MACROECONOMIC MANAGEMENT

Also edited by Soumitra Sharma

DEVELOPMENT POLICY ECONOMIC DEVELOPMENT AND WORLD DEBT (with H. W. Singer) GROWTH AND EXTERNAL DEBT MANAGEMENT (with H. W. Singer)

Macroeconomic Management

Edited by

Soumitra Sharma Professor of Economics University of Zagreb, Croatia

First published in Great Britain 1995 by

MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 6XS and London Companies and representatives throughout the world

A catalogue record for this book is available from the British Library.

ISBN 978-1-349-24282-5 ISBN 978-1-349-24280-1 (eBook)

DOI 10.1007/978-1-349-24280-1

First published in the United States of America 1995 by

ST. MARTIN'S PRESS, INC .. Scholarly and Reference Division, 175 Fifth Avenue, New York, N.Y. 10010

ISBN 978-0-312-12608-7

Library of Congress Cataloging-in-Publication Data Macroeconomic management I edited by Soumitra Sharma. p. em. Includes bibliograpical references and index. ISBN 978-0-312-12608-7 cloth I. Economic policy. I. Sharma, Soumitra. HD87.M24 1995 339.5-dc20 94-44699

CIP

Selection, editorial matter and Chapters 1-4, 6-15 © Soumitra Sharma 1995 Chapter 5 ©James Meade 1995 Softcover reprint of the hardcover 1st edition 1995 978-0-333-45804-4

All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission.

No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Coun Road, London WI P 9HE.

Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

10 9 8 7 6 5 4 3 2 I 04 03 02 01 ()() 99 98 97 96 95

Contents

List of Figures vii

List of Tables viii

Preface IX

Notes on the Contributors xiii

The Evolution of Macroeconomic Management Soumitra Sharma

2 Global Prospects in an Interdependent World Paul Streeten 22

3 Globalisation and Macroeconomic Management Zoran Jasic 40

4 Does Fiscal Policy Matter? James Tobin 51

5 Domestic Stabilisation and the Balance of Payments James Meade 69

6 Incomplete Markets in Foreign Exchange and Asymmetric Financial Integration Pan A. Yotopoulos 87

7 Austrian-Australian Approach (AAA) to Internal and External Stability Emil-Maria Claassen 108

8 International Borrowing Strategy and Sovereign Creditworthiness Ronald Solberg 122

9 Adjustment and Rural Poverty: Monitoring ESRP Rolf Kappel 154

v

VI Contents

10 How to Stop Inflation? Karl Sacher and Theresia Theurl 178

11 Managing Foreign Trade Policy in a Small Economy Tomislav Presecan 203

12 Constraints on Monetary Policy for Transitional Economies Pero Jurkovic 210

13 Macroeconomic Issues in Eastern Europe Jvo Druiic 221

14 Financial Sector Reform: Scope and Sequencing Tomas 1. T. Balino 239

15 Japanese FDI and Economic Policy Kiyoshi Abe 248

Index 259

List of Figures

4.1 Excess demand and deficit schedules for two budget programmes 56

4.2 Laffer Curves 67 4.3 Derivation of Laffer Curves 68 7 .I Policy mix for external equilibrium: expenditure-reducing

and expenditure-switching policies I I I 7.2 Real depreciation under fixed and floating exchange rates 113 7.3 (a) Labour market for T and N 116

(b) Production possibility curve 117 8.1 External financial shocks 134 8.2 Financial flows 142 9.1 Price incentives and supply responses !58 9.2 Gross domestic product (Mt billions, 1980 prices) 164 9.3 Average annual per capita cash income, 1990 (Mt 1000) 167 9.4 Average annual per capita cash income, 1991 (Mt 1000) 167 9.5 Total income in Mozambique, 1991 (Mt.1000) 168

12.1 Foreign exchange reserves, 1992-4 215 12.2 Consumer price index, 1992-4 216 12.3 Monthly prices and interest rates, 1992-4 216

vii

List of Tables

3.1 Analysis of the globalisation of the world economy 42 3.2 Guidelines for global competitiveness 43 4.1 US fiscal and monetary policy and federal debt dynamics,

1952-87 61 6.1 Index of real exchange rates, 1970 and 1975 91 6.2 Cross-section/time series regression on growth,

all countries, 1970 and 1975 93 6.3 Taiwan: rate of growth of GNP and financial statistics,

1953-92 102 8.1 External debt of Baker-15 countries 128 8.2 Terms of debt repayment for Baker-15 countries 136 8.3 External debt flow requirements for Baker-15 countries 140 9.1 Stratification of adjustment policy and monitoring

concerns 159 9.2 Outline of the monitoring concept 160 9.3 Producer prices of farmers, 1986-93 170 9.4 Terms of trade of farmers, selected consumer goods,

December 1986 to December 1993 171 10.1 Eastern Europe and CIS consumer price index 181 12.1 NBC balance sheet 214 15.1 Contrasts in investment 249 15.2 Negative effects of foreign investment on trade

balance 251

viii

Preface

He who knows the art of the direct and indirect approach will be victorious. Such is the art of manoeuvre (Sun Tse, the great Chinese military strategist in his work, The Art of War).

How to stabilise the macro economy through active domestic and inter­national economic policy is a particularly relevant question in a world that swings between intense economic activity and unemployment. To seek an answer to this question is to invite trouble and confusion. However, to restore equilibrium nations must skilfully manoeuvre a variety of forces through direct and indirect policy measures. I call this art macroeconomic management.

Back in 1925 Keynes wrote, 'In the economic field ... we must find new policies and new instruments to adapt and control the work­ing of economic forces, so that they do not intolerably interfere with contemporary ideas as to what is fit and proper in the interests of social stability and social justice' ('Am I A Liberal?', The Nation and Athenaeum, 8 and 15 August 1925)

On macroeconomic management issues, economists are in constant disagreement. They disagree among themselves but believe that a sharp­ening of the tools and solid empirical tests will eventually prove them right. Some theorists see macroeconomic management as nothing dis­tinct from the usual economic policy measures used by the govern­ment, others see it only as a mechanism to handle economic crises. The international institutions visualise it as nothing more than a sys­tem of macroeconomic financial control and regulation.

While Keynesians and neo-Keynesians firmly believe that govern­ments can remedy economic ills, monetarists give due credit to govern­mental policies in the short run, but deny any such influence in the long run. Similarly the new classical economists tend to rely on laissez­faire market economics, while post-Keynesians claim that it is now too late for the government to doctor the economy in any significant way and show little sympathy for conventional economics.

From a long-term perspective macroeconomic management could be seen as method of steering the economy out of an economic muddle. In this sense it could be taken to mean a comprehensive set of policy measures designed by national governments and/or international

ix

X Preface

institutions to attain basic economic goals, for example the best possible utilisation of countries' resources and production potential, encouraging growth, remedying structural imbalances, ensuring an equitable distribution of incomes and wealth, and maintaining a balance in international trade.

From a short- or medium-term macroeconomic policy perspective, economists take it as equivalent to macroeconomic stabilisation or a policy aimed at reducing fluctuations in income, employment and prices and stabilising national income at full employment level.

Since the end of the Second World War the overriding international economic policy question for most nations has been whether they can simultaneously attain the multiple objectives of high levels of employ­ment, price stability, economic growth, trade liberalisation and bal­ance of payments equilibrium. To the extent that these objectives may be incompatible, some policy trade-offs and manoeuvres are necessary.

When confronted by policy conflicts most governments have allowed the objective of full employment to dominate national economic policy. The central challenge to the operation of international macroeconomic management, therefore, is how to allow nations to pursue their dom­estic economic objectives without having to forgo the gains from trade or suffer balance of payments disequilibrium.

The Bretton Woods conference anticipated these problems. It was believed that establishment of the IMF and a fixed exchange-rate mech­anism would allow nations to give primacy to their domestic employ­ment policies over balance of payments adjustment. In the late 1960s and 1970s the major assumptions of the Bretton Woods system in terms of the determination of exchange rates, the disturbance in the balance of payments and the provision of international liquidity were sev­erely tested. In fact, for a successful global macroeconomic manage­ment policy, the most important issues involve decisions about the need for remedial action to restore equilibrium. The type of policy adopted by a country depends upon the source of its balance of payment prob­lem and on its other domestic objectives. Naturally the country would like to adopt the least costly mechanism of adjusting its balance of payments without sacrificing domestic economic autonomy, which will in turn depend upon the international monetary system and the code of international conduct it imposes.

Textbook solutions suggest that under any international monetary system the sources and amount of international liquidity differ, as does the degree to which the balance of payments exercises discipline on a country. The more it is desired that an international imbalance should exercise discipline on a country's domestic policies, the less access

Preface xi

the country should have to international finance. The less the coun­try's access to finance, the more it must resort to other measures to remove its balance of payments problem. Through a tight monetary policy and budgetary surplus, internal measures entail deflation if the country is in deficit, and to this extent the country loses domestic autonomy over its employment policies. External measures constitute the imposition of restrictions on trade and capital movements or a de­preciation of the currency; to this extent the country diminishes its gains from trade or incurs the costs of depreciation. While the internal measures can be seen as expenditure-reducing policies that reduce na­tional income and hence the domestic demand for resources; the ex­ternal measures can be viewed as expenditure-switching policies because devaluation or depreciation of the currency will raise the price of tradables relative to price of nontradables, thereby causing a switch in the pat­tern of expenditure and production.

In the monetary approach, money is a stock for which the optimal level is related to current output. If the actual stock is not equal to the desired stock, the disequilibrium will be removed through reserve flows in the balance of payments. Remedial policies must therefore concentrate on the change in domestic credit creation relative to the demand for money.

Since the emergence of the floating exchange rate regime the focus is more broadly on changes in asset portfolios as the proximate cause of exchange rate variations in the short run. The capital flow associ­ated with trade in financial assets can be part of the adjustment pro­cess as well as a source of pressure on the exchange rate.

If a country has access to sufficient international funds it may be able to eschew both internal and external measures and simply cover its imbalance by drawing upon its international reserves. There would be no need for expenditure-reducing or expenditure-switching policies. Resort to international funds would be expenditure-sustaining and the balance of payments would exercise no discipline over domestic policies.

The range of policy instruments available to a country that is seek­ing to adjust its balance of payments is limited to the narrow policy space whose boundaries are determined by the nature of the interna­tional monetary system and the state of the domestic economy. Nat­urally, skilful manoeuvring is required.

This volume presents the various domestic and international poUcy issues that are involved in macroeconomic management. Two important contributions - 'Domestic Stabilisation and the Balance of Payments' (Chapter 5) and 'Does Fiscal Policy Matter?' (Chapter 4) - were originally written in 1982. They are reprinted in this volume for two

xii Preface

reasons: firstly because of the increased relevance of the key issues involved and secondly because these seminal works contain lasting theoretical findings. The authors of these chapters are the two best­known names in economic literature: Nobel Laureates James Meade and James Tobin. The volume also deals with such issues as incom­plete markets in foreign exchange and asymmetrical financial integra­tion; internal and external stability; international borrowing strategy and sovereign creditworthiness; stopping inflation; and the scope and sequencing of financial sector-reforms (Chapters 6, 7, 8, 10 and 14) by such experts in international economics and finance as Pan A. Yotopoulos, E. M. Claassen, Ronald Solberg, Karl Socher and Theresia Theurl, and Tomas J. T. Balifio. Globalisation, being the theme of the 1990s, is dealt with at length by Paul Streeten in Chapter 2 and Zoran Jasic in Chapter 3. The impact of Japanese overseas investment is ana­lysed by Kiyoshi Abe in Chapter 15. Macroeconomic issues in Eastern Europe are dealt with in Chapter 13 by lvo Druzic. Chapters II and 12, by Tomislav Prese~an and Pero Jurkovic respectively, reflect on foreign trade management problems and fiscal constraints in a transi­tional economy.

I feel obliged to mention that the contributions included in this vol­ume may not necessarily by themselves be sufficient for a full elabor­ation of the concept and issues involved in macroeconomic management, nor are they the last word on the subject, but they certainly shed light on relevant issues. To reflect the spirit with which I present this vol­ume to the readers, I quote here a passage from an article by J. M. Keynes ('The General Theory of Employment', 1937):

I am more attached to the comparatively simple fundamental ideas that underlie my theory than to the particular forms in which I have embodied them, and have no desire that the latter should be crystallised at the present stage of the debate. If the simple basic ideas can be­come familiar and acceptable, time and experience and the collaboration of a number of minds will discover the best way of expressing them.

Finally, I wish to express my sincere gratitude to all those who have contributed to this volume. My thanks also go to my friends Emeritus Gerald M. Meier (Stanford) and Emeritus Sir Hans W. Singer (Insti­tute for Development Studies, Brighton) and to Mr Keith Povey for their useful suggestions during the preparation of this book.

SOUMITRA SHARMA

Notes on the Contributors

Kiyoshi Abe is Professor of International Economics at the Faculty of Law and Economics, University of Chiba, Japan.

Tomas J. T. Baliiio is Chief of the Monetary Operation Division, Monetary and Exchange Affairs Department, IMF, Washington, DC, USA.

Emil-Maria Claassen is Professor of Economics and Finance at the University de Paris-Dauphine, France.

lvo Druiic is Associate Professor of Economics at the Faculty of Eco­nomics, University of Zagreb, Croatia.

Zoran Jasic is Minister of Finance of the Government of Croatia and Professor of Public Finance at the Faculty of Economics, University of Zagreb, Croatia.

Pero Jurkovic is Governor of the National Bank of Croatia and Pro­fessor of Public Finance at the Faculty of Economics, University of Zagreb, Croatia.

Rolf Kappel is Professor of Economics at the NADEL-ETH Swiss Institute of Technology, Zurich, Switzerland.

James Meade is Nobel Laureate and an Emeritus Professor of Politi­cal Economy at Cambridge University, Cambridge, England.

Tomislav Presecan is Lecturer in International Economics at the Fac­ulty of Economics, University of Zagreb, Croatia.

Soumitra Sharma is Professor of Economics and Chairman of the Department of Macroeconomics and Economic Policy at the Faculty of Economics, University of Zagreb, Croatia.

Karl Socher is Professor of Political Economy at the Instituts fi.ir Wirtschaftstheorie und Politik, University of Innsbruck, Austria.

xiii

XIV Notes on the Contributors

Ronald Solberg is President of International Economic Consultants, Los Angeles, California, USA.

Paul Streeten is a former Director of the World Development Insti­tute of the University of Boston and is currently attached to the UNDP, New York, USA.

Theresia Theurl is Assistant Professor of Finance at the Instituts fiir Wirtschatstheorie und Politik, University of Innsbruck, Austria.

James Tobin is Nobel Laureate and an Emeritus Professor of Econ­omics at the Cowles Foundation for Economic Research of Yale Uni­versity, New Haven, Connecticut, USA.

Pan A. Yotopoulos is Professor of Economics at the Food Research Institute of Stanford University, Palo Alto, California, USA.