Macroeconomic Analysis and Policy

A Systematic Approach

Joshua E Greene

• Publisher: WSPC
• Year: 2017
• ISBN:
  9789813223844
• Topic: Economics
• Subtopic: Monetary Policy
• Index: Economics

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This book provides a systematic approach to analyzing macroeconomic developments, focusing on macroeconomic accounts, analysis, and the effects of selected policies on a nation's economy. The first part of the book describes the data, accounts, and analysis of the four main macroeconomic sectors — real, external, fiscal, and monetary — and discusses the accounting and economic relations among these sectors, using a flow of funds approach. Key indicators are presented for each sector and used to show how macroeconomic developments can be assessed and problems identified.

The second part of the book discusses fiscal, monetary, and exchange rate policy and their economic implications. These policies, along with selected structural reforms, are compared along several dimensions and shown how they can be used, in various combinations or individually, to address a variety of macroeconomic difficulties.

--> Contents:

• Preface
• Macroeconomic Accounts and Analysis:
  • Introduction to Macroeconomic Accounts, Analysis, and Related Policy Issues
  • Real Sector Accounts and Analysis
  • External Sector Accounts and Analysis
  • Fiscal Sector Accounts and Analysis
  • Monetary Sector Accounts and Analysis
  • Interrelations among Macroeconomic Sectors and the Flow of Funds
• Macroeconomic Policies and Their Application:
  • Fiscal Policy
  • Monetary Policy
  • Exchange Rate Policy
  • Using Macroeconomic and Structural Policies to Attain Macroeconomic Objectives

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--> Readership: Students, researchers and academics studying or teaching macroeconomics. -->
Keywords:Macroeconomics;Macroeconomic Data;Macroeconomic Policy;Macroeconomic Objectives;Macroeconomic Accounts;Macroeconomic and Structural PoliciesReview: Key Features:

• Unique treatment of the subject: focus on accounts, indicators, and data, rather than theory. The only similar book is about 20 years old
• The information presented enables readers to identify important developments and problems in national economies, without the need to make economic forecasts. This distinguishes this book from books on financial programming
• The coverage of macroeconomic policies allows readers to suggest ways of responding to macroeconomic developments and difficulties through combinations of fiscal, monetary, exchange rate, and structural economic policies

Chapter 1

INTRODUCTION TO MACROECONOMIC ACCOUNTS, ANALYSIS, AND RELATED POLICY ISSUES

Macroeconomics is the study of an entire economy. Macroeconomics assumes the existence of many individual economic sectors and the markets governing them. Thus, the focus is on the behavior of the economy as a whole — the aggregate of all the markets for goods and services, as well as the impact of the public sector (government and government-owned entities, called public or state-owned enterprises) and the rest of the world on the economy. Studying an entire economy requires conceiving of aggregate demand — the total demand for goods and services in the economy — and aggregate supply — the total amount of goods and services made available for sale in the economy. In equilibrium, aggregate demand and aggregate supply should be equal. In practice, aggregate demand and supply can differ, generating a variety of macroeconomic conditions, including short- to medium-term fluctuations in an economy, called business cycles.

Macroeconomic analysis involves studying an economy’s main components. These include

•The main sectors of the economy and relevant information about them, recorded in various sectoral accounts;

•Important indicators of macroeconomic performance, representing key variables drawn from the various sectoral accounts; and

•The principal policies used to achieve broad objectives for the economy, typically high rates of economic growth, macroeconomic stability (meaning low inflation), a sustainable external position, and various other objectives, such as low poverty rates, an acceptable distribution of income and wealth, and a safe and sustainable physical environment.

Although each economy has particular sectors of special importance — the petroleum sector, for example, in Saudi Arabia, or the tourist sector in Maldives or Barbados — for purposes of analysis, it is useful to view every economy as having four broad economic sectors, each with its own set of economic accounts. These sectors and their principal accounts are as follows:

1. The real sector, often called the national accounts. The real sector comprises production and expenditure in the economy. Its accounts measure the total activity in the economy, described either from the standpoint of production, expenditure, or income. The real sector also records data on inflation in the economy, using such measures as a consumer price index, other price indices, and a price index for overall output or expenditure called the gross domestic product (GDP) deflator. Chapter 2 provides an extensive discussion of the accounts and performance indicators in the real sector.

2. The external sector. The external sector covers the relations between the economy and the rest of the world. The economic aspects of these relations are recorded in a set of accounts called the balance of payments. The balance of payments records in detail the amount of trade in goods and services between the economy and other economies. It also shows income, capital, and financial interactions between the economy and the rest of the world, as well as changes in the amount of an economy’s official reserves (the stock of gold, foreign exchange, and similar assets held by the country’s monetary authority or central bank). The accounts of the external sector also record a country’s stock of foreign debt and debt service, including payments of both interest and principal (amortization). Besides the balance of payments and debt, data for the external sector will typically include indicators of the economy’s competitiveness, including data on the country’s exchange rate.

3. The fiscal sector. The fiscal sector involves the activities of government and government-owned non-financial entities called public or stateowned enterprises. (Publicly owned financial entities are covered in the monetary sector, described below.) The government sector’s financial activities are usually recorded in the fiscal accounts of the government sector, typically in a comprehensive budget for the entire sector or for different levels of government (where there are separate budgets for the central and sub-national units of government). There may also be data on the consolidated public enterprise sector — total income, expenses, profits or losses, and any financing needed to cover losses. As with the external sector, fiscal data also include information on government and stateenterprise debt and debt service.

4. The monetary sector. The monetary sector comprises the activities of the economy’s financial institutions, including its central bank or monetary authority, the commercial (deposit money) banks, and other financial institutions, such as investment banks, finance companies, credit unions, and any microfinance entities. The activities of the main part of the financial sector, the banking system, which comprises the monetary authority and the commercial banks, are recorded in a set of monetary accounts. The accounts record the assets and liabilities of the various institutions covered.

I. AN OVERVIEW OF THE ACCOUNTS AND KEY PERFORMANCE INDICATORS FOR EACH SECTOR

1. The real sector. The accounts of the real sector record developments in an economy’s income and prices. The accounts for income (which may also record total value added or total expenditure in the economy) represent flows, meaning activities that occur during a period of time, such as a year, as opposed to quantities of goods or services at a single point in time. The income (or production or expenditure) accounts of the real sector are measured both in nominal terms (meaning at current prices) and in real terms (meaning at a constant set of prices). If measured in real terms, these accounts allow comparison of the true volumes or amounts of goods and services produced, or expenditure made, or income earned, from one period to another. Key indicators of real sector performance include the growth (percent change) in real GDP; the output gap or unemployment rate; the ratios of gross investment and gross saving to GDP; and the rates of change in the consumer price index and other price indices.

2. The external sector. The accounts of the external sector focus on developments in the balance of payments, external debt, and external debt service, along with the composition and direction of trade (both exports and imports, particularly of goods). Except for the stock of external debt, the accounts record flows, since trade, financial flows, and debt service involve funds received or paid out during a period of time. The accounts of the external sector are typically recorded in nominal terms (at current prices) and are often presented both in domestic currency and in a commonly used foreign currency, such as euros or U.S. dollars. Key indicators of external sector performance include the current account balance in the balance of payments as a percent of GDP; the overall balance in the balance of payments and the level of gross official reserves; the ratios of gross reserves to imports (measured in months of imports) and to short-term debt (debt service due during the coming 12 months); the stock of external debt as a percent of GDP and the amount of debt service as a percent of export earnings (usually of goods and services); and competitiveness measures such as the change in the real exchange rate.

3. The fiscal sector. The accounts of the fiscal sector record developments in the government’s financial interactions with the rest of the economy and the rest of the world. They may also include developments in the consolidated set of public enterprises. Except for stocks of government and public sector debt, the accounts record flows, since items such as revenues, expenditures, and budget financing entail funds received or paid over a period of time. The fiscal accounts are measured in nominal terms (current prices), although fiscal data are often also reported in percentages of GDP, to allow comparison across years (and with other economies’ data). A comprehensive view of the fiscal sector includes not only the accounts of the central (national) government, but also the consolidated accounts of any state or provincial governments and, if available, of local governments. Including the consolidated accounts of the public (state-owned) enterprises shows the position of the overall public sector. Key indicators of fiscal sector performance include the overall balance of the central and general (consolidated) government budget as a percent of GDP; total revenues and expenditures as percentages of GDP, ideally with breakdowns of revenue into tax and non-tax receipts and expenditure into current and capital expenditure or expense and net acquisition of non-financial assets (again as percentages of GDP); the buoyancy (elasticity) of total revenue and tax revenue to GDP, which shows whether these items keep pace with the growth of nominal GDP; and the ratios of government and public sector debt to GDP.

4. The monetary sector. The accounts of the monetary sector show developments in the main financial institutions of an economy, typically focusing on the banking system, which usually represents the bulk of the financial system. Because the accounts record assets and liabilities of different institutions or groups of institutions at a point in time, they record stocks, rather than flows. However, flows in the monetary sector can be constructed by calculating changes in these stocks during a time period. Monetary accounts are recorded in domestic currency, in nominal terms (current prices). As a result, the domestic currency value of foreign currency items, such as international reserves and foreign exchange deposits, can change as the exchange rate fluctuates. Important measures of monetary sector performance include the growth rate of broad money and its main components (e.g., broad money in domestic currency); nominal and real interest rates on loans and deposits; the percentage of loans considered non-performing (i.e., seriously delinquent); the growth in real credit to the private sector (after adjusting for changes in the price level over time); measures of household and corporate debt; and indices of equity (stock) and house prices, which may be useful for identifying asset “bubbles” (price increases to unsustainable levels, far beyond what fundamentals would justify).

II. LINKAGES AMONG SECTORS

The four main economic sectors are related in a variety of ways. Developments in one sector affect other sectors, and policies aimed at one sector (for example, changes in fiscal policy) inevitably affect most sectors. For example, a rise in the population’s desire to consume, which increases aggregate demand and total private expenditure (real sector variables), typically raises government revenues, through higher sales or value-added tax collections, thus affecting the fiscal sector. Higher consumption may also boost imports, affecting the external sector (balance of payments). Higher consumption could mean an initial decline in household deposits and/or a rise in consumer loans, affecting the monetary accounts. Thus, a change originating in the real sector spreads to other sectors.

Changes originating in other sectors also affect other sectors. A rise in government pension payments will boost income, and most likely consumer expenditure, thus affecting the real sector. Higher pensions would probably raise imports, affecting the balance of payments. In addition, a rise in government pensions should mean at least an initial rise in household deposits, probably followed by increases in business deposits, thereby affecting the monetary accounts. Depreciation of the exchange rate typically reduces imports, at least over time, and may also boost exports, as competitiveness increases, thereby affecting the trade balance and current account of the balance of payments (external sector). Lower imports would reduce customs (import) duties, thereby affecting the government budget (fiscal accounts), while a stronger current account balance would likely raise international reserves, thereby affecting the monetary sector. Finally, relaxing monetary policy, by cutting the central bank’s policy interest rate, will likely expand lending, thereby affecting the monetary sector. Higher lending, whether for consumption or investment, should add to economic growth and income, thereby affecting the real sector. Moreover, higher investment may lead to more imports of investment (capital) goods, thereby affecting the balance of payments.

III. MACROECONOMIC OBJECTIVES AND POLICIES TO ATTAIN THEM

As mentioned earlier, economies typically aim at achieving certain broad macroeconomic objectives designed to deliver a high or improved standard living for citizens or residents. Attaining a high standard of living typically requires an acceptable rate of real economic growth, sufficient to raise per capita income and to provide enough jobs to keep the unemployment rate low.¹ A well-performing economy also attains relative price stability (low inflation)² and a “sustainable” external position, meaning a balance of payments that can be maintained without need for a major change in exchange rate or trade policy and that does not lead to high ratios of external debt to GDP. Finally, most economies are concerned not only about the average level of income per capita but also about in its distribution. Thus, economies typically aim at reducing the percentage of people in poverty, and many also try to reduce income inequality by providing benefits targeted at low- to middle-income households and, in some cases, imposing higher taxes on upper-income households and the wealthy. As noted earlier, many countries also enact policies aimed at achieving other broad economic objectives, such as reducing pollution or improving the physical environment.

Considerable history suggests that achieving price stability and a sustainable external position are important for being able to sustain growth. Countries like Turkey, which for many years before 2000 experienced high inflation, had trouble keeping growth rates high so long as prices were elevated. In the case of Turkey, a few years of moderate (3–5 percent) real growth was frequently followed by an economic collapse, as the failure of the exchange rate to offset inflation led to a loss of competitiveness and an inability to finance imports and external debt. Similarly Romania, where inflation exceeded 300 percent early in the 1990s, experienced poor growth until inflation fell to more reasonable levels. More generally, many researchers have found that, above a minimum level (perhaps 1–3 percent for advanced economies and somewhat higher rates for developing and emerging market countries), higher inflation corresponds with lower growth rates.³ One reason may be that higher inflation discourages private investment, encourages inefficient activities aimed at preserving the value of financial assets, and promotes capital flight to other economies with less inflation or a shift in assets to more stable currencies. As for external stability, balance of payments crises have imposed huge economic losses on many countries at all levels of economic development. In Asia, Indonesia, Malaysia, Thailand, and the Republic of Korea all suffered major declines in real GDP during 1998 because of large capital outflows (although Korea’s situation stabilized within a year after short-term loans were renewed). Real GDP fell nearly 11 percent in Argentina during 2002 after continuing fiscal imbalances and an end to International Monetary Fund (IMF) support forced the country to abandon pegging its exchange rate to the U.S. dollar. In 2009 Iceland’s real GDP fell nearly 7 percent, as huge losses in the banking sector triggered a collapse in the krona and a sharp decline in real imports and consumption.

Attaining attractive growth rates, low inflation, and a sustainable balance of payments requires a skilled mix of well-coordinated macro-economic policies. These include

•Monetary policy (the choice and level of the monetary policy instrument, typically an overnight interest rate, along with the type of monetary framework and level of reserve requirements);

•Fiscal policy (the level and composition of revenues and expenditures, the level of budget balance or deficit, and the composition of budget financing);

•Exchange rate policy (the choice of exchange rate regime and policies affecting the level of the real exchange rate); and

•Structural policies (a wide array of specific measures involving trade, labor, competition, financial sector regulation, pricing, state enterprises, and governance, many of which affect the economy’s investment climate). In recent years, financial sector regulation has become especially important, as banking crises have led to severe recessions in many economies, including Iceland, Ireland, Mexico, Spain, the United Kingdom, and the United States, with regional and even global spillovers, particularly after the U.S...