L-1 Macroeconomic Framework and Linkages IMF Singapore Regional Training Institute OT 18.52 Macroeconomic Diagnostics February 26 March 2, 2018 Presenter Stephan Danninger This training material is the property of the International Monetary Fund (IMF) and is intended for use in IMF courses. Any reuse requires the permission of the IMF.
2 Question: What are the IMF s 3 core mandates? A. conduct multilateral and bilateral surveillance, B. finance development projects, C. regulate the international monetary system D. lend to central banks E. deliver training and technical assistance F. finance global peacekeeping initiatives
Outline I. IMF macroeconomic surveillance II. Macroeconomic accounts III. Macroeconomic linkages IV. Article IV Staff Reports: structure/content 3
I. IMF Macroeconomic Surveillance 4
What is IMF macroeconomic surveillance? IMF surveillance oversees the international monetary system (multilateral) and the economic and financial situation and policies of its members (bilateral). The objective of this course is to present and demonstrate methods for evaluating the economic performance of an individual economy. Judgment matters. Bilateral surveillance focuses on a variety of assessments: growth (actual and potential) and inflation stance of monetary and fiscal policy assessment of the current account and exchange rate health of the financial sector macro-critical structural reforms
Key goals of IMF surveillance IMF Surveillance aimed at identifying economic risks Medical tests analogy: blood tests are critical to identifying health risks Like routine medical exams, IMF surveillance can be used to develop preventive policy measures as needed Surveillance == consultation
Key Objectives of Economic Policy High economic growth Macroeconomic stability Internal Balance A situation in which real output (or employment) is at or close to its capacity level and the inflation rate is low and stable. External Balance Current account position that can be sustained by capital flows on terms compatible with the growth prospects of the economy without resort to restrictions on trade and payments. 7
appreciation Internal and External Balance Framework (Swan s four zones of economic unhappiness) Real Exchange Rate Unemployment CA Deficit Internal balance (U=U * ) Unemployment CA Surplus Inflation CA Deficit Inflation CA Surplus External balance (CA=CA*) Real Domestic Demand 8
II. Macroeconomic Accounts 9
Macroeconomic Accounts Diagnostics of the state of the economy require: A system of macroeconomic accounts Understanding linkages between sectors Accurate economic information (reliable data is key!) 10
Four Standard Macro Accounts Real Sector External Sector Government Sector Monetary and Financial Sector National Accounts: Real Sector GDP and its components Balance of Payments (BOP): External Sector transactions with nonresidents Government aka Fiscal Sector or Public finances; government transactions, revenue and expenditures Depository Institutions: balance sheet of banking sector 11
Two additional accounts Government balance sheet Public sector debt level and maturity o Public Sector DSA Country s balance sheet External debt and International investment position o External debt DSA 12
IIa. National Accounts
National Accounts Real Sector Gross Domestic Product (GDP), as a standard broadest measure of the economy, can be measured as: 14
Key NA Definitions Gross National Income (GNI) GDP + Net Factor Income from abroad (Y F ) Gross National Disposable Income (GNDI) GDP + Net Factor Income (Y F )+ Net Transfers (TR F ) Gross National Saving (S) GNDI - C
IIb. Balance of Payments (BoP) External Sector 16
Balance of Payments Accounts: BOPM5 (presented usually in US$ or euros) Current Account Trade Exports Imports Services Income Interest Profits Wages Transfers (current) Capital and Financial Account Capital Account Financial Account Direct Investment Portfolio Investment Equity Debt Other Investment Net International Reserves Errors and Omissions 17
Balance of Payments Accounts: BOPM6 (presented usually in US$ or euros) Current Account (CAB) Trade Exports Imports Services Primary Income Interest Profits Wages Secondary Income, net Capital and Financial Account Capital Account Financial Account Direct Investment, net Portfolio Investment, net Equity Debt Other Investment, net in International Reserves Errors and Omissions 18
Key BoP Measure: Current Account Balance Current account balance (CAB): Guess the country: CAB = (X-M) + Y f + TR f CAS>0 CAD<0 X=Exports of goods and services M=Imports of goods and services Y f =Net factor income from abroad TR f =Net transfers from abroad
BoP and the Savings-Investment GAP Absorption approach to BOP Where A: Absorption = C+I CAB = GNDI - A That is: CAB = GNDI C I Since National Savings (S) = GNDI-C, it follows that: CAB = S - I 20
IIc. Fiscal Accounts 21
Government vs. Public Sector General Government 22
A Stylized Fiscal Account (local currency, flow data) Revenues Tax revenue Non-tax revenue Expenditures Current Capital --------------------- Overall balance --------------------- Financing Domestic financing (net) Banking system Nonbanking sector External financing (net) 23
GFSM 2001/14* REVENUE EXPENSE Primary Interest payments NET/GROSS OPERATING BALANCE NET ACQUISITION OF NON-FIN. ASSETS EXPENDITURE NET LENDING/BORROWING NET ACQ. OF FIN. ASSETS NET INCURRENCE OF LIABILITIES *Relevant to consider government coverage level (e.g., central, general, etc) For a detailed explanation of fiscal accounts, see the Government Finance Statistics Manual 2014: http://www.imf.org/external/pubs/ft/gfs/manual/2014/gfsfinal.pdf 24
Measures of Fiscal Balance Primary balance = overall balance (OB) + interest payments Cyclically-adjusted balance (CAB): OB adjusted for the effects of the business cycle Structural fiscal balance: CAB adjusted for one-off fiscal operations and other transient influences (e.g. asset and commodity prices) that are beyond the business cycle Public sector borrowing requirements Beware of contingent liabilities 25
IId. Monetary Accounts
Scope of the financial system Financial System (Financial Survey) Banking System (Monetary Survey) Other Financial Institutions (Consolidated Bal. Sheet of OFIs) Monetary Authorities (Balance Sheet of MA) Deposit Money Banks (Consolidated Bal. Sheet of DMBs)
Banking System (Monetary Survey) ASSETS Net Foreign assets (NFA) Net Domestic assets (NDA) Net credit to government (NCG) Credit to private sector (CPS) Other Items, net (OIN) Broad Money (M) LIABILITIES Narrow money (NM) Currency in circulation (CY) Demand deposits (DD) Quasi money (QM) Time & savings deposits (TD) Foreign currency deposits (FC) M = NFA + NDA 28
Cyclical adjustment of budget balance Case study: revenue is pro-cyclical: what is the underlying budget balance? 29
III. Linkages between accounts 30
Some examples of accounting links Exports and Imports in the real sector accounts (NIA) equal Exports and Imports in the external accounts (BOP) C G in real sector accounts = Current expenditure in fiscal sector accounts I G in real sector accounts (NIA) = Capital expenditure in fiscal sector accounts (GFSM) Reserves (change in net foreign assets) in external sector accounts (BOP) = Net foreign assets in MA part of monetary sector accounts Grants in the fiscal sector accounts (GSFM) = Official (not private ) part of net transfer TR F from abroad in NIA 31
REAL SECTOR National Accounts (local currency, flows) Private consumption General government consumption (Wages + Purchases of goods and services) Private investment General 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 Factor services (net) Transfers (net) Official Private CAPITAL & FINANCIAL ACCOUNT Direct investment Medium/long-term capital (net) Private sector Government Short-term capital (net) Private sector Government Overall balance Reserves (Change in net foreign assets) 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 Auth (local curr., stocks) Net foreign assets Net domestic assets: Net credit to government sector Credit to banks Other items (net) Reserve money Currency Banks reserves DMBs (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
Flow of Funds Presentation Schematic Flow of Funds Accounts Transactions/ Sectors Government Domestic Economy Private Sector Banking System Rest of the World Horizontal Check (1)= (2)+( 3) + (4) ( 2) ( 3) ( 4) ( 5) ( 1)+ (5) Gross National Disposable Income ( GNDI) + GNDI + GNDI g + GNDI p Final Consumption - C - Cg - Cp Gross Investment -I -Ig -Ip Exports of goods and nonfactor serv. Imports of goods and nonfactor serv. Net factor income Net Transfers - X M - Yf - TRf Saving Investment gap Non Financial Balances ( S-I) ( Sg-Ig) ( Sp-Ip) 0 - CAB 0 Foreign Financing Nonmonetary Financing Direct Investment FDI FDI -FDI 0 Net Foreign Borrowing NFB NFBg NFBp - NFB 0 Monetary Financing Change in Net Foreign Assets - NFA - NFA + NFA 0 Domestic Financing Monetary Financing Domestic Credit + NDCg + NDCp - NDC 0 Broad Money - M2 + M2 0 Nonmonetary Financing Non Bank NB -NB Net Errors and Omissions - OINd OINg OINp - OINb OINf 0 Vertical Check 0 0 0 0 0 0 33
The Flow of Funds Gaps and Financing Schematic Flow of Funds Accounts Transactions/ Sectors Government Domestic Economy Private Sector Banking System Rest of the World Horizontal Check (1)= (2)+( 3) + (4) ( 2) ( 3) ( 4) ( 5) ( 1)+ (5) Gross National Disposable Income ( GNDI) + GNDI + GNDI g + GNDI p Final Consumption - C - Cg - Cp Gross Investment -I -Ig -Ip Exports of goods and nonfactor serv. Imports of goods and nonfactor serv. Net factor income Net Transfers Non Financial Balances ( S-I) ( Sg-Ig) ( Sp-Ip) 0 - CAB 0 Foreign Financing Nonmonetary Financing Direct Investment FDI FDI -FDI 0 Net Foreign Borrowing NFB NFBg NFBp - NFB 0 Monetary Financing Change in Net Foreign Assets - NFA - NFA + NFA 0 Domestic Financing Monetary Financing Domestic Credit + NDCg + NDCp - NDC 0 Broad Money - M2 + M2 0 Nonmonetary Financing Non Bank NB -NB Net Errors and Omissions - OINd OINg OINp - OINb OINf 0 Vertical Check 0 0 0 0 0 0 - X M - Yf - TRf Gaps correspond to financing flows one-to-one. It all adds up. 34
What may cause macroeconomic instability? Exogenous factors: terms of trade shocks; changes in international interest rates, world-wide inflation or recession; financial contagion; supply shocks; political instability Inappropriate policies: over expansionary fiscal or monetary policy; exchange rate misalignment; excessive borrowing; inadequate financial regulation or supervision Structural rigidities: wage-price rigidities; structural rigidities in the trade and exchange system, government revenues and expenditures resulting in inefficient allocation of resources 35
IV. IMF Article IVs 36
IMF Article IV Consultations (bilateral surveillance) Article IV consultations normally take place once a year. IMF economists visit the member country to: Gather information Hold discussions with government and central bank officials, Meet with private investors and labor representatives, members of parliament, and civil society organizations. Upon its return, the mission submits an Article IV Staff Report to the IMF s Executive Board for discussion. The Board s views are subsequently summarized and transmitted to the country s authorities. 37
Structure of a Staff Report: Indonesia Article IV 2018: Main content 38
Structure of a Staff Report: Malaysia Article IV 2017: Boxes, Figures, Tables 39
SEI: Show Me the (significant) Vulnerabilities! Greece: Selected Economic Indicators, 2007 11 2007 2008 2009 2010 2011 (Percentage change, unless otherwise indicated) Domestic economy Real GDP 3.0-0.1-3.3-3.5-6.9 Total domestic demand 5.9 0.4-5.7-6.0-8.9 Private consumption 3.8 4.0-1.3-3.6-7.2 Public consumption 7.6-2.1 4.8-7.1-9.5 Gross fixed capital formation 5.0-7.9-18.4-14.5-17.0 Foreign balance (contribution) -1.2 0.9 3.4 3.3 3.0 Exports of goods and services 6.9 3.0-19.5 4.2 3.0 Imports of goods and services 14.6 3.3-20.2-7.2-7.0 (Percent of GDP) Balance of payments Current account -14.6-14.9-11.1-10.1-9.8 Trade balance -11.2-11.6-7.8-6.6-5.8 Net international investment position -96-77 -88-99 -113 Public finances (general government) Total revenues 40.7 40.5 37.9 39.5 41.0 Total expenditures 47.5 50.5 53.6 50.1 50.3 Primary expenditures 42.8 45.5 48.3 44.6 43.4 Overall balance -6.8-10.0-15.7-10.6-9.3 Primary balance -2.0-4.9-10.4-5.0-2.4 Gross debt 107 113 129 145 165 Interest rates and credit Long-term lending interest rate 7.0 7.4 5.7 6.3 7.6 Private credit growth 21.5 15.9 4.2 0.0-3.2 Sustained Negative Growth Sharp Declining Investment Chronic Current Account Deficit Trade Deficit (competitiveness) Chronic Fiscal Deficit Unsustainably High Debt High Credit Growth (2007-08) 40
Key takeaways Macroeconomic surveillance is the monitoring and analysis of the economic/financial situation (country or global) Key objectives of economic policy is strong and sustainable growth and macroeconomic stability Four macro sectors (real, external, fiscal, and monetary), which are linked via accounting and behavioral relationships Using the macro accounts we can analyze the underlying forces of the economy, including the impact of shocks Judgment matters. Article IV Staff report tables can reveal sources of weakness/vulnerabilities 41