Macro Research for Development

Modeling policy choices

November 2023

The development of models for the analysis of economic policies in low-income countries (LICs) has been one of the key achievements of the FCDO-IMF research project. The use of analytical models particularly helps guide policy making in an unprecedent and uncertain situation like the current COVID-19 pandemic. The workhorse models are the Forecasting and Policy Analysis System (FPAS) and the Debt, Investment and Growth (DIG) model (plus an extension of the latter to include natural resources—DIGNAR). The extensive use of these models by policymakers and IMF country teams suggests they have proven useful in illustrating the likely consequences of policy choices, particularly monetary policy and various fiscal policies. What follows is a brief description of how the topic on modeling policy choices has evolved over the four phases of the FCDO-IMF partnership on research on the macroeconomics of LICs.

• Under phase 1 (March 2012 to March 2015), the focus of this topic was to advance the analytics of monetary and exchange rate policy in LICs and to develop and pilot analytic tools to help country authorities and IMF teams sharpen the analysis of short-run macroeconomic policy issues. Under phase 1, there was also work done on developing model-based frameworks to inform the policy analysis on (i) public investment, growth, and debt sustainability and (ii) managing natural resources, as well as on empirical and country case studies that investigated the investment-growth nexus. Some of the achievements under phase 1 include: research papers on The Monetary Transmission Mechanism in the Tropics: A Narrative Approach and Public Investment, Growth, and Debt Sustainability: Putting together the Pieces; and policy papers on the Conditionality in Evolving Monetary Policy Regimes and Macroeconomic Policy Frameworks for Resource-Rich Developing Countries. For a list of all the work produced under phase 1, see the reports for year 1, year 2, and year 3 of the FCDO-IMF partnership.
• Under phase 2 (April 2015 to March 2017), the focus of this topic was to enrich the understanding of the special features of low-income economies in the analysis and design of short-run macroeconomic policies. It also continued empirical studies (including case studies) to obtain a better sense of stylized facts in LICs. The project also facilitated the continued application of tools developed under the project, including through training. Some of the achievements under phase 2 include: research papers on Current account norms in natural resource rich and capital scarce economies and Debt Sustainability, Public Investment, and Natural Resources in Developing Countries: The DIGNAR Model, together with application of the DIG model on Lesotho and the DIGNAR model on Namibia; and policy papers on Evolving Monetary Policy Frameworks in Low-Income and Other Developing Countries. For a list of all the work produced under phase 2, see the reports for year 4, and year 5 of the FCDO-IMF partnership.
• Under phase 3 (April 2017 to March 2020), the focus of this topic was to add features of the LIC environment that are still missing from the models. In particular, we added a description of the labor market with extensive informality, unemployment and wage-setting behavior consistent with that observed in these economies. In addition, we made a push to disseminate the results of our existing models to policymakers through courses designed for them. Some of the achievements under phase 3 include: a research paper on Inflation targeting and exchange rate management in less developed countries and a paper on Monetary Policy and Bank Lending in Developing Countries: Loan Applications, Rates, and Real Effects. Also, a book on Monetary Policy in Sub-Saharan Africa. For a list of all the work produced under phase 3, see the report for year 6, year 7, and year 8 of the FCDO-IMF partnership.
• Under the current phase—phase 4 (April 2020 to March 2025), we will push the frontier of research in the area of public debt vulnerabilities in LICs. We will extend the DIGNAR model to capture the impacts of COVID-19 situations on debt and growth. We will also examine the implications of the shift in the debt composition in LICs from traditional to non-traditional lenders. Separately, we also envisage a cutting-edge research agenda on governance and policy frameworks for central banks in LICs, with a focus on monetary policy. For a list of all the work produced under phase 4, see the upcoming reports for years 9-13.

For a list of products that have been produced under each of the four phases of the FCDO-IMF partnership, see the box on outputs on the left-hand side.