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

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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.

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