DP1552 | Will Gradualism Work When Shock Therapy Doesn't?

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31/01/1997

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Abstract

When shock therapy is politically infeasible, will gradualism work? Mussa (1986) conjectured, in the context of a neoclassical model of adjustment, that the answer was ?yes?. This paper takes up the Mussa conjecture by: (i) building a political-economy model in which it makes sense; (ii) stating the relevant political-economy constraint rigorously; and (iii) analysing the question in the context of Mussa?s model. It turns out that, in general, there is no a priori presumption that gradualism will work when shock therapy does not, because it has conflicting effects in a dynamic general equilibrium. The paper goes on to add further structure to the problem in the form of: (i) a simple parameterization of the policy choice; and (ii) a linearization of the model around a steady state. It is then possible to confirm the Mussa conjecture in a ?local? sense. Extensive numerical simulations of the non-linear model under a wide variety of parameter configurations confirm that the results are robust even for large reforms and even when the economy begins far away from its eventual steady state.