The potency of stabilization policy in developing economies: Kenya, Tanzania, and Uganda

Abstract

In this paper we investigate the comparative potency of stabilization policy instruments in Kenya, Tanzania, and Uganda. We draw on a small, eclectic macroeconomic model that includes features distinctive to developing economies and is sufficiently flexible to be capable of yielding either “Structuralist” or “Orthodox” outcomes. The model is estimated jointly on Kenya, Tanzania, and Uganda in a novel application of Zellner's estimation procedure. Among the findings of interest are that data are able to accept a number of common cross-country elasticity restrictions, suggesting that these three countries share some elements of a common economic structure. However, system-wide multipliers, generated by simulation experiments, uncover different properties of the model across the three countries. This implies that there are important cross-country differences that must be taken into account in the design of stabilization policy. On the structuralist-Orthodox controversy we find that the parameters of all three countries' aggregate demand schedules are broadly good news for the Orthodox position, whereas the aggregate supply schedules are generally bad news for Orthodox policies, as all three economies appear vulnerable to supply-side inflation generated by policies such as monetary contraction, an interest rate reform, or a competitive depreciation of the exchange rate. Overall, the results imply that Orthodox policies can only be applied to these economies with considerable caution.