Chapter

2 A Model of Adjustment and Growth An Empirical Analysis

Author(s):
International Monetary Fund
Published Date:
June 1991
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Information about Asia and the Pacific Asia y el Pacífico
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Author(s)
Carmen M. Reinhart *

The Concept of “growth-oriented adjustment,” or the notion that economic growth is essential for the achievement of the twin goals of a sustained reduction in inflation and a viable balance of payments, has recently received the attention of policymakers and academics alike. Indeed, growth-oriented adjustment is considered a key characteristic of the policy packages that make up Fund-supported programs. Examples of the blossoming literature on the subject of growth-oriented adjustment can be found in Bacha and Edwards (1988), Blejer and Chu (1989), and Corbo, Goldstein, and Khan (1987).1

Any analysis of the effects of policies on the targets of growth, inflation, and the balance of payments requires a consistent and unified framework. Further, because this issue is particularly relevant for developing countries, it is desirable that the framework be both sufficiently simple to allow its application where data are limited, and general enough to ensure its applicability to a diverse set of countries. The model developed by Khan and Montiel (1989), which merges a variant of a neoclassical growth model frequently employed by the World Bank with the monetary approach to the balance of payments associated with the IMF, provides such an integrated framework.2

However, the simplicity that makes a model more tractable from an operational standpoint may have several drawbacks as a result of the necessarily restrictive assumptions it employs. This paper assesses the usefulness of the Khan-Montiel model for policymaking by examining empirically the trade-off between its simplifying assumptions and its ability to fit reality. This trade-off can be assessed by applying the model to a variety of countries. For each country, the following questions are asked: (1) Are the key parameters of the model stable? (2) How sensitive are the policy multipliers to these parameter estimates—that is, how robust are the policy implications? and (3) Are some target variables more vulnerable to forecast err