inducing a shift into inventories and increasing net dollar exposure. But the effect
of this variable on demand for peso-dominated items is insignificant. (The rate
of devaluation appears to a much larger role in predicting peso-dollar substitution.) One implication is that a financial liberalization program that amounts
basically to interest-rate decontrol is unlikely to induce much expansion in the stock
of peso-denominated financial wealth. Indeed, Uruguay's expansion was apparently traceable to other factors. Equally interesting, the extremely small interest
elasticity of demand for peso credit suggests a possible source of financial market
instability when interest rates are decontrolled.
Funding for this research was provided by the World Bank. The authors wish to thank Douglas Brown, Yoon Je Cho, John Cuddington, Dale Henderson, Jaime de Melo, Daniel
Westbrook, and two anonymous referees for comments on an earlier draft. They are also
grateful to Jackson Magargee for typing, and to Gabriel Casillo, Ty Mitchell, and Shoihi
Katayama for assistance with data preparation.
The World Bank does not accept responsibility for the views expressed herein, which
are those of the author(s) and should not be attributed to the World Bank or to its affiliated
organizations. The findings, interpretations, and conclusions are the results of research
supported by the Bank; they do not necessarily represent official policy of the Bank.
Tybout ( 1986) presents descriptive interpretations of the relationships between macro
variables and industrial financial statements in the Southern Cone countries. However, unlike
the present chapter, that study does not attempt behavioral modelling.
An earlier version of this chapter assumed that gross earnings depended on total
financial costs, the wage rate, and output demand. However, this specification was difficult
to reconcile with product market equilibrium and it fit poorly, so the above alternative has
been adopted. The reported figures should thus be viewed as resulting from a specification
We ignore new stock issues as a source of net worth expansion because they are of
negligible empirical significance in the country to which the model will fit.
Variants on equation (8) may be found in Taggart ( 1977), Yardeni ( 1978), and Jalilvand and Harris ( 1984). Unlike Taggart, we place no zero constraints on elements of M.
Also, unlike Jalilvand and Harris, we do not require that the off-diagonal elements of M
within a column be equal. Cross-equation consistency constraints implied by the identity 5
( Brainard and Tobin 1968) are nonetheless imposed by our estimation technique, as will be
Equation (9) resembles the dynamic factor demand system derived by Prucha and Nadiri ( 1986) if we assume that exogenous variables in the system follow a first-order
autoregressive process. Details of the analogy are available on request.
Jalilvand and Harris ( 1984), in the only other panel-data study of industrial portfolio
adjustments we are aware of, employ the same mean square error correction we use.
Such effects have been generally ignored in earlier empirical portfolio balance models.
For more details, see Hanson and de Melo ( 1985) and de Melo and Tybout ( 1986).
General patterns that emerge from the data are described in de Melo, Pascale, and Tybout ( 1985). Details of the inflation adjustment procedure are provided in the World Bank
Staff Working Paper version of this same study, and in Tybout ( 1988).