# **1. INTRODUCTION**

For the evaluation of macroeconomic policies Colombian authorities rely heavily, if not exclusively, on the operational framework known as the Financial Programming Model originally developed by Polack (1957) in the 1950s and further refined by the IMF (1987) and Mussa and Savastano (1999). Based on this analytical framework, and on a constitutional mandate that requires policy coordination, the Central Bank and the Ministry of Finance periodically agree on a _Macroeconomic Program_ containing the policies needed to regulate aggregate demand and to ensure a sustainable growth path for the economy and the public accounts. National authorities summarize this policy design process as follows: “(...) As has been the case for many years, the program takes as given the inflation target, forecasts of monetary aggregates, the government’s economic growth projection and the parameters of foreign exchange and fiscal policies. (...) Regarding fiscal policy, [the program] analyses revenue and expenditure goals and concludes with the analysis of the consistency of the public sector balance with the rest of economic variables” (Banco de la República, 1999). The IMF has a similar description: “In implementing the approach, the overall fiscal balance and public debt targets are set at levels which - in combination with other macroeconomic and structural polices - support specific output, inflation and balance of payments objectives, and ensure a sustainable (i.e., constant or declining) debt path” (IMF, 2004a).

There are fundamental weaknesses in this analytical approach. The analytical framework is essentially static, important variables such as the growth rate are determined exogenously and thus independently of the policies being assessed and the type of economic policies evaluated do not correspond to what modern macroeconomic theory understands for economic policy. The timing of policies is irrelevant, expectations play no role whatsoever and forward-looking behavior as well as the fact that agents make purposeful decisions is plainly ignored.<sup>1</sup> Furthermore, the implicitly assumed connection between program designed policies and intertemporal fiscal solvency is unwarranted.

An issue for which the existing policy evaluation process is particularly ill equipped is the question of fiscal space for investment in infrastructure since decision-makers cannot evaluate the intertemporal trade-offs they face and thus cannot assess how current actions affect future behavior and performance or how future actions restrict the set of current feasible actions available.<sup>2</sup> In the Financial Programming approach, policies are judged on the basis of their effect on conventional fiscal balance and gross public debt targets where the distinction between current and capital expenditures becomes blurred, intertemporal effects are overlooked and a bias against public investment may arise at times of fiscal retrenchment when it is clearer that investment is “the least rigid component of expenditure” (De Haan et al., 1996). In support of this last assertion, Echeverry et al. (2004) report recent data from the Colombian ministry of finance estimating in 97% the proportion of the central government budget that is “inflexible”,

> 1 For a more detailed critique of the Financial Programming Model see Edwards (1989).

> 2 Other tools used by the IMF as analytical basis for policy advice and program design in middle income countries are the _Balance Sheet Approach_ and the _Debt Sustainability Analysis._ These tools are not useful either to address the question at issue.

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