relations between the balance of payments and other macroeconomic accounts
DESCRIPTION
Relations Between the Balance of Payments and Other Macroeconomic Accounts. Course on External Vulnerabilities and Policies Tunis, March 2 – 1 3 , 2009. Thorvaldur Gylfason. Outline. Monetary approach to balance of payments Accounting relationships Trace linkages among - PowerPoint PPT PresentationTRANSCRIPT
Relations Between the Balance of Relations Between the Balance of Payments and Other Macroeconomic Payments and Other Macroeconomic
AccountsAccounts
Thorvaldur GylfasonThorvaldur Gylfason
Course on External Vulnerabilities and Policies Tunis, March 2–13, 2009
OutlineOutline
Monetary approach to balance of paymentsbalance of payments Accounting relationships
Trace linkageslinkages amongo Balance of payments accountso National income accountso Fiscal accountso Monetary accounts
Proceed from linkages to financial programmingfinancial programming
Numerical examples of financial programming Flow of funds matrix A little algebra
RemarkRemark
External adjustmentExternal adjustment is more effective if it is framed in the context of a financial program financial program agreed jointly with the authorities to ensure consistency among policies
In practice, a financial program is prepared using an accounting framework accounting framework that summarizes all economic transactions and shows the interrelations among all sectors
Main objective of lectureMain objective of lectureIntroduce the different pieces of the financial financial programming framework programming framework to illustrate the linkages and show how to build a single table focused on the financing side of the interrelations, i.e., the flow of flow of fundsfunds
What is money?What is money?
Liabilities of banking system banking system to the public That is, the private sector and public enterprises
M = C + TM = C + T C = currency, T = deposits
The broader the definition of deposits ... Demand deposits, time and savings deposits, etc.,
... the broader the corresponding definition of money M1, M2, M3, etc.
11
Overview of banking systemOverview of banking system
C entra l Bank C om m ercia l Banks
Banking System(M onetary Survey)
O ther F inancia l Institu tions
Financia l System
Balance sheet of Balance sheet of Central Central BankBank
AssetsAssets LiabilitiesLiabilities
DG C
DB B
RC
DG = domestic credit to government
DB = domestic credit to commercial banks
RC = foreign reserves in Central Bank
C = currency
B = commercial bank deposits in Central Bank
Balance sheet of Balance sheet of Commercial Commercial BanksBanks
DP = domestic credit to private sector
RB = foreign reserves in commercial banks
B = commercial bank deposits in Central Bank
DB = domestic credit from Central Bank to commercial banks
T = time deposits
DG + DP + DB + RB + RC + B = C + T + B + DB
Adding up Adding up the two balance the two balance sheetssheets
D R
MHence, M = D + R
Balance sheet of Balance sheet of banking banking systemsystem
AssetsAssets LiabilitiesLiabilities
D M
R
Monetary Survey
D = DG + DP = net domestic credit from banking system (net domestic assets)
R = RC + RB = foreign reserves (net foreign assets)
M = money supply
A fresh view of moneyA fresh view of money
The monetary survey implies the following new definition of money:
M = D + RM = D + Rwhere M is broad money (M2), which equals narrow
money (M1) + quasi-money One of the most useful equations in economics Money is, by definition, equal to the sum of
domestic credit from the banking system (net domestic assets) and foreign exchange reserves in the banking system (net foreign assets)
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = B + B + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
Now, add them up
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = B + B + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
G – T + I – S + X – Z = 0,
so left-hand sides sum to
zero
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = BB + + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = BB + + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = BB + + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = BB + + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
An alternative derivation of An alternative derivation of monetary surveymonetary survey
PublicPublic sector G G –– T = T = B + B + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - MM - - BB
ExternalExternal sector X X –– Z = Z = RR - - DDFF
So, adding them up, we get: 0 = D - M + R because DDGG + D + DPP = D = D
Hence,
M = D + RM = D + R
Monetary approach to balance of Monetary approach to balance of paymentspayments
The monetary survey (M = D + RM = D + R) has three key implications:
Money is endogenousendogenous If RR increases, then MM increases Important in open economies
Domestic creditDomestic credit affects money If RR increases, may want to reduce DD to
contain MM R = R = M - M - DD
Here R = X – Z + FR = X – Z + F Monetary approach to balance of payments
Monetary approach to balance Monetary approach to balance of paymentsof payments
The monetary approach to the balance of payments (R = R = M - M - DD) has the following implications:
Need to Forecast M
And then Determine D
In order to Meet target for R
DD is determined as a residual given both MM and R*R* R*R* = reserve target, e.g., 3 months of imports
Essence of Essence of
financial financial
programmingprogramming
Monetary approach to balance Monetary approach to balance of paymentsof payments
Domestic credit is a policy variable that involves both monetary and fiscal policy
Can reduce* domestic credit (DD) To private sectorTo public sector
By reducing government spendingBy increasing taxes
Monetary and fiscal policy are closely related through domestic credit
*Or rather slow down*Or rather slow down
Linkages: OverviewLinkages: Overview
22Macroeconomic Sectors
Macroeconomic Accounts
Flow of Funds (Transactions)
Private Sector
Government
Monetary Sector
National Accounts
Fiscal Accounts
Monetary Accounts
Real:Revenue, Expenditure(C, S, I, X, Z)
Rest of the World Balance of Payments
Financial: Changes in financial assets and liabilities
LinkagesLinkages
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
LinkagesLinkages
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
National accountsNational accountsY = E + X – Z
LinkagesLinkages
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
LinkagesLinkages
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Linkages: ReservesLinkages: Reserves
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Linkages: Current accountLinkages: Current account
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Linkages: Foreign creditLinkages: Foreign credit
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Linkages: Credit to governmentLinkages: Credit to government
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
LinkagesLinkages
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Private sector accountsPrivate sector accountsI – S = DP – M – B
Linkages: BondsLinkages: Bonds
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Private sector accountsPrivate sector accountsI – S = DP – M – B
Linkages: Linkages: MoneyMoney
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Private sector accountsPrivate sector accountsI – S = DP – M – B
Linkages: Linkages: Private creditPrivate credit
Balance of paymentsBalance of paymentsR = X – Z + F = X – Z + DF
Monetary accountsMonetary accountsM = D + R= DG + DP + R
National accountsNational accountsY = E + X – Z
Fiscal accountsFiscal accountsG – T = B + DG + DF
Private sector accountsPrivate sector accountsI – S = DP – M – B
Further detailsFurther details
National accountsNonfinancial public sectorMonetary accountsBalance of paymentsMacroeconomic interrelationsFlow of funds matrix
National AccountsNational Accounts
1. Consumption C = Cg+CpPublic (general government) CgPrivate Cp
2. Gross Investment I = Ig+Ip Public (fixed capital formation) Ig Private (includes changes in inventories) Ip
4. Exports of goods and services X5. Imports of goods and services Z
3. Absorption or domestic demand (1+2) A = C+I
6. Gross Domestic Product (1+2+4–5) GDP = C + I + X – Z
7. Net factor income from abroad Yf
9. Current transfers from abroad TRf10. Gross National Disposable Income (8+9) GNDI = GNP + TRf
8. Gross National Product (6+7) GNP = GDP + Yf
11.National Savings (10 – 1) Sn=(GNDI – C)Public Sg = (GDIg – Cg)Private Sp = (GDIp – Cp)
12. External Savings (1+2–10) Se= (C + I –
GNDI)
OperationsOperations of the Nonfinancial of the Nonfinancial Public Sector (NFPS)Public Sector (NFPS)1.Total Revenue and Grants RGg
Revenue Rg Current CRg Tax revenue Nontax revenue CapitalGrants
2.Total Expenditure and Net Lending GNLgExpenditure Gg
Current CGgWages and salaries Goods and services Interest Subsidies and other current transfers
Capital CAPGgo/w: fixed capital formation Ig
Net Lending NLg
3. Overall Balance (1 - 2 ) OBg = RGg - GNLg
4. Financing (4.1 + 4.2 = – 3) Fg = NEFg + NDFg4.1 External NEFg4.2 Domestic NDFg = NDCg + NBg
Bank NDCgNonbank NBg
Cg: government consumption
ASSETSForeign assetsDomestic assets Credit to public sector Credit to other financial
institutions
Credit to private sector
Other assets
LIABILITIESForeign liabilities
Short termMedium and long term
Deposits of public sectorPrivate sector depositsOther liabilitiesCapital and reserves
Liabilities to private sector(MB, M1, M2, M3)
Monetary Accounts:Monetary Accounts:From Accounting to Analytical Format From Accounting to Analytical Format
Net Foreign Assets (NIR, NFA)Net Domestic Assets (NDA) Net domestic credit (NDC) Credit to public sector (net) (NDCg)
Credit (+) Deposits (-)
Credit to other financial institutions
Credit to private sector (DCp)
Other assets net (OAN)
Accounting Analytical
Monetary Accounts: StocksMonetary Accounts: Stocks
Banking System 1. Net Foreign Assets NFA
Central bank (NIR)Rest of banking system
2. Net Domestic Assets NDANet Domestic Credit
Net credit to the nonfinancial public sectorCredit to the private sector
Other Assets Net
3. Money Supply (monetary liabilities to private sector) = 1 + 2 (M3 = NFA + NDA)Central Bank 1. Net International Reserves NIR2. Net Domestic Assets NDA
Net Domestic CreditNet credit to the nonfinancial public sectorCredit to the rest of the banking systemClaims on private sector
Other Assets Net3. Monetary Base (monetary liabilities of CB) = 1 + 2 (MB = NIR + NDC)
Monetary Accounts:Monetary Accounts:Annual flows at end-of-period exchange rateAnnual flows at end-of-period exchange rate
1.Net Foreign Assets NFA = NIR + NFAb
Central Bank NIR
Rest of banking system NFAb
2.Net Domestic Assets NDA = NDC + OANNet domestic credit NDC = NDCg + DCp Nonfinancial public sector (net) NDCg Private sector DCpOther assets net OAN
3.Money and Quasi-money (M3) M3Money (M1)Quasi-moneyOther liabilities ∆NFA + ∆NDA = ∆M3 (monetary
liabilities)∆NIR + ∆NDAMA = ∆MB (monetary liabilities)
Balance of Payments: Balance of Payments: Analytical PresentationAnalytical Presentation
1. Current account CAB A. Goods and services X – Z
Goods (trade balance)Services
B. Factor income YfOf which: interest
C. Current transfers TRf 2. Capital and financial account CFAB
A. Capital account CAB. Financial account CF
Direct investment (net)Portfolio investment (net)
Public sectorPrivate sectorBanks
Other investment (net) Public sector
Private sectorBanks
3. Overall balance (1 + 2 = 3 = – 4) CAB + CFAB
4. Reserves and exceptional financing –NIR + ExF
Macroeconomic InterrelationsMacroeconomic InterrelationsNational Accounts
Consumption Public Private Gross domestic investment Public Private Exports of goods and servicesImports of goods and servicesGross Domestic ProductNet factor incomeNet current transfersGross National Disposable Income
Balance of PaymentsCurrent account Exports of goods and servicesImports of goods and servicesNet factor incomeNet current transfersCapital and financial accountCapital accountFinancial account Direct investment Net foreign financing Nonfinancial public sector Nonfinancial private sector BanksChange in net international reservesOperations of the NFPS
Total revenue and grantsTotal expenditure and net lending Current expenditure Wages and salaries Goods and services Interest Capital expenditure o/w fixed capital formation Net lendingOverall balanceFinancingExternalDomestic
Banking Survey (flows)Net foreign assets Central bank Rest of banking systemNet domestic assets Net domestic credit NFPS Private sector Other assets net Medium/long term foreign liabilitiesMoney and quasi-money (M3)
Flow of Funds Matrix FormatFlow of Funds Matrix Format
Sectors
Transactions
Nonfinancial (real)
Financial: changes in
financial assets and liabilities
Internal NFPS Private Banks External Total
S – I Sg –Ig Sp –Ip 0 – CAB 0
Total 0 0 0 0 0
Financing – Financing 0
Dom. Dom. Dom. Foreign Foreign Foreign Foreign – Foreign
Y = C + I + G + X - Z
An alternative derivation of An alternative derivation of monetary survey: Recap, same storymonetary survey: Recap, same story
PublicPublic sector G G –– T = T = B + B + DDGG + + DDFF
PrivatePrivate sector I I –– S = S = DDPP - - M - M - BB
ExternalExternal sector X X –– Z = Z = R - R - DDFF
G – T + I – S + X – Z = 0,
so left-hand sides sum to
zero
Overview 1Overview 1
Presents real transactions and their financing For each sector, shows the gap in all
nonfinancial transactions (income – expenditure => gap = savings – investment = deficit/surplus) and how it is financed
Shows financing flows among different sectorsFor the economy as a whole, shows how the
savings–investment gap is financed by foreign sources
Overview 2Overview 2
The flow of funds matrix can be seen as the representation of the budget constraint faced by all sectors of the economy because it shows real transactions and how they are financed
The domestic economy is subject to the amount of resources the rest of the world is willing to provide: financing of the balance of payments Excess of domestic demand (absorption) over supply
deficit in current account of the BOPGNDI – C – I = S – I = CABGNDI – C – I = S – I = CAB
Deficit in the CAB must be financed by net capital inflows or drawdown of international reservesCAB + CFA = CAB + CFA = ΔΔNIR (i.e., X – Z + F = NIR (i.e., X – Z + F = ΔΔR)R)
Overview 3Overview 3
• Each sector of the economy has a budget constraint
The overall balance of the public sector must be equal to the change in its net financial assetsExcess of expenditure over revenues deficit that
must be financed either by increasing liabilities (domestic or foreign) or by reducing assets.
RGg – GNLg = DIg – Cg – Ig = Sg – Ig = ΔNAFg
The private sector also has a budget constraint If expenditures exceed revenues, it must either
reduce assets or acquire more debt (domestic or foreign)Sp – Ip = ΔNAFp
ModelModel
Express accounting linkages in terms of simple algebra
Use model to describe how nominal income and reserves depend on domestic credit Demonstrate how BOP target translates into
prescription for fiscal and monetary policy Financial programming in action
33
List of variablesList of variables
M = moneyD = domestic creditR = foreign reservesR = R - R-1 = balance
of paymentsP = price levelY = real incomev = velocity
X = real exportsPx = price of exports
Z = real importsPz = price of imports
F = capital inflowm = propensity to
import
Two behavioral
parameters: m and v
List of relationshipsList of relationships
M = D + R (monetary survey)
M = (1/v)PY (money demand)
R = (1/v)PY – D (M schedule)
R = PxX – PzZ + F (balance of payments)
PzZ = mPY (import demand)
R = PxX – mPY + F + R-1 (B schedule)
Estimate m and v by
regression analysis
The M scheduleThe M schedule
Reserves (R)
GNP (PY)
M schedule
1
v
R = (1/v)PY – D
D up
An increase in reserves increases demand for money, and hence also income
PY = v(R + D)
PY is nominal income
The B scheduleThe B schedule
Reserves (R)
GNP (PY)
B schedule
1
m
R = PxX – mPY + F + R-1
F up, e down
An increase in income encourages imports, so that reserves decline
Solution to modelSolution to model
Two equations in two unknowns1) R = (1/v)PY – D 2) R = PxX – mPY + F + R-1
Solution for R and PY
FXPRDmv
vPY x
11
Dmv
mvFXPR
mvR x
11
11
Multipliers: AlgebraMultipliers: Algebra
mv
v
dD
dPY
1 mv
v
XdP
dPY
x
1
mv
mv
dD
dR
1 mvXdP
dR
x
1
1
Multipliers: NumbersMultipliers: Numbers
22
4
4)4/1(1
4
dD
dPY
2
1
4)4/1(1
4)4/1(
dD
dR
Suppose m = ¼ and v = 4
Credit multiplier
Half of credit
expansion
leaks abroad
through balance of
payments
Macroeconomic equilibriumMacroeconomic equilibrium
GNP (PY)
M schedule
Equilibrium
B schedule
Reserves (R)
D up
F up, e down
Economic modelsEconomic models
Exogenousvariables
Endogenousvariables
Model
Change in domestic credit or the exchange rate
Financial programming model
Foreign reserves and nominal income
Experiment: Export boomExperiment: Export boom
M schedule
B schedule
Reserves (R)
GNP (PY)
A
Export boomExport boom
GNP (PY)
M
BB’
A
C
Exports increase
Reserves (R)
Export boomExport boom
GNP (PY)
M
BB’
A
C
Reserves (R)
An increase in exports increases both reserves and nominal income
An interpretationAn interpretation
Exogenousvariables
Endogenousvariables
Model
Export boom orcapital inflow
Financial programming model
Foreign reserves and nominal income increase
Another experiment: Domestic Another experiment: Domestic credit expansioncredit expansion
GNP
M
B
D upM’
A
C
An increase in D increases PY, but reduces R.
Reserves (R)
D up M up PY up PzZ up R down
Domestic credit contractionDomestic credit contraction
GNP (PY)
M
B
D down
M’
A
When D falls, M also falls, so that PY goes down and PzZ also decreases. Therefore, R increases. Here, an improvement in the reserve position is accompanied by a decrease in income.
R*
C
Reserves (R)
Too low reserves
Domestic credit contraction Domestic credit contraction accompanied by devaluationaccompanied by devaluation
GNP (PY)
M
B
F up, e down
D down
B’
M’
A
C
When D falls, M also falls, so that PY goes down and PzZ also decreases. Therefore, R increases. Further, a devaluation strengthens the reserve position and helps reverse the decline in income.
R*
Reserves (R)
Comparative statics: Comparative statics: An overviewAn overview
D PxX F e
R - + + + -
PY + + + + +
= inflation= inflation
Experiment: Experiment: Inflation goes upInflation goes up
M
B schedule
Reserves (R)
GNP (PY)
M’
A
C
An increase in inflation () increases v, so the M schedule becomes flatter. Hence, R goes down and PY increases in the short run.
up
Experiment: Experiment: Inflation goes upInflation goes up
M
B schedule
Reserves (R)
GNP (PY)
M’
A
C
An increase in inflation () makes domestic currency appreciate in real terms, so the B schedule shifts left. Hence, R goes farther down and PY can rise or fall in the short run.
up
B’
up eP/P* up X down B shifts left
History and targetsHistory and targets Record history, establish targetsRecord history, establish targets
ForecastingForecasting Make forecasts for balance of payments, Make forecasts for balance of payments,
output and inflation, moneyoutput and inflation, money
Policy decisionsPolicy decisions Set domestic credit at a level that is Set domestic credit at a level that is
consistent with forecasts as well as consistent with forecasts as well as foreign reserve targetforeign reserve target
Numerical examplesNumerical examples 44
1)1)Make forecasts, set reserve target R*Make forecasts, set reserve target R*– E.g., reserves at 3 months of importsE.g., reserves at 3 months of imports
2)2) Compute permissible imports from BOPCompute permissible imports from BOP– More imports will jeopardize reserve More imports will jeopardize reserve
targettarget
3)3) Infer permissible increase in nominal Infer permissible increase in nominal income from import equationincome from import equation
4)4) Infer monetary expansion consistent with Infer monetary expansion consistent with increase in nominal incomeincrease in nominal income
5)5) Derive domestic credit as a residual: D = M Derive domestic credit as a residual: D = M – R*– R*
Financial programming step by Financial programming step by stepstep
KnownKnown at beginning of program period: at beginning of program period: MM-1-1 = 70, D = 70, D-1-1 = 60, R = 60, R-1-1 = 10 = 10
Recall: Recall: M = D + RM = D + R
XX-1-1 = 30, Z = 30, Z-1-1 = 50, F = 50, F-1-1 = 15 (all nominal) = 15 (all nominal)
Recall: Recall: R = X – Z + FR = X – Z + F
So,So,RR-1-1 = 30 – 50 + 15 = -5, so R = 30 – 50 + 15 = -5, so R-2-2 = 15 = 15Current account deficit, overall deficitCurrent account deficit, overall deficit
RR-1-1/Z/Z-1-1 = 10/50 = 0.2 = 10/50 = 0.2Equivalent to 2.4 (= 0.2Equivalent to 2.4 (= 0.2••12) months of 12) months of
importsimportsWeak reserve positionWeak reserve position
HistoryHistory
X grows by a third, so X = 40X grows by a third, so X = 40
F grows by 67%, so F = 25F grows by 67%, so F = 25
Suppose R* is set at 15 (Suppose R* is set at 15 (R* = 5)R* = 5)Z = X + F + RZ = X + F + R-1-1 – R* – R*
= 40 + 25 + 10 – 15 = 60= 40 + 25 + 10 – 15 = 60
Level of imports is consistent with R*Level of imports is consistent with R*RR**/Z = 15/60 = 0.25/Z = 15/60 = 0.25Equivalent to 3 (= 0.25Equivalent to 3 (= 0.25••12) months of 12) months of
importsimports
Forecast for balance of Forecast for balance of paymentspayments
BOP BOP fore-fore-castscasts
Increase in Z from 50 to 60, i.e., by Increase in Z from 50 to 60, i.e., by 20%, is consistent with R20%, is consistent with R** equivalent equivalent to 3 months of importsto 3 months of imports
Now, recall that Z depends on PY Now, recall that Z depends on PY where P is price level and Y is outputwhere P is price level and Y is output
Hence, if income elasticity of import Hence, if income elasticity of import demand is 1, PY can increase by demand is 1, PY can increase by 20% 20% E.g., 5% growth and 15% inflationE.g., 5% growth and 15% inflation
Forecast for real sectorForecast for real sector
If PY can increase by 20%, then, if If PY can increase by 20%, then, if income elasticity of money demand is income elasticity of money demand is 2/3, M can increase by 14% 2/3, M can increase by 14%
Hence, M can expand from 70 to 80Hence, M can expand from 70 to 80
Alternatively, by quantity theory of Alternatively, by quantity theory of moneymoneyMV = PYMV = PY
Constant velocity means that Constant velocity means that
%%M = %M = %PY = %PY = %P + %P + %YYIf so, income elasticity of money demand is
1
Forecast for Forecast for moneymoney
˜
Recall M = D + M = D +
RR
Having set reserve target at R* = 15 Having set reserve target at R* = 15 and forecast M at 80, we can now and forecast M at 80, we can now compute level of credit that is compute level of credit that is consistent with our reserve target, consistent with our reserve target, based on M = D + Rbased on M = D + R
So, D = 80 – 15 = 65, up from 60So, D = 80 – 15 = 65, up from 60D/DD/D-1-1 = 5/60 = 8% = 5/60 = 8%Quite restrictive, given that PY rises by Quite restrictive, given that PY rises by
20%20%Implies substantial reduction in domestic Implies substantial reduction in domestic
credit in real termscredit in real terms
Determination of creditDetermination of credit
Financial programming : RecapFinancial programming : Recap
Sequence of stepsSequence of steps
R*R* ZZ YY MM DD
Z = X + F + RZ = X + F + R-1-1 – R – R**
Z = mPYZ = mPY
MV = PYMV = PY
D = M – RD = M – R**
ConclusionConclusion
The four mains sets of macroeconomic accounts are closely intertwined
These interrelations form the analytical basis of financial programming Fund economists understand that countries
differ, and they seek to help tailor financial programs to the needs of individual countries
Even so, certain fundamental principles and relationships apply everywhere
These slides will be posted on my website: www.hi.is/~gylfason
The EndThe End