Chapter

III. An Overview of Macroeconomic Measures in Fund-Supported Adjustment Programs

Author(s):
International Monetary Fund
Published Date:
September 1986
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Several studies have surveyed the adjustment measures which have been employed in Fund-supported programs in recent years, concentrating on both the external and domestic fiscal adjustment efforts.7 The more common of these measures are listed in Appendix I; the macroeconomic measures are discussed in this section. As the studies demonstrate, Fund-supported adjustment programs contain understandings about the economy, some of which are identified through performance criteria and other measures intended to ensure that the desired progress is achieved. In many cases, important policy measures are undertaken prior to the beginning of a program. Even though the distributional effect of fiscal policies is the main concern here, monetary and external sector policies have far-reaching implications for the distribution of income. Their effect, however, is in many ways more indirect and difficult to identify than those of fiscal policy. To put the later discussion of fiscal policies in perspective, a general overview of exchange rate and monetary policies affecting the distribution of income follows.

Exchange Rate and Other External Sector Policies

In the simplest sense most adjustment programs arise from a chronic imbalance in the external sector, for which the most obvious solution following exhaustion of external capital sources is to reduce imports or stimulate exports. The most intuitively obvious solution to an imbalance of this type is to adjust relative prices so that imports are more dear or exports more profitable, or both. In this regard, adjustment of the exchange rate suggests itself as a measure which has favorable effects in both directions. A devaluation will increase the price in domestic currency terms of traded goods and consequently direct domestic resources to import substitution and export promotion. The argument for devaluation is particularly appealing in view of price and wage rigidities which normally prevail in markets, limiting the scope for absolute price decreases in the nominal price of nontraded goods. Given these circumstances, the only practical means of securing sufficient adjustment in the traded/nontraded goods price ratio is often an upward adjustment of the price for traded goods. Of course, the ultimate success of the strategy depends on sufficient monetary restraint to prevent the erosion of the devaluation-induced change in relative prices by subsequent increases in the prices of nontraded goods, as is discussed in the next subsection.

Those who resist exchange rate action often suggest that a devaluation will reduce the resources available to the country and will precipitate a cost-push wage spiral that will ultimately leave the country in a worse position than before. Apart from such issues as those of timing subsumed in the “J-curve” literature, the main issues are those of the relative elasticities of the import and export markets and the quantity of exports which must be offered to satisfy import demands. These are legitimate concerns, but it bears mentioning that a devaluation aimed at easing the excess demand for foreign exchange also improves the administrative efficiency of the economy. An economy which is chronically short of foreign exchange often develops a complex system of exchange controls to allocate the scarce resource in the absence of a market mechanism, with the importation of some goods strictly controlled or the imposition of waiting periods before they can be imported. Ultimately, import licenses become increasingly difficult to obtain, and often the exchange system is subjected to special tax and export bonus schemes. The devaluation permits the public and private sector resources used in these activities to be reduced and the accompanying rules simplified, with a consequent freeing of resources for more productive uses. Moreover, greater use of the price mechanism reduces arbitrariness in the allocation of foreign exchange and improves the allocation of the economy’s resource base. This is of course particularly valid for those countries where the export sector has greater potential for growth than the nonexport sector.

It is possible to argue, then, that the success or failure of a stabilization program can be judged in terms of its effect on the ratio of prices for nontraded goods to those for traded goods. Although the focus of these programs is on resource allocation, they can over time have profound implications for income distributions in response to the necessary changes in relative factor rewards associated with the movement toward external balance.8 The reason for this is, of course, that the release of such resources can usually come only from reduced factor rewards to labor and capital employed in the production of nontraded goods. Although it is possible to minimize the ability of the adversely affected factors of production to restore the factor returns they previously enjoyed through appropriate demand-management measures, the final distribution will depend on the elasticity of demand for exports and imports and the effectiveness of the exchange rate reform. Beyond the broad generalization that the resource reallocation will ultimately entail a related income redistribution in favor of factors used to produce traded goods, it is difficult to speculate on the distributional effects. It is often the case, however, that the overvaluation of the currency has protected the standard of living for those who are sufficiently well off to consume a high proportion of imported goods (normally concentrated in urban areas) and has turned the terms of trade against the rural sector. Under these circumstances, devaluation can act to restore a more equal and normal distribution of income.

In those countries where residents hold substantial wealth abroad, devaluation will have an additional effect. Normally those holding capital abroad are better off (in terms of domestic purchasing power) than those holding domestic capital. Succinctly, the initial effect of a devaluation is to favor the capital owner who (possibly anticipating the eventual devaluation) is in a position to move capital abroad. Clearly this distributional impact will affect an assessment of devaluation; of course, little can be done about it unless the government can force the repatriation of foreign assets or can find an effective way of identifying and taxing the capital gains made on wealth held abroad. It should also be noted, however, that when returns to capital are artificially reduced to protect labor’s income, capital will normally emigrate, harming growth.

It is sufficiently important to stress here that although the resource reallocation initiated by the devaluation may initially reduce the incomes of factors used in producing nontraded goods, in the longer run the economy’s improved efficiency should stimulate growth and employment and offer the opportunity for all to share in the higher level of national income. On the other hand, the government may try to largely compensate those factors of production adversely affected by a devaluation through related demand-management policies and accommodating monetary policies. Those policies will increase inflationary pressures and act to restore the earlier income distribution, but at the cost of maintaining the initial balance of payments disequilibrium and lowering the growth potential of the economy. While it is possible that this distribution of income is more equitable, it is very likely that everyone—with the possible exception of those few who enjoy privileged access to goods made cheaper by an overvalued exchange rate—will be worse off eventually.9

Exchange and trade policy measures have been a common feature of Fund-supported adjustment programs and occurred in nearly three fourths of the programs (see Table 1 and Appendix III). In most instances, measures focused on exchange rate action with more frequent adjustment of the exchange rate; where multiple exchange rates existed, reunification of the exchange rate was an important objective. In some cases the appropriateness of the exchange rate was monitored by a target on net foreign assets. Usually, understandings with members that impose or maintain exchange measures subject to approval under Article VIII of the Fund’s Articles involve policies and measures that eliminate the need for the exchange measures and facilitate their removal during the program period. In some cases, therefore, the understandings on the jurisdictional side have called for the removal of exchange and other taxes on international transactions consistent with the position of the Fund that all taxes on international transactions must be applied outside the exchange system.

Table 1.External Sector Policies Employed in Fund-Supported Adjustment Programs
Number

of

Programs
Percent
Liberalization and reform of exchange rate arrangement5255
Frequently adjusted rates4952
Gradual merging or unification of exchange rate1920
Other33
Target on net foreign assets2122
Source: Appendix III.
Source: Appendix III.

Money and Credit Policies

Some upward drift of domestic prices may ease the problem of reducing real returns to those factors engaged in producing nontraded goods in economies with wage and policy rigidities, and hence mitigate the unemployment problem that demand constraint may create. On the other hand, too much money growth may act to fuel inflation and dampen the incentives for the transfer of resources that was the purpose of the devaluation in the first place. It is for this reason that appropriate money and credit policies are key elements of all Fund-supported adjustment programs. Reflecting both the importance of credit policy to the overall adjustment process and the timely availability of reliable data, credit aggregates are also used in most cases as performance criteria.

Within these overall limits, constraints are normally placed on the public sector access to credit to ensure that the private sector receives an adequate share of the total credit. Most often this restriction takes the form of a subceiling on government borrowing from the banking system, and less frequently a subceiling on public sector borrowing or borrowing by particular nonfinancial public enterprises. Other approaches to the same objective have been quantitative limits on the public sector and government overall deficits and, less often, the use of special performance clauses which limit the growth of government outlays or specify a specific increase in government revenues.

The financial measures undertaken as part of a Fund-supported adjustment process encompass a wide range (Table 2). Controls on credit allocation may be reduced and interest rates raised toward positive rates in real terms both to improve the allocation and supply of financial resources to foster growth and to reduce domestic inflation. A more equitable income distribution can be facilitated by expanding access to credit markets. Other policies which support this objective include those which limit insider loans and those which promote the ability of each sector to compete for credit, such as fixing farm loan interest rates at free market levels instead of fixing them at such unrealistically low levels that little credit is available.

Table 2.Monetary Policies Employed in Fund-Supported Adjustment Programs
Number

of

Programs
Percent
Limit on credit expansion9298
Ceilings on:
Net domestic assets or total bank credit8287
Bank credit to central government5053
Bank credit to public sector including nonfinancial public enterprises3537
Separate ceiling on bank credit to parastatals66
Reduction in the rate of growth of liquidity2830
Interest rate reform2527
Adequate share of credit to private sector2223
Measures to mobilize domestic savings5154
Interest rate measures3739
Reform of the financial system2324
Other1819
Source: Appendix III.
Source: Appendix III.

The distributional effects of these policies are mixed. As the general policies limiting monetary growth and providing equal access for all are supportive of the growth effect, the link between growth and distribution also applies indirectly here. Furthermore, the limited evidence regarding the relationship between inflation and income distributions indicates that the poor typically do not possess assets that hold their real values and often cannot secure effective indexation of their wages in periods of inflation, further suggesting that these monetary policies do not worsen income distributions.10

It should be noted also that during periods of tight credit a firm’s access to credit may depend on such factors as the foreign exchange it earns, its past record of repaying credit lines, and nonbank sources of funds, with the result that overall credit constraints may skew productive resources toward large well-established firms and away from smaller companies, and toward consumers and producers in the urban sector and away from entities in the rural sector; the result is that the distributional effects of such credit constraints may not be as favorable as they might first appear.

Other Macroeconomic Policies

Most Fund-supported programs included other macroeconomic policies, which in a few cases mitigated the effects of exchange rate or other policies on certain sectors of society. Nearly all of the measures, however, were directed at restraining demand or improving supply, as they introduced a more rational system of incentives through limits on wage increases, price flexibility, and structural adjustments in the economy (Table 3).

Table 3.Other Macroeconomic Policies Employed in Fund-Supported Adjustment Programs
Number

of

Programs
Percent
Wages and Prices8388
Partial or general wage restraint13638
Wage guidelines or wage reform policies4346
Flexible pricing system3638
Reduction in price-cost distortions3032
Review or increase sector prices3234
Increases in energy prices4346
Review price control system2729
Structural adjustment measures7074
Development and restructuring of a sector6367
Shift of overall management1516
Shift of resource from public to private2729
Investment planning and execution procedures3537
Source: Appendix III.

One policy measure in the opposite direction.

Source: Appendix III.

One policy measure in the opposite direction.

Increases in public sector wages and salaries were frequently limited (38 percent of the programs) but differentiated so that higher-paid employees received smaller increases or no increase at all (see also Section V). In one case, it was agreed that the private sector should have an increase similar to that granted to lower-paid government employees. In another, the impact of the higher cost of living on lower-income groups was mitigated by increasing minimum wages, unemployment benefits, and pensions.

The intention to establish a more flexible pricing system was present in nearly two fifths (38 percent) of the programs surveyed, but most generally this was to be achieved within the context of simplifying the existing price control system instead of relying exclusively on market forces. Much of the interest in price flexibility focused on energy prices, which were adjusted upward in nearly half (46 percent) of the programs (see also Section VI). One of the most common measures to upgrade a particular sector’s performance was through a specific review of that sector’s policies, frequently including a change in investment policies and operational objectives (also see Sections V and VI). One fourth of the programs included transfers of state-owned enterprises to the private sector.

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