Macroeconomic Accounts and Policies: Introduction and Internal and External Balances(*)

Transcription

1 Macroeconomic Accounts and Policies: Introduction and Internal and External Balances(*) 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 Macro Models Macroeconomic Stability The Analytics of Macroeconomic Balance Financial Programming What is Adjustment? Is it needed?

3 Short- versus long-term modeling T=1 to N (N=2...5) T=N+1 to 20 Horizon Short to medium term Medium to long term Objective Policies Assumptions Modeling tool Achieve macro stabilization (internal & external balance) Comprehensive set of coordinated demand-side policies (monetary, exchange rate, fiscal) Multi-year program to reach internal & external balance Significant divergence from steady state values possible until T=N Financial programming RMSM-X MFMod (Classical Keynesian (IS-LM) model with a supplyside; Cross-country Interlinkages; Within model linkages Usually excel with data bank Detailed modeling of monetary, fiscal, external and real sector with feedback effects (iterative) Achieve sustained per capita GDP growth Improve income distribution/poverty reduction Overcome structural weaknesses Structural reforms (for example, taxation, pension reform, investment climate, education, health) Public investments Typically population growth, productivity Convergence to steady state-growth (taking into account effect of large investments, mining, etc) Sustainable fiscal and external accounts No one-size-fits-all model Model usually driven by assumptions on steady-state growth, sustainable fiscal and external accounts, while monetary sector usually accommodative

4 What is a financial program? A financial program (or economic adjustment program) is a comprehensive and consistent set of economic policies, implemented in a coordinated fashion and designed to achieve internal and external balance A sensible approach to economic policy even in the best of times A consistent, coordinated approach is imperative when significant adjustment to economic policies is needed

5 Objective: macroeconomic stability Macroeconomic stability exists when a country achieves: Internal balance - real output is at or close to its capacity level (potential) and the inflation rate is low and non-accelerating. External balance - current account position can be sustained by capital flows on terms compatible with the growth prospects of the economy without resort to restrictions on trade and payments. No excessive build-up of external debt.

6 Why stability matters for growth: external balance Growth is hard to achieve without a sustainable balance of payments. External crisis usually brings disruptions to imports, capital outflows, and sometimes trade or payments restrictions. Country and Year % D in Real GDP Mexico: Indonesia: Turkey: Consider GDP losses during external crises Source: IMF. World Economic Outlook. Argentina: 02 Latvia:

7 Why stability matters for growth: price stability Growth is also hard to achieve without price stability (low inflation) Why? High inflation discourages saving, domestic and foreign investment, distorts relative prices, promotes wasteful financial activities, and encourages speculation, dollarization, and capital flight. Poor people are the most impaired Considerable research supports this view

8 Mind macro imbalances CPI Inflation (yearly basis) Which country? What (were) are the consequences? Any Impacts on income distribution? Why?

9 Macro imbalances harm the poor High inflation, for example, hinders investment and economic growth (employment) Brazil s during early 90s: inflation was higher than 2000% in some years.. July 1994: a worker in Sao Paulo (biggest labor market in the country where monthly pay is usually higher than the minimum wage) needed 229 hours to buy a basic food basket. July 1994: the government implemented a inflation reduction plan with a new currency: Real May 2014: inflation had been subdued. The same worker needed 111 hours to buy the same items in the basic food basket.

10 How can we tell if the economy is at internal balance? -- Real GDP growth in relation to potential growth

11 How can we tell if the economy is at internal balance? -- Evidence of inflationary pressures in the non-traded goods sector

12 How can we tell if the economy is at external balance? External debt sustainability analysis: look at whether, under current policies, external debt will grow faster than the real economic growth Even if debt is sustainable in the long run, the country may become illiquid in the short run; confidence of foreign investors is a key element (mind contamination, Brazil 1998)

13 Gross external debt of South Africa (reference path and after shocks) See Tresor-Economics, No. 176, Aug. 2016, for assumptions and shocks

14 Review of the country s economic conditions Is the economy in internal and external balance? (previous slides) What are the causes of imbalances (following slide) Are the imbalances transitory of permanent What do the vulnerabilities indicators show?

15 Vulnerabilities indicators External vulnerabilities indicators Reserves/short-term debt by remaining maturities Reserves in months of imports Current account balance/gdp Short-term debt/total debt Debt services/exports Total external debt/gdp or external debt/exports (sustainability) Fiscal vulnerabilities indicators Central government budget balances/gdp Interest payments/gdp and interest rate spread Concentration of maturities Contingent liabilities Total public debt/gdp (sustainability)

16 Vulnerabilities indicators Indicators of financial and balance sheet vulnerabilities Capital adequacy: regulatory capital ratios Asset quality: NPLs/total loans Liquidity: liquid assets ratio; liquid assets/short-term liabilities Currency mismatches Maturity mismatches Weak capital structures: high debt/equity ratios

17 CAUSES OF MACROECONOMIC IMBALANCES Exogenous shocks can move the economy away from external or internal balance Unanticipated shocks: commodity price shocks, terms of trade shocks, natural disasters, wars But also, spillovers from events or policies in other countries Inappropriate policies Ex) excessively loose fiscal policy Private sector behavior Ex) irrational exuberance; speculative investment in financial assets leading to bubbles

18 WHAT SHOULD POLICYMAKERS DO? Remove destabilizing policies that are themselves sources of shocks Use policies as stabilizing instruments in response to exogenous shocks Use policy to restore foreign investor confidence

19 Internal and external balances and the Swan diagram The Diagram of Swam (due to Trevor W. Swan) helps to understand the internal and external balances within a macro framework Internal balance requires full employment of resources (sufficiently low unemployment rate) and price stability (low and stable inflation rate) External balance corresponds to a balanced current account (the supply and demand for the domestic currency are balanced). For simplicity, external balance is defined as zero trade balance Internal balance and external balance both are assumed to depend on two variables: domestic expenditures and the real exchange rate

20 The internal balance

21 Interpreting the internal balance function

22 External balance function

23 Interpreting the external balance function

24 The Swan diagram

25 Where are you? The Swan diagram combines the IB and EB functions. It separates the plane into four regions: In region I, the economy experiences unemployment and trade deficit (Spain, Egypt, Poland). In region II, inflation coexists with a trade deficit (Brazil, Turkey, Colombia, Morocco). In region III, there is inflation and a trade surplus (China, Russia, Korea). In region IV, the economy has unemployment and runs a trade surplus (Hungary, Slovakia).

26 Financial programming Financial programming is a technique used to set out the policies necessary for a country s economy to move toward internal and external balance

27 Financial programming Is not a formal economic model It is a simple flow-of-funds framework that combines basic macro-accounting identities It does involve a small number of behavioral equations, e.g., demand for money

28 Financial programming definition FP is a comprehensive set of coordinated policies aimed at achieving Macroeconomic Stability which is a necessary condition for Sustained per capita growth aimed at improving Credibility: the role of expectations Structural Reforms (long term) Shocks

29 WHAT IS ADJUSTMENT? Macroeconomic adjustment involves the application of policies to address or prevent the emergence of imbalances in an economy Structural adjustment involves changing aspects of the structure or organization of the economy that contribute to long-term imbalances

30 WHEN IS ADJUSTMENT NECESSARY? FINANCING VS. ADJUSTMENT Financing is possible when imbalances appear temporary and resources to cover them are sufficient (e.g., short-term shocks in commodity prices) Adjustment is needed when resources are insufficient or imbalances seem long-term in nature (e.g., inability to pay external debt) Financing in this case allows more time for adjustment

31 HOW DOES ADJUSTMENT WORK? Stabilization helps contain demand Structural reform expands supply Price level Aggregate Supply Stabilization is faster, but structural reform allows stabilization at a higher level of real income Aggregate Demand Real GDP

32 POLICY MEASURES Demand management policies reduce aggregate demand: Fiscal policy Monetary policy Expenditure switching policies...shift demand (production) between domestically- produced and foreign goods: Exchange rate policy Some structural policies

33 LIMITS OF MACROECONOMIC STABILIZATION Macroeconomic stabilization can achieve low inflation and external sustainability But stabilization alone is often not enough to achieve rapid growth and higher real incomes Structural reform must usually accompany stabilization to achieve higher incomes

34 STRUCTURAL REFORM: RATIONALE Address institutional rigidities that create imbalances and slow growth Improve efficiency of resource allocation Raise potential output, allowing stabilization at a higher level of real income Ensure sustainability of stabilization policies May bolster the credibility of stabilization programs