Macroeconomic Factors and Growth: Theory and Case Studies Lecture 1: The Washington Consensus

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Macroeconomic Factors and Growth Theory and
Case Studies Lecture 1 The Washington
Consensus

• Ulrich Fritsche
• DIW Berlin

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Structure

• Lecture 1 The Washington Consensus (Fritsche)
• Lecture 2 The Struggle for a Post-Washington
  Consensus (Seidel)
• Lecture 3 Case studies
• Basic aim of this lecture Background,
  theoretical arguments, discussion

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Lecture 1 The Washington Consensus

• Background IMF, World Bank and the invention of
  Development after 1945
• Basic model of stabilization and structural
  adjustment (Ref. Fischer, 1997 Agénor/Montiel,
  1996)
• The clash of the 1970s Old-fashioned
  (structuralist) macroeconomics vs. Neo-liberal
  development economics (Ref. Gore, 2000)
• Basic elements of the Washington Consensus of
  the early 1990s (Ref. Williamson 1990/2002)

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The Background The Inter-war Gold Standard

• In the beginning God created sterling and franc.
• On the second day He created the currency board
  and (...) money was well managed.
• On the third day God decided that man should have
  free will and so He created the budget deficit.
• On the fourth day, however, God looked upon his
  work and was dissatisfied. It was not enough.
• So, on the fifth day God created the central bank
  to validate the sins of man.
• On the sixth day God completed His work by
  creating man and giving him dominion over all of
  God's creatures.
• Then, while God rested on the seventh day,
  man created inflation and the
  balance-of-payments problem.
• Peter B. Kenen

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The Inter-war Period Disturbances and trouble

• Inflation periods in industrialized countries in
  the early 1920s Austria, Germany, France ....
• Return to the old exchange rates of the Gold
  standard Overvaluation problem
• Keynes Tract on Monetary Reform
• with externally fixed interest rate wage
  stickiness internal adjustment is costly,
  devalution preferable
• Great Depression Behaviour of USA not compatible
  with the stability conditions!
• Beggar-thy-neighbor problems!
• For a excellent survey Nurkse (1944)!

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Finance of Development The idea of development
finance

• If either an undeveloped or a war-ravaged
  country is unable to meet its capital
  requirements by capital imports, then it may be
  driven to use up whatever international cash
  reserves it can command, so as to meet at least
  part of those requirements. International
  liquidity, which should merely serve as a
  short-term buffer in the balance of payments,
  will be used in effect for long-term purposes. If
  international currency reserves are distributed
  among countries in accordance with needs arising
  from normal short-term balance-of-payments
  fluctuations, and if these reserves are in fact
  expended for capital purposes, then capital
  capital will have been distributed according to
  an inappropriate criterion that is, not
  according to capital requirements but according
  to international liquidity requirements. (Nurkse
  1949)

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The IMF Articles of Agreement

• (ii) To facilitate the expansion and balanced
  growth of international trade, and to contribute
  thereby to the promotion and maintenance of high
  levels of employment and real income and to the
  development of the productive resources of all
  members as primary objectives of economic policy.
• (iii) To promote exchange stability, to maintain
  orderly exchange arrangements among members, and
  to avoid competitive exchange depreciation.
• (iv) To assist in the establishment of a
  multilateral system of payments in respect of
  current transactions between members and in the
  elimination of foreign exchange restrictions
  which hamper the growth of world trade.

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The IMF Articles of Agreement

• (v) To give confidence to members by making the
  general resources of the Fund temporarily
  available to them under adequate safeguards, thus
  providing them with opportunity to correct
  maladjustments in their balance of payments
  without resorting to measures destructive of
  national or international prosperity.

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The Monetary Approach to the Balance of Payments

• Elasticity approach partial approach, no income
  effects
• Absorption approach no separation of price and
  income effects
• Jacques J. Polak 1957 Monetary Analysis of
  Income Formation and Payments Problems. (IMF
  Staff Papers).

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The Monetary Approach to the Balance of Payments
PPP
Full employment
Money market equilibrium
Interest rate parity
Solution
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The Monetary Approach to the Balance of Payments

• The reserves are determined by those forces who
  determine supply and demand on the money market
  (assumption money market equilibrium!)
• The desired money holding determines the balance
  of payment.
• The balance of payments is a monetary
  phenomenon. (Frenkel/Johnson 1976)

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The Monetary Approach to the Balance of Payments

• H? or E?or Pausl?
• Excess demand for money
• leads to disequilibrium on money market (after
• real devaluation)
• ? real balance effects,
• money holding adjustment
• (2) increase of reserve
• holding

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The Monetary Approach to the Balance of Payments
Money market equilibrium
?R
(1)
Coincidence of external and internal equilibrium
External equilibrium
?P
(1) monetary expansion
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The Savings Gap
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The Savings Gap
T? for instance
The availability of resources constrains growth!
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The Merged Model (cf. Agénor/ Montiel 1996) in
the ?P-?y-space
?y
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Structuralist macroeconomics and the IMF-World
Bank paradigm

• IMF Monetarist and strictly stability oriented
• Prebisch, Singer, CEPAL, structuralists
• Secular deterioration of terms of trade
• Development as a political struggle
• Dependencia theories
• Importsubstitution as a tool for development
• Development planning
• Bottleneck theories
• Inflation as a necessary by-product of development

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IMF annual report 1948

• Inflation is a serious handicap to recovery and
  to the restoration of international economic
  equilibrium. Waste of resources and misdirection
  of production have resulted from rapidly rising
  prices. Much of the investment in some countries
  has been directed toward escaping the
  consequences of holding cash rather than toward
  expand-ing output and increasing efficiency. The
  excessive domestic demand that accompanies
  inflation adds to the difficulty of maintaining
  an appropriate flow of exports, for output that
  might have been available for export is otherwise
  absorbed and prices are pushed to non-competitive
  levels. Inflationary pressure also stimulates
  imports, in-cluding imports of goods which may
  not be necessary for essential consumption and
  investment.

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Neo-liberal supply-side economics of the early
1980s

• The struggle became more pronounced
• Oil price shocks
• Stagflation in the 1970s
• primitive Keynesianism was blamed for the fault
• Reagonomics, Thatcherism gt intellectual climate
  changed
• This in turn bounced back to development
  economics Bhagwati, Krueger gt Free trade
  arguments, Political economy arguments for
  privatization

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Financial repression
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The Washington Consensus according to
Williamson (1990/2002)

• Avoidance of fiscal deficits
• Public expenditure priorities
• Tax reform (and Laffer curve)
• Competitive interest rates and fight against
  financial repression
• Competitive exchange rates
• Trade policy (and the gains from free trade)
• FDI as a driving force of development
• Privatization
• The role of property rights
• Deregulation

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The Washington Consensus according to Williamson
World bank (growth part)
?P
Money market equilibrium
?y
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The Concordat Responsibilities of the IMF and
the World Bank
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Specific Aspects

• Exchange Rate-based vs. Money-based programs
• heterodox vs. orthodox
• Financial Crisis and contagion
• Moral Hazard and Fund Programs
• Special features of programs in transition
  countries
• property rights
• deregulation of prices
• institution-building

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Critique

• Neo-classical critique
• Frank Hahn (1976) monetarist model does not
  discuss the possibility of multiple equilibria
  and stability of the equilibrium.
• Implicit assumption of full employment (Walras
  Law!)
• Structuralist critique
• monetarist approach is wrong, inflation is
  inertial, price-wage spirals
• Two-gap approach (foreign exchange and savings
  gap) becomes Three-gap approach (government
  investment is complementary to private investment
• Discussion about Post-Washington Consensus
• Lecture 2