Modelling macroeconomic adjustment with growth in developing economies : the case of India

Abstract

The aim of this research is to understand the current economic scene and the stabilisation policies in historical perspective, and to survey and develop models for analysing issues of macroeconomic adjustment with growth. The topics have been chosen for their continued relevance in the current policy debates. The standard open economy model on which the Bretton Woods macroeconomics is based takes into account neither the endogeneity and decomposition of aggregate government expenditure or investment nor the price formation process in a developing economy. Further, with the opening up of the Indian economy since 1991, macroeconomic policy analysis needs to be examined in a different analytical framework from the essentially closed economy framework that has hitherto characterised policy discussions in India.T he present study investigates the appropriateness of the Fund-Bank approach to macroeconomic adjustment; modifies and analyses the respective effects of the model in light of the structural constraints in the form of low capital formation in the Indian economy after having disaggregated government expenditure into government consumption and investment expenditures. This thesis models trade, inflation and the determinants of long-run growth considering the role of endogenous growth and the demand factors in growth. The modelling procedure follows the VAR-based time series literature as against the traditional Cowles Commission approach to structural macroeconometric modelling. It estimates a macroeconomic model that incorporates the paradigm underlying the IMF's policy recommendations to developing countries, using Indian time series data from 1950-51 to 1995-96. It discusses structural sensitivities, dynamics and deterministic optimal control. This study investigates the effectiveness of three sets of key macroeconomic policy instruments which are typical in financial liberalisation process - namely, a tight credit policy, a depreciation of domestic currency and, a hike in regulated interest rates. Finally this study solves a multi-target and multi-instrument optimal control problem and finds that the two-target two-instrument problem of a standard policy package is not growth inducive and must target output growth in order to make the adjustment program as growth-oriented. This research has focused on explicitly recognising and analysing the operation of a credit or lending channel in the transmission of monetary policy