.2 Flexible Exchange Rate Regimes 5.1.3 Band Regimes 5.1.4 Multiple Exchange Rate Regimes 5.2 Evidence on Exchange Rate Regimes 5.2.1 General Trends 5.2.2 Exchange Rate Bands 5.3 Choosing an Exchange Rate Regime 5.3.1 Some Conceptual Issues 5.3.2 The Evidence 5.3.3 A Practical Guide 5.4 Trade-offs and Exchange Rate Credibility 5.5 Exchange Rates and the Trade Balance 5.5.1 Measuring Competitiveness 5.5.2 Devaluation and the Trade Balance 5.6 Devaluation with Imported Inputs 5.7 Summary 6 INFLATION AND DISINFLATION PROGRAMS 6.1 Sources of Inflation 6.1.1 Hyperinflation and Chronic Inflation 6.1.2 Fiscal Deficits, Seigniorage, and Inflation 6.1.3 Other Sources of Chronic Inflation Wage Inertia Exchange Rates and the Terms of Trade The Frequency of Price Adjustment Food Prices Time Inconsistency and the Inflation Bias 6.2 Nominal Anchors in Disinflation 6.2.1 Controllability and Effectiveness 6.2.2 Adjustment Paths and Relative Costs 6.2.3 Credibility, Fiscal Commitment, and Flexibility 6.2.4 The Flexibilization Stage 6.3 Disinflation: The Role of Credibility 6.3.1 Sources of Credibility Problems 6.3.2 Enhancing Credibility Big Bang and Gradualism Central Bank Independence Price Controls Aid as a Commitment Mechanism 6.4 Two Stabilization Experiments 6.4.1 Egypt, 1992-97 6.4.2 Uganda, 1987-95 6.5 Summary Appendix - Inflation Persistence and Policy Credibility 7. CAPITAL INFLOWS: CAUSES AND POLICY RESPONSES 7.1 Capital Flows: Recent Evidence 7.2 How Volatile Are Capital Flows? 7.3 Domestic and External Factors 7.4 Macroeconomic Effects of Capital Inflows 7.5 External Shocks and Capital Flows 7.5.1 Households 7.5.2 Firms and the Labor Market 7.5.3 Commercial Banks 7.5.4 Government and the Central Bank 7.5.5 Equilibrium Conditions The Money Market The Credit Market The Market for Home Goods 7.5.6 Graphical Solution 7.5.7 Rise in the World Interest Rate 7.6 Policy Responses to Capital Inflows 7.6.1 Sterilization 7.6.2 Exchange Rate Flexibility 7.6.3 Fiscal Adjustment 7.6.4 Capital Controls Forms of Capital Controls Pros and Cons of Capital Controls 7.6.5 Changes in Statutory Reserve Requirements 7.6.6 Other Policy Responses 7.7 Summary Appendix - Measuring the Degree of Capital Mobility 8. FINANCIAL CRISES AND FINANCIAL VOLITILITY 8.1 Sources of Exchange Rate Crises 8.1.1 Inconsistent Fundamentals 8.1.2 Rational Policymakers and Self-Fulfilling Crises 8.1.3 Third-Generation Models 8.2 Currency Crises: Three Case Studies 8.2.1 The 1994 Crisis of the Mexican Peso 8.2.2 The 1997 Thai Baht Crisis 8.2.3 The 1999 Brazilian Real Crisis 8.3 Banking and Currency Crises 8.3.1 Causes of Banking Crises 8.3.2 Self-Fulfilling Bank Runs 8.3.3 Links between Currency and Banking Crises 8.3.4 Liquidity Crises in an Open Economy 8.4 Predicting Financial Crises 8.5 Financial Volatility: Sources and Effects 8.5.1 Volatility of Capital Flows 8.5.2 Herding Behavior and Contagion 8.5.3 The Tequila Effect and the Asia Crisis 8.6 Coping with Financial Volatility 8.6.1 Macroeconomic Discipline 8.6.2 Information Disclosure 8.6.3 The Tobin Tax 8.7 Summary Appendix - The Mechanics of Speculative Attacks and Interest Rate Defense 9. POLICY TOOLS FOR MACROECONOMIC ANALYSIS 9.1 Assessing Business Cycle Regularities 9.2 Financial Programming 9.2.1 The Polak Model 9.2.2 An Extended Framework 9.3 The World Bank RMSM Model 9.4 The Merged Model and RMSM-X 9.4.1 The Merged IMF-World Bank Model 380 9.4.2 The RMSM-X Framework 9.5 Three-Gap Models 9.6 The 1-2-3 Model 9.6.1 The Minimal Setup 9.6.2 An Adverse Terms-of-Trade Shock 9.6.3 Investment, Saving, and the Government 9.7 Lags and the Adjustment Process 9.8 Summary Appendix - Money Demand and Cointegration 10. GROWTH, POVERTY, AND INEQUALITY: SOME BASIC FACTS 10.1 A Long-Run Perspective 10.2 The Power of Compounding 10.2.1 Growth and Standards of Living 10.2.2 How Fast Do Economies Catch Up? 10.3 Some Basic Facts 10.3.1 Output Growth, Population, and Fertility 10.3.2 Saving, Investment, and Growth 10.3.3 Growth and Poverty 10.3.4 Inequality, Growth, and Development The Kuznets Curve Education and Income Distribution 10.3.5 Trade, Inflation, and Financial Deepening 10.4 Summary Appendix - Common Measures of Poverty and Inequality 11. GROWTH AND TECHNOLOGICAL PROCESS: THE SOLOW-SWAN MODEL 11.1 Basic Structure and Assumptions 11.2 The Dynamics of Capital and Output 11.3 A Digression on Low-Income Traps 11.4 Population, Savings, and Output 11.5 The Speed of Adjustment 11.6 Model Predictions and Empirical Facts 11.7 Summary Appendix - Dynamics of k, the Output Effect of s, and the Speed of Adjustment 12. KNOWLEDGE, HUMANCAPITAL, AND ENDOGENOUS GROWTH 12.1 The Accumulation of Knowledge 12.1.1 Knowledge as a By-Product: Learning by Doing 12.1.2 The Production of Knowledge 12.2 Human Capital and Returns to Scale 12.2.1 The Mankiw-Romer-Weil Model 12.2.2 The AK Model 12.3 Human Capital and Public Policy 12.4 Other Determinants of Growth 12.4.1 Fiscal Policy Government Spending The Dual Effects of Taxation Budget Deficits and Growth 12.4.2 Inflation and Macroeconomic Stability 12.4.3 Trade and International Financial Openness 12.4.4 Financial Development 12.4.5 Political Factors and Income Inequality 12.4.6 Institutions and the Allocation of Talent 12.5 Summary Appendix - Determinants and Costs of Corruption 13. THE DETERMINANTS OF ECONOMIC GROWTH: AN EMPIRICAL OVERVIEW 13.1 Growth Accounting 13.2 The East Asian "Miracle" 13.3 Growth Regressions and Convergence 13.3.1 Diminishing Returns and Convergence 13.3.2 Convergence and Cross-Section Regressions 13.3.3 Testing the Mankiw-Romer-Weil Model 13.4 The Empirics of Growth 13.5 The Econometric Evidence: Overview 13.5.1 Saving and Physical and Human Capital 13.5.2 Fiscal Variables 13.5.3 Inflation and Macroeconomic Stability 13.5.4 Financial Factors 13.5.5 External Trade and Financial Openness 13.5.6 Political Variables and Income Inequality 14. TRADE AND LABOR MARKET REFORMS 14.1 Trade Liberalization 14.1.1 The Gains from Trade 14.1.2 Recent Evidence on Trade Reforms 14.1.3 Trade Reform, Employment, and Wage Inequality 14.1.4 Obstacles to Trade Reform 14.2 Trade and Regional Integration 14.3 Reforming Labor Markets 14.3.1 Labor Markets in Developing Countries Basic Structure Employment Distribution and Unemployment Wage Formation and Labor Market Segmentation Minimum Wages Trade Unions and the Bargaining Process 14.3.2 Labor Market Reforms and Flexibility 14.4 Summary Appendix - Reforming Price Incentives in Agriculture 15. FISCAL ADJUSTMENT AND FINANCIAL SECTOR REFORMS 15.1 Fiscal Adjustment 15.1.1 Reforming Tax Systems The Excess Burden of Taxation Fighting Tax Evasion Guidelines for Reform 15.1.2 Expenditure Control and Management 15.1.3 Civil Service Reform 15.1.4 Fiscal Decentralization 15.2 Pension Reform 15.2.1 Basic Features of Pension Systems 15.2.2 Pension Regimes and Saving: A Framework 15.2.3 Recent Evidence on Pension Reform 15.3 Interest Rate Liberalization 15.3.1 A Simple Framework 15.3.2 Potential Pitfalls 15.4 Sources of Financial Fragility 15.4.1 The Nature of Banks' Balance Sheets 15.4.2 Microeconomic and Institutional Failings 15.4.3 Moral Hazard and Perverse Incentives 15.4.4 Macroeconomic Instability 15.4.5 Premature Financial Liberalization 15.5 Strengthening Financial Systems 15.6 Summary Appendix - Structural Policy Indices 16. AID, EXTERNAL DEBT, AND GROWTH 16.1 The Effects of Foreign Aid 16.1.1 Aid Effectiveness and the Fungibility Problem 16.1.2 Aid, Investment, and Growth The Situation without Aid The Effects of Aid on Investment 16.1.3 Aid and Growth: Cross-Country Evidence 16.2 Growth, Debt, and Fiscal Adjustment 16.3 The Debt Overhang and the Debt Laffer Curve 16.4 Measuring the Debt Burden 16.4.1 Conventional and Present Value Indicators 16.4.2 Sustainability and External Solvency 16.5 Debt Rescheduling and Debt Relief 16.6 Summary Appendix - The Theory of Stages in the Balance of Payments 17. SEQUENCING, GRADUALISM, AND THE POLITICAL ECONOMY OF ADJUSTMENT 17.1 Stabilization and Structural Adjustment 17.2 The Order of Liberalization 17.2.1 Liberalization of External Accounts 17.2.2 Financial Reform and the Capital Account 17.2.3 A Formal Framework Analysis of Liberalization Policies Financial Deregulation Relaxation of Capital Controls Trade Liberalization 17.3 Sequencing and Labor Market Reforms 17.4 Political Constraints and Reforms 17.4.1 Modeling Political Conflict 17.4.2 The Benefits of Crises 17.4.3 Political Acceptability and Sustainability 17.5 Shock Treatment or Gradual Approach? 17.6 Summary Appendix - Calculating the Welfare Effects of Reform References Figure Credits Index