Macroeconomic Policies

Macroeconomic policy management has a large impact on investor confidence in the reforming country. Economic volatility raises uncertainty for investors, who look for stability and predictability. The basic elements of macroeconomic policy management for effective reform are the following.

Fiscal Policies.An important indicator of prudent fiscal management is a low, predictable rate of inflation. A lack of control over inflation points to macroeconomic and fiscal unbalances. The most extreme manifestation of this problem, hyperinflation, leads to the introduction of shock programs as a basis for stabilization. When countries impose shock programs, recessions often result, posing difficulties for local workers and consumers. By bringing inflation under control, countries establish a necessary precondition for stability and growth. The stabilization programs implemented by the survey countries had this fundamental objective in mind. For example, Argentina endured many bouts of high inflation, followed by wage and price freezes to arrest them. The controls only halted inflation temporarily,

as the root cause - excessive spending by the public sector - was not addressed. Now that public spending has been brought under control with the Cavallo Plan, Argentine inflation has subsided. Real positive interest rates (i.e., interest rates higher than the rate of inflation) are important in maintaining stability in the balance of payments and are a key element of sound fiscal management.

Appropriate Exchange Rates.Appropriate exchange rate policy adjusts the value of the local currency on a steady, predictable basis, which, again, contributes to economic stability and investor confidence. Countries that experience high rates of inflation typically have overvalued exchange rates, because adjustments in the value of the local currency lag behind the rate of inflation. However, local currencies that are overvalued hurt exports, which are more expensive in international markets compared to the exports from countries with cheaper currencies. Exchange rate reform usually entails a devaluation of the local currency, making the country's export more competitive in terms of price and the country itself more attractive for private investment.

Prices and Wages.As noted earlier, price and wage controls are often used to control inflation. While they may have the desired effect in the short-term, they almost always unravel and end up creating more inflation. When governments repeatedly employ wage and price freezes, consumers and businesses adjust their behavior in anticipation of the next round of controls by hoarding goods, raising wage demands or raising prices, leading to yet higher inflation. In Poland, prices and wages were set by the government for many years under the system of central planning. One of the first steps of the Balcerowicz Plan was to free all wages and prices as of January 1, 1990. This step marked a major event in the Polish transition to a market-oriented economy.