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April 16, 2008 Time: 07:07pm fm.tex Development Macroeconomics | April 16, 2008 Time: 07:07pm fm.tex DEVELOPMENT T H I R D E D I T I O N April 16, 2008 Time: 07:07pm fm.tex MACROECONOMICS Pierre-Richard Agénor and Peter J. Montiel P R I N C E T O N U N I V E R S I T Y P R I N C E T O N A N D O X F O R D P R E S S April 16, 2008 Time: 07:07pm fm.tex c 2008 by Princeton University Press Copyright Published by Princeton University Press, 41 William Street, Princeton, New Jersey 08540 In the United Kingdom: Princeton University Press, 6 Oxford Street, Woodstock, Oxfordshire OX20 1TW All Rights Reserved Library of Congress Cataloging-in-Publication Data Agénor, Pierre-Richard. Development macroeconomics / Pierre-Richard Agénor and Peter K. Montiel.—3rd ed. p. cm. Includes bibliographical references and index. ISBN 978-0-691-13090-3 (cloth : alk. paper) 1. Developing countries—Economic conditions. 2. Development economics. 3. Macroeconomics. I. Montiel, Peter. II. Title. HC59.7 .A7422 2008 330.9172/4 22 2007061030 British Library Cataloging-in-Publication Data is available This book has been composed in Times Roman and Myriad Printed on acid-free paper. ∞ press.princeton.edu Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 April 16, 2008 Time: 07:07pm fm.tex To our fathers, the late Frédéric and Pedro, for their support and guidance April 16, 2008 Time: 07:07pm fm.tex April 16, 2008 Time: 07:07pm fm.tex Contents | Preface to the Third Edition XiX Introduction and Overview 1 1 Overview of the Book 2 2 Some Methodological Issues 7 1 | Scope of Development Macroeconomics 10 1 Historical Background 12 2 Economic Structure and Macroeconomics 14 2.1 Openness to Trade in Goods and Assets 15 2.2 Exchange-Rate Management 17 2.3 Domestic Financial Markets 17 2.4 The Government Budget 18 2.5 Aggregate Supply and the Labor Market 20 2.6 Stability of Policy Regimes 22 2.7 Macroeconomic Volatility and Fluctuations 23 2.8 Income Inequality 27 3 Some Special Topics 28 Part I Macroeconomic Accounts, Market Structure, and Behavioral Functions 2 | Aggregate Accounts, Production, and Market Structure 1 A General Accounting Framework 35 1.1 The Nonfinancial Private Sector 36 1.2 The Public Sector 37 1.2.1 The Nonfinancial Public Sector 37 1.2.2 The Central Bank 38 1.2.3 The Consolidated Public Sector 39 1.3 The Commercial Banking System 40 1.4 Aggregate Relationships 40 2 Production Structure in an Open Economy 41 2.1 The Mundell–Fleming Model 41 2.2 The “Dependent Economy” Model 45 2.3 A Model with Three Goods 48 3 The Structure of Labor Markets 51 3.1 Functioning of Labor Markets 52 3.2 Open and Disguised Unemployment 54 35 April 16, 2008 viii Time: 07:07pm fm.tex Contents 3.3 Indexation and Wage Rigidity 55 3.4 Labor Market Segmentation 56 3 | Behavioral Functions 62 1 Consumption and Saving 62 1.1 Consumption Smoothing 66 1.2 Planning Horizon and Liquidity Constraints 67 1.3 Liquidity Constraints and Asymmetric Effects 69 1.4 Effects of Interest Rate Changes on Savings 73 1.5 Public and Private Consumption 74 2 Private Investment 74 2.1 Conventional Determinants 75 2.2 Reformulation of Theories 76 Nature of the Financial System 76 Imported Goods 76 Debt Overhang Effects 77 Role of Public Capital 77 Macroeconomic Instability and Uncertainty 78 2.3 Uncertainty and Irreversibility Effects 79 3 The Demand for M