Macroeconomic Accounts and Policies: Financial Programming and Macro Interrelationships (*)

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Macroeconomic Accounts and Policies: Financial Programming and Macro Interrelationships (*) World Bank/Poverty and Equity Summer University, Washington, DC, July 20-21, 2017 Alvaro Manoel

1 Macroeconomic Accounts and Policies: Financial Programming and Macro Interrelationships (*) World Bank/Poverty and Equity Summer University, Washington, DC, July 20-21, 2017 Alvaro Manoel International Consultant +1(240) (*) This lecture is based on a Workshop on Financial Programming and Policies delivered to World Bank staff in May 2013 by Richard Barth and Alvaro Manoel

2 Summary Macroeconomic issues and Financial Programming What is Adjustment? Is it needed? Main Steps in an Adjustment Program Macro Accounts and Interrelationships Interesting and critical relationships between the current account and domestic aggregates

3 Financial program steps Step 1: Project baseline under existing policies Step 2: Check accounting consistency Step 3: Check economic consistency & diagnose problems

4 Checking for economic consistency illustrations Is consumption growth in line with household disposable income? If not, does the change in the saving rate make sense? Do the relative changes of the GDP deflator and the CPI make sense? How does your projection of the growth of real credit to nongovernment compare to other forecasts? Is there real growth of credit to the private sector? If not, is your inflation forecast realistic? Is projected GDP growth compatible with credit growth? (depending on past relationship)

5 Financial programming steps Step 4: Set objectives Step 5: Develop measures to achieve the objectives Step 6: Determine impact of proposed policy measures on baseline Step 7: Iterate to achieve objectives ST & MT and economic and accounting consistency

6 Macroeconomic statistics cover either The whole economy (ex. National Accounts) Or a large and well-defined part of it (ex. Government Finance Statistics or Balance of Payments) Accounting relationship link the various accounts to for a coherent data System

7 Macroeconomic accounts: four main components Real Sector (Aggregate Economy) General Government (Fiscal Accounts) External Sector (Rest of the World) Monetary Sector (Depository Corporations)

8 Putting the 4 major sectors together Helps to build a coherent picture (macro framework) that can be used to: Analysis and policy prescriptions Scenario building (which allows to assess the macro impact of hypothetical shock to the economy

9 Key accounts GDP identity: links aggregate supply & demand for good and services Y = C + I + (X - M) Y + M = C + I + X Cp Ip private sector Cg Ig public sector

10 Key accounts Accounting links and behavioral relationships Accounting links give a starting point to the analysis Behavioral relations... Show what factors precisely determine economic transactions between sectors

11 Macro accounts: national income accounts & analysis Gross Domestic Production (GDP) Institutional units Income, saving, and investment Nominal vs. real variables Inflation Productivity Contributions to GDP Growth Forecasting National Income Accounts

12 Private Consumption Real Sector GDP by expenditures Final Government Consumption Private Investment Government Investment Exports of Goods and nonfactor services Imports of Goods and nonfactor services Gross Domestic Product (National Accounts (SNA2008), domestic currency, transactions)

13 Fiscal Sector Definition of government: Coverage Public Sector (PS) Nonfinancial Public Sector (NFPS) Public Financial Corporations General Government (GG) Public Nonfinancial Corporations Other Levels of Government (states, municipalities, etc.) Central Government Central Administration Social Security Other Decentralized Agencies

14 Macro accounts: GFSM 1986 General Government Operations Revenue & Grants Tax Revenue Turnover tax/vat Excise taxes Income taxes Corporate Personal Social security/pension taxes Foreign trade taxes Other tax revenue Nontax Revenue Licenses, fees, etc. Central Bank profits Operating surpluses of public enterprises Expenditure & Net Lending Current expenditure Wages Goods & services Interest payments Pensions Subsidies Other Transfers Other Capital Expenditure Net lending New policy loans Repayments Grants Overall Balance = Revenue - Expenditure = S G -I G Financing = - Overall Balance External (net) New borrowing Repayments Domestic Bank (net) New borrowing Repayments Non-bank (net) Privatization

15 GFSM 1986: Fiscal Indicators (Flows) Overall Balance (OB) Current Balance Revenue and grants expenditure and net lending Current revenue current expenditure Primary Balance (PB) Revenue and grants excluding interest earned expenditure and net lending excluding interest due Financing OB (interest earned interest due) Δ Liabilities Δ financial assets (Flows recorded according to the flow of funds) OB = Financing OB < 0: deficit => Financing must be positive: increase in debt or use of financial assets Financial constraints impose a limit to the deficit: Budget constraint

16 2001/2014 GFSM: Statement of Government Operations I. Transactions affecting net worth 1. Revenue (increase net worth) 2. Expense (reduce net worth) II. 3. Gross Operating Balance = Consumption of fixed capital (depreciation) 4. Net Operating Balance Change in net worth = Transactions in nonfinancial assets 5.1 Net acquisition of nonfinancial assets Fixed assets Change in inventories Other 6. Net lending/borrowing = III. Transactions in financial assets and liabilities = (= 6) 5.2 Net acquisition of financial assets 5.3 Net incurrence of liabilities Foreign Domestic

17 2001/2014 GFSM: Fiscal Indicators (Flows) Gross operating balance (GOB) Net operating balance (NOB) Revenue expense GOB consumption of fixed capital NOB = ΔNWg NOB = Sg + net capital transfers receivable Net lending/borrowing (NL/NB) Financing Primary NL/NB Adjusted fiscal balance NOB Net acquisition of NFA (Net investment in NFA) Δ financial assets Δ Liabilities NL/NB = Financing NL/NB Excluding interest earned interest due NL /NB excluding flows outside government s control: Grants Oil revenue Externally financed projects

18 More Indicators of the Fiscal Stance Contingent liabilities Government guarantees Social security benefits under defined benefits systems Contractual obligations under Public-Private partnerships Cyclically adjusted balance B ca : fiscal balance subtracting the impact of the economic cycle on revenue and expenditure Structural balance: Subtracting also other shocks to the OB not related to discretionary fiscal policy

19 Implications of Government Financing Budget constraint External debt Risk factors: foreign interest rate, exchange rate, changes in market access Possible impact on exchange rate => affects net external demand Domestic debt Central Bank => monetization (money creation) => inflation Rest of Banking System => possible crowding => negative impact on aggregate demand (interest rate/ availability of credit) NF Private => crowding out (less resources to banks)

20 Macro accounts: Balance of Payments Accounting Current Account (Real transactions) Capital & Financial Account (Financial Transactions) Trade Exports of goods Capital Account Imports of goods Financial Account Direct investment DFDI Services X-M Portfolio investment Transport Insurance Travel Income Y F Interest Profits Wages M/LT capital Borrowing Amortization ST capital (net) Errors & Omissions DNFB Transfers TR F (current) Overall Balance Financing D NIR Net International Reserves * S N - I = CAB CAB + DFDI + DNFB = DNIR

21 Macro accounts: Thailand: Consolidation of the Monetary Accounts,1996 (End-year stocks; in billions of baht) Central Bank Commercial Banks Banking System Net foreign assets -78 Net foreign assets 991 Central Bank 991 Net foreign assets -1,069 Commercial Banks Banks' reserves Cash in vault 61 Deposits with BOT 74 Net domestic assets -538 Net domestic assets 4,478 Net domestic assets 3805 Claims on government (net) -294 Claims on government (net) -169 Claims on government (net) -463 Claims on nonfinancial public enterprises 18 Claims on nonfinancial public enterprises 113 Claims on public enterprises 131 Claims on rest of economy 453 Claims on businesses and households 4,687 Claims on firms and households 4687 Claims on other financial institutions 214 Claims on other financial institutions 272 Claims on commercial banks 25 Claims on other financial institutions (net) 58 Other assets, net -310 Other assets, net -367 Other assets, net -822 Liabilities to the BOT 25 Base Money (RM) 453 Liabilities to private sector 3,409 Money (M2) 3727 Money (M1) Currency issued 366 Currency in circulation 304 Demand deposits 106 Demand deposits 119 Commercial bank deposits 74 Other deposits 13 Time & savings deposits 3,302 Quasimoney 3303

22 Accounting links Fiscal and national Accounts

23 Accounting links BOP and National Accounts Exports and Imports of goods and services are valued in domestic currency in the real sector

24 Accounting links Monetary Sector and General Government

25 There are behavioral relationships too Change in the stock of claims on nongovernment must be related with developments in the real sector Broad money growth must be consistent with developments in the demand for money.

26 REAL SECTOR National Accounts (local currency, flows) Private consumption Government consumption (Wages+Goods and services) Private investment Government investment Exports of goods and nonfactor services Imports of goods and nonfactor services EXTERNAL SECTOR Balance of Payments (US Dollars, flows) CURRENT ACCOUNT Exports of goods and nonfactor services Imports of goods and nonfactor services Income (net) Current Transfers (net) Official Private CAPITAL AND FINANCIAL ACCOUNT Capital account o/w Capital transfers Direct investment Medium/long-term capital (net) Private sector (o/w banks) Centr. Government Short-term capital (net) Private sector (o/w banks) Centr. Government Overall balance Reserves (Change in net foreign assets) Interrelations GENERAL GOVERNMENT Fiscal Accounts (local currency, flows) Revenues Grants Expenditures Current Capital Overall balance Financing Domestic financing (net) Banking system Nonbanking sector External financing (net) MONETARY SECTOR Monetary Authorities (local currency, stocks) Net foreign assets Net domestic assets: Net credit to government sector Credit to banks Other items (net) Reserve money Currency Banks reserves Deposit Money Banks (local currency, stocks) Net foreign assets Banks' reserves Net domestic assets: Net credit to government sector Credit to nongovernment sector Other items (net) Liabilities to monetary authorities Private sector deposits

27 Link national accounts and government financial operations Capital expenditure in the government financial operations = public investment in national accounts

Link government financial operations to balance of payments External grants in government financial operations (KMF 15,174 mn) = government current transfers in balance of payments (KMF 2,053 mn) +

28 Link government financial operations to balance of payments External grants in government financial operations (KMF 15,174 mn) = government current transfers in balance of payments (KMF 2,053 mn) + capital transfers in balance of payments (KMF 13,121 mn) Interest on external debt in government financial operations = income debit (outflows) in balance of payments (but could also include interest payments on private external debt or dividend payments)

29 Link government financial operations to balance of payments Drawings of foreign financing in government financial operations = drawing of government loans in balance of payments Amortization in government financial operations= amortization of government loans in balance of payments 29

30 Link government financial operations and monetary survey Domestic bank financing in government financial operations (KMF 1,549 mn)= change in net domestic credit to government in monetary survey (KMF 5,195 mn -> KMG 6,744 mn)

Link balance of payments to monetary survey Net private bank foreign financing in balance of payments (KMF 312 mn)= change in 2011 net commercial bank assets (KMF 2,344 mn - KMF 1,909 mn) relative to

31 Link balance of payments to monetary survey Net private bank foreign financing in balance of payments (KMF 312 mn)= change in 2011 net commercial bank assets (KMF 2,344 mn - KMF 1,909 mn) relative to 2010 net commercial bank liabilities in monetary survey (KMF 2,215 mn KMF 1,468 mn) BoP financing through accumulation of net foreign assets of central bank (KMF 967 mn)= change in 2011 net foreign central bank assets (KMF 53,512 mn - KMF 9,028 mn) relative to 2010 net foreign central bank assets 31 in monetary survey (KMF 52,545 mn KMF 9,028

32 The relationship between the current account and domestic aggregates There are various analytical ways to look One is the absorption approach to the balance of payments We can look at the income-absorption gap

33 From the GDP definition and identity GNDI = Y + Yf + TRf Y: C + I + (X M) Yf: primary income (net) TRf: secondary income (net) If C + I = A GNDI = A + (X M + Yf + TRf) GNDI - A = CAB a current account deficit (CAB) is associated with an excess of absorption over disposable income

34 Analysis, analysis Suppose a country experiencing a near-zero current account balance for an extended period of time. Suddenly, the CAB turns into a large deficit First question is: what drives the change? The identity does not indicate the direction of causality. Therefore, analysis is needed.

35 What could explain the CAB shift? The CAB deficit could among other possibilities be: The result of a substantial exogenous rise in the price of imports with the volume of imports unaffected The result on and endogenous consumption boom fueling and increase in the volume of imports whatever the underlying cause is, the identity holds and is useful in framing the analysis

36 Keeping CAB deficit for a long period What to do? depends on financing Contracting consumption or investment to reduce absorption Tightening monetary and fiscal policies to achieve this Can output and income be raised? In the short term exchange rate depreciation can help In the medium- and long-term, higher investment and adequate structural reforms can raise GDP potential and output. Other policy options?

37 Saving-investment gap There is also the interaction between saving and investment in the domestic economy and the CAB From previous identities: GNDI - A = CAB GNDI C I = CAB S = GNDI - C S - I = CAB The resources needed to cover the excess of investment over saving must come from abroad

38 Saving-investment gap Canada: Selected Economic Indicators, (in percent of GDP) CAB (from BOP) Saving & Investment Gross National Saving General government Private Gross domestic Investment

39 The government s savinginvestment gap The saving-investment gap of the government Sg - Ig corresponds broadly to the overall fiscal balance: the government s disposable income less final government consumption and investment

40 CAB deficit: three situations and policies Situation 1 Sp - Ip > 0 And Sg - Ig > 0 Situation 2 Sp - Ip < 0 And Sg - Ig < 0 Situation 3 Sp - Ip < 0 And Sg - Ig > 0 What policies can target the sources of the imbalances??

41 Twin Deficits Is the situation in which a fiscal deficit Sg - Ig < 0 Is the main source of the current account deficit, that is, even with private positive saving (Sp Ip > 0), there is a CAB deficit. It corresponds to situation 1 before. reducing the current account deficit will require fiscal adjustment

42 Why learning the financial programing? Understand the macro accounts and theirs interrelationships it is applied macroeconomics Apply those techniques to your own country of interest Professional development To better understand reports prepared across the street!

43 Main references Fischer, S., 1997, Applied Economics in Action: IMF Programs, American Economic Review, Papers and Proceedings, Vol. 87, No. 5 Fischer, S, 2016, Reflections on Macroeconomics Then and Now, 32 nd Annual National Association for Business Economic Policy Conference, Washington (DC), March 7 International Monetary Fund, ( ). Financial Programming and Policies, IMF Institute fo Capacity Develoment, Vol. 1. Mussa & Savastano, 1999, the IMF Approach to Economic Stabilization, WP/99/104 Pollac, J.J., 1997, The IMF Monetary Model ar Forty, IMF Working Paper, 97/49 Wong, C. H., 2002, Adjustment and Internal-External Balance, in M. S. Khan et al (edit)macroeconomic Management Programs and Policies (IMF)

Interrelations among Macroeconomic Accounts

Interrelations among Macroeconomic Accounts INTRODUCTION Macroeconomic statistics cover either: the whole economy (example : National Accounts) or a large and well-defined part of it (example : Government