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Homework answers / question archive / there are three factors that incentivized governments to embark on economic reform 1

there are three factors that incentivized governments to embark on economic reform 1


  1. there are three factors that incentivized governments to embark on economic reform
    1. economic crisis altered interest- group politics as key members of ISI coaltion lost strength and faced higher costs from opposing reform
    2. US institute this new plan to debt crisis in 1989- debtor government could convert existing commercial bank debt into bond- based debt with lower face value, the amount of debt reduction that government realized would be determined by negotiations between debtor government and commercial bank creditors
    to make the proposal attractive to commercial banks, advanced industrialized countries and multilateral financial institutions advanced $30 billion with which to guarantee the principal of Brady bonds
    Mexico was first to take advantage of this in 1989- reduced Mexico's net transfers by about $4 billion (2% of Mexico GDP) which allowed the economy to grow by 2% more than would been possible without debt reduction
    1994- this plan agreements covered about 80% of commercial bank debt and reduced debt- service payments by about 1/3
  2. links exchange- rate policy to the government's monetary policy decisions
    assumes that every government values monetary autonomy more than exchange- rate stability
    all government will maintain a fixed exchange rate only when monetary policy required to do so is consistent with domestic economic objectives
    - different political parties pursue distinct macroeconomic objectives, some use monetary policy to reduce unemployment and are forced to float currency and other parties use monetary policy to limit inflation and can maintain a fixed exchange rate
    - model based on trade- off between unemployment and inflation called Phillips Curve - when inflation high- unemployment low but when inflation low- unemployment high
    -parties from left- low levels of unemployment but with higher inflation
    link with organized labor- incentive for leftist governments to use macroeconomic policy to maintain high levels of employment
    less likely to maintain a fixed exchange rate- expansionary policies will reduce domestic interest rates and raise domestic demand- cause capital outflows and increasing imports- capital outflows and a widening current- account deficit will lead to foreign exchange imbalances and a weakening currency <- left committed to domestic expansion so more open to a floating currency

    - parties from the right- low inflation but higher unemployment
    closer links to business interests, financial sector, and the middle class- less concerned about unemployment and more concerned about protecting the value of their accumulated wealth and in modern economies- people maintain large portions of wealth in financial instruments and so that desire to protect the value of wealth is transformed into desire to protect real value of financial assets and since inflation erodes real value of financial wealth- wealth holders have an interest in policies that maintain stable prices- incentive to adopt macroeconomic policies that maintain stable prices

    more likely to maintain a fixed exchange rate, restrictive monetary policies are less likely to generate capital outflows or increase domestic demand and as a result- conservative governments are unlikely to confront persistent imbalances in foreign exchange market and will not be forced to change monetary policies to sustain a fixed exchange rate as they will be more likely to establish and maintain a fixed exchange rate

    leftist governments are less likely to maintain a fixed exchange rate than rightist government

    e.g case with France- Francois Mitterrand

    a rightist government committed to low inflation tightened monetary policy and embraced fixed exchange rate
    leftist government gave priority to reducing unemployment, adopted expansionary macroeconomic politics in pursuit of objective and devalue the currency

    - partisan macroeconomics policies are differentiated too sharply- not all leftist governments pursue expansionary macroeconomic policies and adopt floating exchange rates
    French Socialists- embraced fixed echange rate
    Conservative Party led by Thatcher- refused to adopt fixed exchange rate for pound
  3. exchange rate policy reflects decisions that governments make concerning monetary policy
    assumes that governments care most about monetary- policy autonomy and will maintain a fixed exchange rate only when monetary policy required to do so corresponds with domestic economic objectives
    domestic economy objectives are shaped by need to win elections
    - politicians are more likely to adopt expansionary macroeconomic policies in the 18 months prior to an election in order to create strong economic growth and falling unemployment at time of election
    - as election approaches- politicians might be reluctant to cede to monetary authority- choosing to allow exchange rates to fluctuate instead
    because economic performances shapes how people vote, politicians will be less inclined to adopt economic policies that slow economic growth and rise unemployment and more inclined to adopt policies that boost economic growth and lower unemployment
    - politicians operate within a specific institutional context that limits ability to adjust macroeconomic policies to their benefit- must win the approval of veto players and overcome objections from opposition party- subnational/ supranational governing units have influence over economic policy
    e.g: early 1970s- US devalue the dollar by 10%- Nixon break link with gold and devalue to win election- when it became apparent that expansionary macroeconomic policies were inconsistent with fixed exchange rate- Nixon administration devalued dollar

    1) offers a limited explanation of exchange- rate policy- tells us that government might abandon a fixed exchange rate prior to an election but tells us little about exchange- rate policy at other times
    2) does not provide deterministic prediction- does not claim that all governments will abandon a fixed exchange rate prior to an election- only suggests that governments sometimes have incentive to do so
    offers limited explanation of exchange- rate policy
  4. state
  5. stabilization was not enough to solve the debt problem in Latin America so creditors came up with this second, more invasive, set of policy reforms, rest on belief that the economic structures developed under ISI provided too little capacity for export expansion, the government were too involved in economic activity and economic production was too geared to domestic market and locally produced manufactured goods were uncompetitive in world market, economic structure stifled entrepreneurship and reduced the capacity for growth and limited the potential for exporting so these types of programs sought to reshape the indebted economies by reducing the government's role and increase the market's, reforms sought substantial market liberalization in 4 areas: trade liberalization, liberalization of FDI, privatization of state- owned enterprises, broader deregulation to promote economic competition
    accompanied by additional lending by the World Bank, new IMF programs, commercial banks

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