NI 1-041, extension 61769 (54 pages with tables). rhe PPR ...... rearrange the decomposition expressed in equation (17) and to introduce some relations ...
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L
Policy,Planning,and Research
WORKING
PAPERS
MacroeconomicAdjustment and Growth
CountryEconomicsDepartment The WorldBank December1989 WPS321
Economic and Policy Determinants of Public Sector Deficits
Jorge Marshall and Klaus Schmidt-Hebbel
A framework fordetermining howmuch the most important economic and policy variables contribute to the public sector deficit - and for comparing the direct effects of economic shocks with those arising from policy-controlled variables.
The Policy. Planning, and Research Complex dismhuies PPR Working Papers to disseminatc the findings of work in progress and to encourage the exchange of ideas among Blankstaff and all others interestej in dcvelopment issues. These papers carry the names of the authors. reflect only thetr vicws, and should he used and cited accordingly.The findings, interpretations, and conclusions are the authors own. They should not be altnbuted to the World Blank,its Board of Drectors. its management, or any of its member cotntries.
Plc Planning,and Research
Adjustment Macroeconomic andGrowth
Marshall and Schmidt-Hebbel have developed a framework for determining how much thc most important economic and policy variables contribute to the public sector deficit.
This allows one to compare the direct cffects of various foreign and domestic ccono-iic shocks an the deficit with thosc arising irom changes in policy-controlled variables.
Their method involves behavioral relations, identities for some key macroeconomic and sector variables, and an accounting breakdown of the consolidated public sector deficit.
The method is useful for decomposing historical time series of publEcdeficits according io their main determninants- and for carrying out simulation or projection cxercises for the level and structure of future deficits.
This paper is a product of the Macroeconomic Adjustmcnt and Growth Division, Country Economics Depar.mcnt. Copies are available free from the World Bank, 1818H Street NW, Washington DC20433. Please contact Susheela Jonnakuty, room NI 1-041, extension 61769 (54 pages with tables).
rhe PPR Working Paper Series disseminates the findings of work under way in the Bank's Policy, Planning, and Rcscarch Complex. An objective of the series is to get these findings out quickly, evenif presentations are lessthan fully polished. The findings, interpretations, and conclusions in thcsc papers do not necessarily represent official policy of iltc Bank. Produced at the PPR Dissemination Center
Economic and Policy Determinants of Public Sector Deficits* by Jorge Marshall* and Klaus Schmidt-Hebbel
Table of Contents
I.
Introduction
3
I.
An Accounting Framework for Public Sector Analysis
7
Sources and Uses of Funds of the Public Sector The Consolidated Deficit of the Public Sector
7 17
IL.1. 11.2. III.
Economic and Policy Determinants of Public Sector Deficits 111.1. III.2.
IV.
Accounting Decomposition of the Deficit Determinants of Public Deficits
Final Remarks
19 19 23 34 35
References Appendix 1.
Definitions and Identities
36
Appendix 2.
Economy-wide Accounting Consistency
40
Appendix 3.
Balance Sheets of the Public and Private Sectors
47
Appendix 4
Economic and Policy Determinants of the Public Debt Output Ratio
49
Efficient editorial assistance provided by C. Almero and K. Jurgensen is gratefully acknowledged. ** Graduate Program in Economics, IIADES/Georgetown University.
-3-
I. INTRODUCTION Public sector deficitshave shown significantvariationsin their levels and structuresin most developingcountriesduring the last 15 years. This has been the result of both policy shifts planned by policy makers and shocks in internationaland domrestic variables,not under direct controlof policy makers. Foreign shocks and domestic swings have been particularlyintense since the seventies. Public deficitshave often reflectedthese changesimmediately,while policy reactions to them have tended to be slower, probably because of both political-institutional constraints and uncertainty on how transitory these shocks were. Particularlysevere were foreign shocks related to commodity prices and international interest rates.
On the financing side the foreign credit
constraintimposed in the aftermathof the foreigndebt crisis forced a mix of fiscaladjustmentand substitutionof domesticfinancingfor externalborrowing, 1 combinatior.which varied widely between different developing countries.
Domestic recessions,induced in part by adverse foreign shocks,contributedto public deficits by eroding tax bases and revenuesof public enterprises. The lack of fiscal adjustmentoften worsenedthe situation,when domesticfinancing of the deficits led to higher inflation and real interest rates, which
1 For a discussionof the fiscal dimensionof commodityexport cycles and adjustmentto the foreign debt crisis, see World Bank (1988),chap. 3.
-42 contributedto even higher primary deficits.
The purpose of this paper is to derive a framework for quantifying the contributionof the most importanteconomicand policy variables to the public sector deficit. In particular,this paper distinguishesthe effects of various foreign and domesticeconomicvariableson the deficit from those stemmingfrom policy-controlledvariables.
Combining an accounting decompositionof the
consolidated public sector deficit with various behavioral relations and identitiesfor some key macroeconomicvariables,the frameworkquantifies the direct impact of the most importanteconomicand policy variableson the deficit. This methodology is useful for decomposinghistorical time series of public deficits according to their main determinantsand for carrying out simulation or projectionexercisesfor the ie-'eland structureof future deficits.3 Becausethe budget deficit,its compositionand its financinginteractwith domesticmacroeconomicvariables,it is importantto note that this paper focuses only on the one-way causalityfrom economicvariables to the deficit. For the simultaneousinteractionbetween the public sector budget constraintsand goods and asset markets, one should refer to macroeconomicmodels which include conditionsfor those markets,in additionto the equilibrium(or disequilibrium) public sector budget restriction.
2 The contributionof higher inflationto the inflation-adjusted or primary public deficit is due to the Oliveira-Tanzieffect on tax revenues or, in general,on public sector net income. 3 The methodologypresentedhere will be applied by the country studies of the World Bank researchproposalon Macroeconomicsof Public SectorDeficits(see Easterly,Rodriguez,and Schmidt-Hebbel,1989). An applicationto Colombiaand Venezuela is already presented in Schmidt-Hebbeland Webb (1989).
The model developedhere is related to other decompositionor simulation studies for the public sector deficit (such as the applicationsfor Brazil by Oliveira (1985) and Werneck (1987), and is based on a significantdegree on Marshall and Schmidt-Hebbel(1988). It is also related to recent work on economy-widemacroeconomicconsistency (see, in particular, Easterly (1989), Holsen (1989),and Khadr and Schmidt-Hebbel(1989a,1989b)),presentingmutually consistentflow constraintsfor the public, private,and external sectors. The derived measure for the consolidated public sector deficit is consistentwith the most comprehensiveconceptof the public sector,encompassing general government,public enterprises,the central bank, and other financial institutions. The budget structureof each of these sectorsfollowsclosely the format of the IMF Public FinanceStatisticsYearbook. The deficit conceptused throughoutthe paper is the nominal consolidatedpublic sector deficitor public 4 sector borrowingrequirement.
Section II presentsan accountingframeworkfor the public sector. Budget restrictionsfor the four above mentioned sub-sectorsare combined to obtain an equationfor the consolidatedpublic sector deficit. Appendix 2 shows economywide consistencybetweenthe public sector accountsand those of the private and foreign sectors. SectionIII introducesvariousbehavioralfunctions,arbitrageconditions, and identities (some of them following Buiter (1988)),and combines them with the public deficit expression of section II, in order to quantify the
4 Simple transformationsof the equationsderived in the paper would allow to obtain measureswhich correspondto the primary deficit,for instance. For a discussionof the differencesbetweennominal,pricingand operationaldeficits see World Bank (1988), chap. 3, and for empirical comparisonsof alternative deficit concepts for Brazil and Mexico see Schmidt-Hebbeland Webb (1989).
contributionof the most importanteconomicand policyvariabl's to the deficit. The final derived expressionallows to distinguishthe effects of foreign and domesticeconomic shocks from the changes induced by the policy makers. An alternative expression to this, which is based on flow budget constraints,quantifies the effects of economic and policy variables on net public debt. This alternativemeasure,which considerscapitalgains and losses from inflationand exchange rate depreciation(as consideredby Buiter (1988) and Khadr and Schmidt-Hebbel(1989a,b)) is developed in appendix 4. IV concludes.
Section
- 7 -
II. AN ACCOUNTINPFRAMEWORK FOR PUBLIC SECTOR ANALYSIS This sectionpresentsan accountingframeworkfor the public sector,which will allow to derive the consolidatedput' c sector deficit and to decompose it accordingto its main determinantsin section III. Budgetary identitiesof four public sub-sectors,ordered by eources and uses of funds, are introduced in III.1. This allows to obtain an expressionfor the consolidatedpublic sector deficit in II1.2. Consistencybetween the public sector accounts and those of the nrivate and foreign sectors is explicitlytreated in appendix2.
I1.1. Sources and Uses of Funds of the Public Sector Public s,-tor accounting in this section is based on flow budget constraintsfor four public sub-sectors,consistentwith well-known sourcesand uses of funds tables for each sub-sector. The four subsectorsconsideredhere are:
public sector, general government (which comprises central and local
governments,the public social securitysystem,and the decentralizedagencies), the consolidatedpublic enterprisesector, the central bank, and other public financial institutions. The central governmentis explicitly assumed to own the equity of the remainingpublic subsectors. Regarding the public enterprisesector, it is convenientto classifythe enterprisesaccordingto their activity. The proposedclassificationidentifies four different categories of public enterprises: producers of exportable, importable, and non-tr:'able goods and producers of public services. These
-85. groups are referredto by subscriptsX, M, N and S, respectively
A useful feature of this disaggregationis that it allows to measure che impact of relevantrelativeprice changes (termsof trade, real exchangerate, and prices of puiblicservices) and to quantify the effect of changes in the sectoraloutput compositionon the consolidatedbudget. Next, the identitiesbetween sources and uses of funds are introducedfor each public sector. Expenditure,revenue,and financingitems are expressedin current-pricedomestic currency units. Notation and variable definitionsare introducedin Appendix 1.
General Government (G) The identitybetween sources and uses of funds for the general government is presentedin Table 1. It can be written as follows:
(1) (1) TDIR + +
t t~~ PQ *J
+ SC + UDCB + UDPFI + E UDPE +i i E.UPE
A(B + DLG + E LG ) + APFIC + fAPEC + APFI WB
+ SCG +
i
P.Qj + V + SB + t WPEj + .33. .3
(DPFI + DPRBG) + +DPB
+ &APE*
jJ.
pPjQG
+ E i* LG* + A(CUG + DPFIG + DPRBG + ACB + APFI +
E
+ i B + i DLG +
B
G
APEj)
5 The distinctionbetweenpublic serviceenterprisesand non-tradablegoods or serviceenterprisesis drawn becauseof the economicimportanceof the former and the central role played by public tariffs in contributingto public sector deficitsin many developingcountries.
-9TABLE 1 GENERAL GOVERNMENTs
SOURCES AND USES OF FUNDS
SOURCES
I. -
TAX REVENUE Direct taxes Indirect taxes Social sec. contrib.
II. -
-
-
-
I. TDIR
EtjPjQj SC
NON-TAX CURRENT REVENUE
Distributed profits + Central Bank UDCB + Public fin. instit. UDPFI + Public enterprises EUDPEj Interest receipts from deposits in: + Public fin. instit. iDDPFIG + Private banks IDDPRBG
III.
-
'JSES
CAPITAL REVENUE
Bond issues Domestic loans Foreign loans Equity sales to the private sector
Equity jales to the foreign sector
CURRENT OPERATIONAL EXPENDITURE
- Wage bill - Social sec. contrib. - Purchase of goods - Transfers to the private sector - Social sec. benefits - Transfers to pub. ent.
II.
AB
V SB £WPEJ
CURRENT FINANCIAL EXPENDITURE
- Interest payments on: + Public bonds + Domestic loans + Foreign loans
III.
WL SCG EPjQJG
iBB iGDLG Ei*LG*
FIXED CAPITAL EXPENDITURE (REAL INVESTMENT)
- Real investment
EpjQjICB
ALG E ALG* ACBC APFIC EAPEjC
IV.
E FACBE E bAPFIE EE,&APEjE
-
-
-
OTHER CAPITAL EXPENDITURE FINANCIAL INVESTMENT Currency ACUG Deposits in pub. fin. instit. QDPFIG Deposits in priv. banksADPRBG Equity subscription of the central bank AACB Equity subscription of pub. fin. instit. AAPFI Equity subscription of public enterprises AEAPE
- 10
-
The general government'scurrent tax revenuescorrespondto direct and 6 Other taxes that may indirect taxes, and to social security contributions.
constitute an important sourc, of current revenues, such as fcreign trade, propertyand real estate taxes, could be easily added if they are not already in indirect taxes. Average indirecttax rates tj are defined net of sectoral subsidies. The generalgovernment'snon-taxcurrentrevenueincludesboth distributed profitsby the public enterprisesand interestreceiptsobtainedfrom government deposits in public financialinstitutions(PFI) and private banks (P.B). According to the bals e sheet, there are three liabilitieswhich are traditionalsourcesof financingor capital revenuesof the general government: public bonds issues by the general government,domesticloans from the central bank, and foreign loans. Aside from traditionalfinancing,privatizationor equity sales of public enterprisesor public financial institutionsare "non-traditional" sources of 7 When funds. These shares can be purchasedby the private or foreign sectors.
the general governmentpurchasesequity from either sector, it uses government
6 A behavioralrevenue functionfor direct taxes is explicitlyintroduced in section III.2 below. 7 The purchaseby the nationalprivate sector is denotedby the superscript C, and the purchaseby the foreignsector by an :terisk (*). Note that in the period that follows the sale of equity, the equi., stock of the domesticprivate sector or of the foreign sector increasesby the value of the privatization carriedout in the previousperiod. This increasesthe size of the privatebank or of the private enterprisesector (heldby the nationalprivate sector or by the foreign sector) followed by a reduction in the PFI or PE sectors. To simplify, we consider only purely public or purely private institutionsor enterprises,excludingthose of mixed property,since these would significantly complicatethe consolidationof the public sector.
-
11
-
resources,which implies a sign change of the correspondingitems. The general governmeru'soperationalexpenditurecorrespondsto the wage bill, totalexpenditureon currentgoods, direct transfersto the privatesector, subsidiesgranted to public enterprises,and social securitybenefit payments. Current financialexpenditurecorrespondsto interestpaymentson the three liabilitiesheld by the generalgovernment. Fixed capitalexpenditure or gross investmentcorrespondsto the purc'tase of capitalgoodsby the generalgovernment from each of the relevantproductionsectors (exportables,importablesand nontradables). Finally, there are three assets whose increaseconstitutethree uses of funds of the general government: currency,bank deposits (in public financial institutionsand private banks),
and equity (of the central bank, public
enterprises,and public financialinstitutions).
Central Bank %CB) The Central Bank's sources and uses of funds table is Table 2.
The
followingidentitysummarizesit: (2)
iBBCB + D + iDCG CG + iDCPFI DCPFI + iDCPRB DCPiBDDCPE+i
DCPE
DCPEJ+
+ i i DCPREj + E i*R + A (CU + RES + ELCB + ACB) E WLCB+ DCPRE j + SCCB + i
JQJ
+ i
JES + E i LCB
+ UDCB + A (B
+ DCG +
+ DCPFI + DCPRB + i DCPEj + fDCPREJ) + E AR
In the case of the central bank (as with other public financial institutionsand privatebanks),currentrevenuesare only comprisedby interest
-
12 -
TABLE 2 CENTLRL BANKR SOURCES AND USES OF FUNDS
SOURCES
I.
USES
CURRENT REVENUE
I.
CUtRENT EXPENDITURE
- Interests receipts from: + Public bonds iBBCB + Domestic credit to the gen. govt. iGDCC7 + Domestic credit to pub. fin. instit. iDCPFIDCPFI + Domestic credit to private banks iDCPRBDCPRB + Domestic credit to public ent. iDC'EEDCPEJ + Domestic credit to private ent. iDCPREjDCPREQ + International reserves Ei R*
- Wage Bill - Social sec. contrib. - Interest payments on: + Bank reserves + Foreign loans
II.
III. OTHER CAPITAL EXPENDITURE (FINANC. XL INVESTMENT)
-
CAPITAL REVENUE
Currency Bank reserves Foreign loans Equity issues
U
ARES E ALCB*
AACB
II.
WLCB SCCB iRRES Ei *LCB
FIXED CAPITAL EXPENDITURE (REAL INVESTMENT)
- Real investment
EPQ.ICB
- Public bonds ABCB - Domestic credit to the gen. govt. ADCG - Domestic credit to the pub. fin. instit.ADCPFI - Domestic credit to private banks ADCPRB - Domest3c credit to public enterprises AEDCPEj - Domestic credit to private enterprises AEDCPREj - International reserves E AR
IV.
DISTRIBUTED PROFITS
- Distributed profits
UDCB
-
13
-
payment receipts. However, in contrastto the commercialbanking sector which only distinguishesbetween loan and deposit interestrates, in the case of the central bank we identifya specificrate for each asset or liability. Capital sourcesof funds of the centralbank are given by the accumulation of domestic monetary liabilities (currency and bank reserves), foreign liabilities(foreignloans), and equity issues. The centralbank's currentexpenditurecorrespondsto the wage bill, social securitycontributions,and interestpayments. Fixedcapital expenditureis its real investment. Acquisition of
public bonds, extension of
domestic credit, and
internationalreserveaccumulationconstitutethe centralbank's three forms of financial investment. Its last use of funds item is comprised by profits transferedto the general government.
Public FinancialInstitutions(PFI) Table 3 is the sourcesand uses of funds table for the consolidatedpublic financialsector (excludingthe centralbank). The followingidentitysummarizes it: (3)
PFI PFI PFI S PFI PFI i RES + i B + i (LLPE. + LPRE + LC ) + A (DLPFI+ R B C 3 j I j .£
+ DPFI + E LPFI
+ APFI) *
+ i DPFI + E i LPFI D +
f LPEPF
3
1
WLPF + PFI + SCPFI ~~~P~~QI
QPFII" + i DLPFI + + 'DLPFI
+ UDPFI +A(CUPFI + RESPFI + BPFI +
+ fLPREjPFI +
.
E
LCPFI)
- 14 -
TABLE 3 SOURCESAND USES OF FUNDS OF PUBLIC FINANCIAL INSTITUTIONS
SOURCES
I. -
USES
CURRENT REVENUES
I.
Interest payments received for: + Bank reserves iRRESPFI + Public bonds iBBPFI + Loans to pub. ent. iCECPEjPFI + Loans to priv. ent. iCECPREjPFI T
II.
Loans to consumers
CAPITAL INCOME
Domestic loans -Deposits - Foreign loans - Equity issuance -
iCLCPFI
CURRENT EXPENDITURE
- Wage bill WLPFI - Social sec. contrib. SCPFI - Interest payments: + Domestic loans iDLPFIDLPFI + Deposits iDDPFI + Foreign loans Ei*LPFI
II. CAPITAL EXPEND. (REAL INVEST.)
ADLPFI
- Real investment EPjQPFII
ADPFI EALPFI* AAPFI
III. -
FINANCIAL INVESTMENT
Currency &CUPFI Bank Reserves ARESPFI Public bonds ABPFI Loans to pub. ent. AELPEjPFI Loans to private AELPREjPFI Loans to consumers ALCPFI
IV.
DISTRIBUTED PROFITS
- Distributed profits
UDPFI
- 15 -
This budget constraintis similarto that of the centralbank. To simplify the model, public financial institutionsdo not grant loans to the general government,nor to the central bank or private banks.
Public Enterprises (PE) Finally, we present the sources and uses of funds table for the consolidated public enterprise sector, and the corresponding flow budget constraint. The starting point is the informationon each public enterprise sector. According to the sector decompositionproposed in this paper, each enterprisej (j = X, M, N, S) representsa consolidationof public enterprises that operate in that sector. Tha correspondingidentityis the following:
(4)
(1 - t )
+ LPEj
QPE + WPEJ + iB PEj + iD (DPFIPE + DPRBPEj) + A(DCPEj +
W LPEi + SCPEj +
PFI + LPEj PRB + E LPE* + APEj)
iDLpEDLPEj + i
A(CUPE
(LPEjP
+ LPEJ
) + E i
+ BPEj + DPFI PEj + DPRBj
LPE.
pQIPEj
+
+ UDPEj +
)
Public enterprises have three sources of funds: 8; comprisedby their sales income
i
operational revenue
non-operationalrevenue (transfersfrom the
8 Throughout the analysis we have assumed no demand or purchases of intermediategoods. Therefore,gross value of productionor sales coincidewith value added.
-
16 -
TABLE 4 PUBLIC ENTERPRISESt
SOURCESAND USES OF FUNDS
SOURCES
I.
USES
OPERATIONAL REVENUE
- Sales income
I. PjQ;PE
II. NON-OPERATIONAL REVENUE - Fiscal transfers WPEj - Interest received by: + Public bonds iBBPEj + Deposits in public rfin.instit. iDDPFIPE
OPERATION EXPENDITURE
- Wage bill - Social Sec. Contrib. - Paid interest: + Domestic + Loans from pub. fin. instit. + Loans from priv. banks + Foreign loans
WLPEj SCPEj iDLPEDLPEj iLLPEjPFI iLLPEjPRB J Ei*LPEj*
+ Deposits in
private banks
iDDPRBPEJ
II. CAPITAL EXPENDITURE (REAL INVEST.) -Real investment EPjQjIPEj
III.
CAPITAL REVENUE
- Domestic credit - Loans from public financial instit. - Loans from priv.banks - Foreign loans - Equity issues
ADCPEj
III. OTHER CAPITAL INVESTMENT (FINANCIAL INVESTMENT)
ALPEjiP1
ALPEJPRB E ALPEj* AAPEj
- Currency - Public bonds - Deposits in pub. fin. instit. - Deposits iLL private banks
ACUPEj ABPEj ADPFI ADPRB
IV. DISTRIBUTED PROFITS - Distributed profits
,UDPEj
- 17 -
generalgovernmentand interestpaymentsreceivedfor bank deposits),and capital revenue (equity issues and loans).
Public enterprisesuse funds for operationalexpendituressuch as the wage bill, social security contr,.butions, interestpayments and indirecttaxes. A second use of funds categoryis fixed capital expez.diture, or real investment, which allows increasesin productioncapacity. The remainingsurplusis divided among increases in currency,public bonds, and bank deposits. Finally,public enterprises use funds to d'stribute profits to their owner, the general government.
II.2. The ConsolidatedDeficit of the Public Sector Now let's obtain the consolidatedpublic sector deficit. Substitutingthe distributedprofits of the centralbank, the public financialinstitutions,and the public enterprises (from equations (2) - (4)) into the general government budget constraint (equation (1)), and reorderinguses and sources of funds, obtain the followingidentitybetween the "belowthe line" financingsourcesand the "above the line" consolidatedpublic sector deficit: (5)
BA PRB +
+
BPRE
1
CUPREj + Cu
+ Bc) + A(ACBc + APFI
+
,APEC)+ A(CU ii
+ RE5 PRB) + A( DPFIPREJ + DPBC + A( LPE PR)
- A(DCPRB + gDCPREj) - A(LPREJPB + LCPB) _(DPRBG
+ E A(LG + LCB* + LPFI
- E AR
+
+ tLPE
W (LG + LCB + LP
+ IDPRBPEj) +
) + E A(ACB* + APFI
+ L PJ) +
-
+
PQG + V + SB
APE
TDIR
-
- SCPRB
-
gSCPREJ -
PE + p
-
(QIF + QICB
£PRj
+ i (BPRB + IBPREJ + BC) + iD
+ ic(ILPEJPRB)
LCPFI) - i
tjpjQPRE _
PREi £ PREjI J
SIPEj + QIPEJ
18 -
(DPRBG +
DPRBPEi) + E i
(LG
+ LCB
+
C
(IDPFIRE
(iDCPRBDCPRB+ iDCPRE IDCPREJ)
+ QIPFI
+ DPFI ) +
-
ic (LPREJ PFI +
+ LPFI
+ ELPEj* - R*)
The left-handside of equation(5) indicatesthat the consolidatedpublic sector deficit can be financedby issuingpublic liabilitieswith the domestic private sector, selling public sector equity to the domesticprivate sector, selling domestic private liabilities,issuing foreign public liabilities (net of internationalreserves),and selling public equity stocks to the foreign sector. The consolidatedpublic deficit is made up of three components. First, the non-financialpublic deficit, comprised by public expenditure on wages, social securitybenefitsand goods, transfersand real investment,minus direct and indirect taxes, social security contributionsof the private sector and revenuesfrom the operationof public enterprises. Second,the financialdeficit with the domestic private, and third, the financialdeficit with the foreign sector. The public subsectors'budget constraintsare explicitly linked to the budgetary restrictionsof three private sub-sectorsand the external sector in Appendix 2.
There, macroeconomicand financial consistency of all sector
accounts is summarizedin a flow of funds table.
-
19
-
III. ECONOMICAND POLICY DETERMINANTSOF PUBLIC SECTOR DEFICITS This section decomposesthe consolidatedpublic sector deficit, in order to quantifythe direct contributionof the main economicand policy determinants of public deficits. Section III.1 presentsan accountingdecompositionof the public deficit, aa a fractionof GDP, according to the main budgetary items. After introducing a set of behavioral functions, arbitrage conditions, and identities,the contributionof economicand policy variablesto the deficit is quantifiedin SectionIII.2. The final derivedexpressionallows to distinguish the effects of foreign and domestic economic shocks on the deficit from those induced by changes in variablesunder direct control of the policy makers.
III.I. AccountingDecompositionof the Deficit In decomposingthe deficit,equation (5) is used to identifyeach of the budgetary items that affect the consolidatedpublic sector deficit and its financing. However,it is convenientto simplifythis equationby consolidating various assets and liabilities,and to normalizeit by dividing it by currentprice GDP. We will pursue these two tasks next. With regardto consolidation, define totalpublicbonds in domesticprivate hands, BPRS, as: (6)
BPRS
=
BPRB +
BPREj
BC
The monetarybase belongingto the domesticprivate sector, H, is: (7)
H
CUPRB + JCUPREj + CUc + RESPRB cu-
Total other liabilitiesof the public sector in domestic private hands, OPSPR, are:
-
(8)
OLPRS
DPFIPRE F DPFIC +
=
20
-
LPEJPRB
Total other assets of the public sector, OAPS, (which correspond to liabilitiesof the private sector in public hands) can be written as: (9)
OAPS
DCPRB + fDCPREj + fLPREB
E
+ LCPFI + DPRBC + fDPRBPEj
Regardingprivatizationsor equity sales of public financialinstitutions or of public enterprises,revenuesfrom sales to the domesticprivate sector and abroad are respectivelydefined as: (10)
AC E
(11) AA
E
AAPFIC + A APEjC AAPFI + AfAPEj
The weightedaverageinterestrate paid by the public to the privatesector for other liabilitiesof the public sector,consistentwith eq. (18),is defined as: (12) i0 p E
(iD (fDPFIPR + DPFIC) + ic fLPEJ
)/OLPRS
Similarly,the weighted average interestrate paid by the private sector to the public sector correspondingto other public assets, consistentwith eq.(19),can be expressedas: (13) iOA
DLPRB DLPRB + iD
=(
DCPREj + iL (fLPREjPB+ LCPFI) +
+ iD (DPRBC + fDPRBPEj))/OAPS
Aggregate public employment,LPS, is defined as: 14)
LPS
L
+ LCB + LPFI + fLPEj
Total public investmentis: (15) QIPS
QIG + QICB + QIPFI +
IPEJ
- 21 Next, equation (5) is written as a proportionof output, dividingeach of the budgetary items by nominal GDP, PY, where P is the GDP deflator and Y is real GDP. Then each budgetary item is rewrittenas its value at a given base period9 times one plus
the percentagevariation of its components,minus the
percentagechange of the GDP deflator (1) and real GDP (n) with respect to the base period,plus a residual. For example,the public wage bill in any current period, as a fractionof nominal GDP, can be expressedas:
~~PS
PS (16)
W L
WL py
} I (1 + W + LPS
n + RL)
where the line above the first fractiondenotes the base period value and the caret (*)denotes the percentagechangebetweenthe base and the currentperiods. RWL is a residual, which corresponds to the sum of all combinationsof the products of percentagechanges. To simplify the exposition,this residual is 10 assumed to be zero in all what follows.
Substitutingequations (6) - (15) into (5) and expressingall budgetary items as shown in eq. (16), the public sector deficit as a share of currentprice GDP is the following:
9 The base period could be the precedingperiod in most applications. 10 The exact value for RWL in this particularcase is: RWL
(
++
+ {n + A
A
1 A
+ W (
A
A
1
)} + W LPS + W A
(S 1)
)+L
1
-
( y
A
+ WLPS
+ LPS (1) A5
+ LPS
(
)+
A
A
1
1
p
y
(
p
+ WL
-A
(
)
+
A
11
AA5
) + W,LPS
(
y
This value approacheszero for "small' values of the percentage variations. Thereforeit is significantlydifferentfrom zero in higher inflationcountries.
- 22 1
+ E
ADEN 1( E
SB
[p
-
](1+ SB
L
pPRB ](1 + SCPRB - I (
[E
~PQ
-Li J)
+
PRE
1](1 +
Q AP
t,
t
+
p I +
PRS~
P Y
(B
B)
nA
OA) p y -
[ i
)
1 (1 +
TDIR
P
]
-](1+
~
+rOL
P PY
-
+(iOLiOL)
pY DEN + (i
n)
I
-
n -
ESCPRE. - I
_ n)
i
+
-
n)
(1+
+
nBPRS
PR 0 PSOAPS~
PY
FE
p
APSI
PS
~OPR 0
-
(I +
Q A PRE
+
Q+pi
n)+
B
TIy
-
-
(1 + V-
TDIR
n)
-
L(S
+
n) +
r - n) _
-
-f -n)+
}(1+W+L
A j
A AC +
AOAPS +
1
AOLPRS
p + Q}(1 + NY
+ E {
-
1
PY~~~~~~P p y
PY y ADEN+
+p
AH +
1
ABPRS +
OA
P Y
Ei)DEN E
This form of decomposingthe public sectordeficit (as a proportionof GDP) offers severaladvantages. First, it identifiesdirectlyeach of the budgetary items affected by the change in a particular economic variable; second, it identifiesthe public subsectorto which the budgetaryitems belongs;and third, a distinctionof the budget accordingto the currency(domesticor foreign)can be made. However, in order to obtain a more meaningfuleconomicdecomposition of the deficit, several additionalhypotheseshave to be introducednext.
- 23 -
III.2. Determinantsof Public Deficits To analyze the economic determinantsof the deficit it is useful to rearrange the decompositionexpressed in equation (17) and to introduce some relationsbetween the underlyingeconomicvariableswhich cause changes in the deficit. The behavioral functions, arbitrage conditions, and identities to be introducednext are a revenue functionfor direct taxes, arbitrageconditions for prices, identitiesfor the GDP deflator and the real exchange rate, and Fisher equations for domesticand internationalinterestrates. The revenue function for direct taxes depends on the average direct tax rate (T), real GDP (Y), and the rate of inflations(r).11 (18) TDIR _
f (r, Y, T) (+) (4 )(-)
where the positive dependencyof direct taxes on the tax rate assumes that the economy is on the left-hand side of the tax Laffer curve and the negative dependencyof inflationreflectsthe well-knownOlivera-Tanzieffect (see Tanzi et al. (1987)). To simplifythe presentationof the effe:ts of the independent variableson direct taxes, below we introduceelasticitie:a. 7, ay, and a, for the tax rate, GDP and inflation,respectively. For exportableand importablegoodspricesconsiderthe followingimperfect arbitrage conditions, between domestic and internationalprices (the latter denoted by asterisks),where the deviation from perfect parity is given by
11 The signs of the correspondingpartial derivativesare indicatedbelow each variable.
- 24 -
factors X and oS12 PX
-
x PxE
(20) PM
-
M PME
(19)
Thereforethe changes in the relativeprices of exportableand importable goods can be written as:
(19')
(PX/P)
(20')
'
X + Px
-
OM + PM
+
-
+ c
-
The GDP deflator, P. is a geometric (Cobb-Douglas)average of the four domesticprice indices: (21)
P
= paX paM paN p(l-aX-_M-aN)
X
M~ N
"S
where the ai (i = X, M, N,) coefficientsare the sector output shares in GDP. For domestic and foreign nominal interestrates, let's make use of the Fisher equationto distinguishbetween real rates and inflationrates.13 r +f
(22) i (23)
i'
=
r* + 1*
We also define the real or effectiveexchangerate as the relationbetween the average foreign and domesticprice levels,EP*/P. The real devaluation rate 7 is defined as:1 4
12 The variablesOX and OM differ fromunity due to productdifferentiation, transportationand intermediationcosts, and imperfectcompetition. 13 With actual (and not expected)values, the Fisher equationis either an ex-post identityor an ex-ante equationunder perfect foresight. In addition, as written in eqs. (22) and (23), it is a valid approximationfor low inflation countries,as the product of both rates is excluded from the right-handside. 14 Here also productsof rates are deleted for similification.
- 25 (24) 7
- r
_ e +
Suostituting equations (18), (19'), (20'), (22), (23) and (24) into equation (17),and rearrangingthe latter,the public deficitdecompositioncan then be presentedaccording to its economicdeterminants,as follows: (25)
1
^AB PRS +
p y A DEN +
+
1
AH +
p y
AA
t P QPRE
*1
_
[p
f
**
GMQ + p y
(p
G
H H
+
(
X X)
+
PRQE
PPSI
) + ( p y
QPRE f] 1(tNPNQN
^V tX~PR! p y
__I
)
_
PEQE PXQXE
+
FE N N
) + (
+ ( P-QE. p y
y)
+ [w - WI [
QG N N
(-p -y-)
p GxQ
_
+
GMS
PMQM
PMQSIW-P
+ ( x x
y
X_X
AA +
PSI
PxQ
~~PxQ
txPxQM
NP 5-f] [r(
-pxl
XX
t(
L AOAPS + p y
PE
PREPR X___)_ ( M MPRE
]
+1
1
_
1 AOLPRS
p y
QPSI NN
p1-
PXQSI
(PXqX )+
- 26
t P QM
(#J mm (OM) ] [(NH_)
+(
-
1] [(f(T.ply)) gR - [
-
n [
[QNRE-
QF y
][(NNy
-(
+ ('
- nn p
- n] [( PE y -
P Y
n]
(QS
C(
-i](
y (V)+ CQ P Y )QS ) )((XX
-
pS
S
-n SB (
Qi
-
n)
R
MH
1(xQx
P I(Y )S-
( yCPS n]
-
LS ~
1) ]- P
(VLS
[
P Y
P1 QGG 1
~~P yQ
)1
^5p
p QPSI
+ IQQ-
-n]
G
)]
i(
PSI +(PSI
-
MQPE
G +(
n]
REPR
P PE
- i
)
qpRE_n
~
n] 1(
PY
)-
][(p
[Q -] E
p y
-PRE~
PSI mHH
-a
tPQ
+[^PRE _
+
(1
-
PGQ (-VHH
pMQPE HH )
PSi + (^PSI
-
n]
PMQ~H
+
+
27 -
-
+
^P(SI~ SQN n]
+ SB _
-
1-t
( ]
pQS )py
)
]t(SB
('r
^][(f
p y
+
Y. W) )ar,
- t SCPRB >] [SC 1 SP j1[ESCPREJ ( [pir ( R)_ ][ (ESCPREJ-r ] 1 [tSCPRB A]
ta] [(p
)J+
y
[t (
PRE -
E C PY
A r3
+
(r OL + r)
(
ACOA ( +
[pOAPS y-]
+A Cr+*^ ++1) r )
[ p
ESCPREJ pyY
p
) +
p
-
E DENI +
P Y
~~~PRSPS ( P)Y--I +
+
(
P y,
(rOL + J)
Y)
A [POAPS Y ] (rOA + 1) +
A IE PDEN Y
-(
p+
BPRS
+[ p L
PSI
P.
)
(Q ~
(
(Y] Y
BPRE
SCPRB) p Y
p Y
+ P£+
-I
~~s] y ]
f(,r,Y,r))
+
( (v - Jr)
r
*
1
*
]
+s
Cry +
pjPQQJPEQ p Y
r Br+1r)+
-
BPRS
+
(rB
+
+
(rOA
+
i) (P -Y)
1 *)
)
+
(rOL +
28 -
~~OL PR I) t- -y)
OAPS -
(rOA + I)
(F Y)
(EDEN Y
This equationsummarizesthe decompositionof the public deficit according to its main macroeconomicand policy determinants.Eq. (25) distinguishesfirst between the operationaland the financialdeficit. Each of these is separated into the current-periodchange of the deficit (explained by its economic determinants)and its base-year level. The current period change identifies line-by-linethe determiningvariable (in the first square bracket) and the affected,base-periodbudgetaryitems (in the second square bracket). A summary of determinantsand affectedbudgetary variables is presented in Table 5, which follows the order of eq. (25). It separatesthe determinants by their effects on the operationaland the financial deficits. The major categoriesof determinantsare changes in relativeprices, domestic inflation, sectorand aggregatedomesticgrowth,and changesin public policyvariables (all of them affectingthe operationaldevicit);and changesin nominal interestrates and debt/outputratios (which impact on the financialdeficit). A simple rearrangementof determinants,slightlymore relevantfor policymaking purposes,enables to distinguishbetweenthreemain sets of determinants: Foreign variable shocks, domestic macroeconomicand sector variable shocks (exogenousto policy makers), and changes in public policy variables (under control of policy authorities). This rearrangementwould allow, for instance, to add the effects of inflation on tax revenue and on public debt interest payments,by separatingeffects 18 and 19 in Table 5 into the real interestrate
- 29 -
and inflationrate effects on public interestpayments. The decompositionof the deficit summarizedby eq. (25) is performed on a cash base inasmuchas it does not incorporatecapital gains. An alternative principle is accruals base. The latter incorporates,among other differences between accruals and cash flows, capital gains and losses due to changes in prices of assets and liabilities. Appendix 3 presentsa decompositionof the net public debt/outputratio, which differsfrom the cash-flowdecompositionof eq. (25) by consideringcapital gains and lossesdue to domesticinflationand nominalexchangerate devaluation. This form of presentingthe deficit,which reflectsthe change in the net wealth position of the consolidated public sector, is particularly useful when addressingsolvencyquestions as done, for instance,by Buiter (1988).
-
30 -
TABLE 5 DECOMPOSITION OF THE PUBLIC DEFICIT ACCORDING TO ITS ECONOMIC DETERMINANTS EFFECT t
ECONOMICAND POLICY DETERMINANTSVARIABLE
AFFECTED BUDGETARYVARIABLES
A. DECOMPOSITIONOF THE OPERATIONALDEFICIT Changes
in Relative
Prices
A Terms of trade
1.
1.1
A+ Relative Export Prices (P*x-f*)
1.1 Revenue
from
direct
taxes,
enterprises, purchases capital goods. 1.2 A+ Relative Import Prices (p*H-l*)
(7)
1.2 See 1.1
2.
Real Devaluation
3.
A+ Real Wages (W - 3)
3. Wage Bill
4.
A+ Relative Prices of Non-tradables (PN-')
4. See 1.1
2. See 1.1
revenues of
of
public
consumption
and
- 31
A+ Relative ^ 5.
5.
-
. . of Public Services Prices
5.
of public revenues direct taxes, from expenditure Revenue services. on public enterprises,
(PS-f)
Changes in Competitiveness
6.
6.1 See 1.1 6.1
A+ in Deviation factor of export prices (#X) 6.2 See 1.1
6.2 A+ in Deviation factor of import prices (#) Domestic Inflation 7. Revenue from direct taxes 7.
Inflation Rate (C)
Growth 8.
Relative sector growth (in relation to GDP growth)
'PRE '~PRE APRE n, QH - n, Q N - n,
8.1 Private Sector (QX
8.1 Revenue from indirect taxes
APRE
QS n)
8.2 Public Sector
APE
- n,
-q
APE
QS
n)
APE
APE
- n, QN - n,
8.2 Revenue of public enterprises
- 32
9.
-
GDP growth (n)
9. Wage bill, transfers,social securitybenefits, direct taxes, contributionof the private sectors to social security
Changes in Public Policies 10.
A Public employment(LSL)
10. Wage bill
11.
A Real currentexpenditureon goodsrelative
11. Total current expenditure
to GDP growth A^G
QX- n,
12.
a
AG
AG
QN-
-
AG
n, QG
n)
Real currentexpenditureon capitalgoods relativeto GDP growth
^IPS ^IPS ^IPS ^IPS (QXPS - n, Q - n, Q - n, QS
13.
12. Total expenditureon capitalgoods
n
real expenditure on transfers (V-X)
13. Total transfers
+
14.
A real expenditureon social security A
benefits(SB-f)
1
S
14. Social Security benefits
15.
A direct tax rates (AT)
15. Revenue from direct taxes
16.
Ah real contributionsof the privatesector
16. Social SecurityContributions
to social security A
(SCPRB-f,
A
ESCRPEJ-fr)
- 33
a +Indirect
17.
-
tax rates (txt tm, tN)
17. Revenue from indirect taxes
B. DECOMPOSITION OF THE FINANCIAL DEFICIT Changes in Nominal Interest Rates 18.
A Domestic nominal interest rates
18. Net domestic public debt
19.
+ Foreign nomirnl interest rates
19. Net foreign public debt
Changes in the Public Debt/Output Ratio 20.
A Domestic debt/output ratio
20. Domestic debt interest payments
21.
a
21. Net foreign public debt interest payments
Net foreign debt/output ratio
- 34
-
IV. FINAL REMARKS
This paper has developedan analyticalframeworkfor quantifyingthe impact oi the most importanteconomicand policy variableson the public deficit. The model was derivedfrom combiningthe consolidatedpublic sectorbudget constraint (takinginto account the relevantfinancialand non-finacialpublic subsectors) with a number of behavioralequationsand identitiesfor some key macroeconomic variables. It seems to be particularlyuseful for measuring, simulating,or projecting the effects of changes in the main foreign and domestic economic variables,and policy variableson the public deficit. However,lack of detailed informationon the budget structurecould force to simplifythe methodology,as done for instance by Schmidt-Hebbeland Webb (1989) in their application to Colombia and Venezuela.
- 35 -
REFERENCES Buiter, W. (1983): "Measurement of the Public Sector Deficit and its Implicationsfor Policy Evaluationand Design",IMF Staff Papers,vol. 30. (1985): "A Guide to Public Sector Debt and Deficits",EconomicPolicy, November. (1988): 'Some Thoughtson the Role of Fiscal Policy in Stabilization and StructuralAdjustmentin DevelopingCountriee", World Bank. Easterly,W. E., C. A. Rodriguezand K. Schmidt-Hebbel(1989): Research Proposal: The Macroeconomics of the Public Sector Deficit. Manuscript,World Bank. Easterly,W. E. (1969): A ConsistencyFrameworkfor MacroeconomicAnalysis. PPR Working Paper No. 234, The World Bank. Holsen, J. (1989): An Illustrationof RMSM-X (RevisedMinimum Standard M-Extended). Manuscript,The World Bank. InternationalMonetary Fund: Public Finance StatisticsYearbook. Khadr, A. and K Schmidt-Hebbel(1989a): A Methodologyfor Macroeconomic Consistency in Current and Constant Prices. PPR Working Paper, forthcoming,The World Bank. Khadr, A. and K. Schmidt-Hebbel(1989): A MacroeconomicConsistencyFramework for Zimbabwe.PPR Working Paper, forthcoming,The World Bank. Marshall,J. and Schmidt-Hebbel(1989): Un Marco Analitico - Contablepara la Evaluacionde la PoliticaFiscal en AmericaLatina, Serie PoliticaFiscal No. 1, ECLAC, Santiago. Oliveira,J. C. (1985): "Deficitsdos Or,amentosPiblicosno Brasil: Conceitos e Problemasde Mensuragao",manuscripto,Brasilia. Schmidt-Hebbel, K. and S. B. Webb with G. Corsetti (1989): "Policy
Chap. 6 in World Bank: manuscript.
and Saving",
Second Report on Adjustment Lending,
Tanzi, V., M. I. Blejer and M. 0. Teijeiro (1987): "Inflation and the Measurementof Fiscal Deficits",IMF Staff Papers, Vol. 34, No. 4. Werneck, R. L. F. (1987): Um Modelo de Simula,ao para a Andlise do Financiamentodo Setor P4blico",Texto Para DiscussaoNo. 175, Department of Economics PUC, Rio de Janeiro. World Bank (1988): World DevelopmentReport 1988. Oxford UniversityPress.
- 36 -
APPENDIX 1: DEFINITIONSAND IDENTITIES
1. DEFINITIONSOF PUBLIC SECTOR ASSETS AND LIABILITIES Public Sector DomesticLiabilities (in domesticcurrency) B: DCG: CU: RES: ACB: DCPFI: DPFI: APFI: DCPEj: LPEJ: APEJ:
Bonds issued by the generalgovernment Domestic credit (from the central bank) to the general government Currency (bills and coins issued by the central bank) Reservesof the commercialbanks held by the central bank Equity value (stock)of the central bank Domestic credit (from the central bank to public financial institutions Deposits in public financialinstitutions Equity value (stock)of public financialinstitutions Domestic credit (from the central bank) to public enterprisesof sector j Commercialbank loans to public enterprises Equity value (stock)of public enterprisesof sector j
Public Sector Foreign Liabilities(in foreigncurrency) LG LCB . LPFI s LPEj :
Foreign loans to Foreign loans to Foreign loans to Foreign loans to
the general government the central bank public financialinstitutions public enterprisesof sector j
Public Sector DomesticAssets (in nationalcurrency) KG: KCB: KPFI: KPEi:
Real Real Real Real
capital of capital of capital of capital of
the general government the central bank public financialinstitutions private enterprisesof sector j
Public Sector Foreign Assets (in foreigncurrency) R :
Internationalreservesof the central bank
- 37
-
2. DEFINITIONSOF PRIVATE SECTOR ASSETS AND LIABILITIES Private Sector DomesticLiabilities LC: DCPRBs DPRB: APRB: DCPREj: LPREJ: APREj:
Commercialbank loans to consumers Domesticcredit (from the central bank) to private banks Deposits in private banks Equity value (stock)of the private banks Domestic credit (from the central bank) to private enterprisesof sector j Loans from private banks to private enterprisesof sector j Equity value (stock)of private enterprisesof sector j
Private Sector Foreign Liabilities LC*: LPRB : LPREJ*:
Loreign loans to consumers Foreign loans to private banks Foreign loans to private enterprisesof sector J.
Private Sector DomesticAssets KPRB: KPREJ:
Real capital of private banks Real capital of private enterprisesof sector j
3. ADDITIONALDEFINITIONSAND IDENTITIES H: NWG: NWC: E:
Monetary base Net wealth of the general government Net wealth of consumers Nominal exchange rate (units of domestic currency per unit of foreign currency) With regard to the symbolsused for assets and liabilities,base letters
denote the liabilityand the sectorwhich issued it, while superscriptsdenote the sector which holds the correspondingfinancial liability or owns the correspondingreal capitalstock. Thereforethe followingadding-uprestrictions hold for each liability: B
BCB +
B PFI +
BPEi + CUC + CUPRB + fBPREj
J
- 38 _
RES
RESPFI + RESPRB
DPB E
DPBG + gDPBPEI + DPBC + gDPBPREJ
S
LPEJ LC
+ LPEjPRB
LCPFI + LPEjPRB
S
DPRBG + §DPRBPEJ + DPRBC + gDPRB
DPRB S LPREj
LPEjPI
E
LPREjPFl
+ L?REjPRB
4. DEFINITIONSOF OTHER VARIABLES Taxes and Subsidies Direct taxes Fiscal transfersto consumers Fiscal subsidiesto public enterprisesof sector j tax rate (net of subsidies)of sector j Net ind..rect Social vecuritycontribution(payments) Social securitybenefitspaid to consumers
TDIR: V: WPEJ: tj: SC: SB:
DistributedProfits UD:
Profits distributed by the central bank (UDCB), public financial institutions(UDPFI),public enterprisesof sector j, for J = X, M, N, S (UDPEj),private banks (UDPRB),and private enterprisesof sector j, for j = X, M, N, S (UDPREJ)
Emp yment LS
Employment in sector S, for S = G (generalgovernment),CB (central bank), PFI (public financial institution),PEj (publicenterprises of sector j), PRB (privatebarks), and PREj (privateenterprisesof sector j)
- 39 -
Prices,Wages and InterestRates P1: W~i is:
i*s
Unit price of the compositegood producedby sector j Unit wage Interestrate which correspondsto liabilityor asset S, for S - B (public bonds) DCG, DCPFI, DCPRB, DCPE, DCPRB (domestic dredit to various borrowers), R (internationalreserves),D (bank deposits), and L (ba.ik loans) Interestrate on foreign liabilitiesand assets
Productionand Demand
eSji
Volume of compositegood producedby sector J, enterpriseof sector S, for S - PE (publicenterprise).PRE (privateenterprise)
QlSj Volume of compositegood producedby sector J, demandedfor investment by sector S, for S = G, CB, PFI, PEj, PRB, PREj QCj: Volume of composite good produced by sector J, demanded for private consumption QGj: Volume of composite good produced by sector J, demanded for public consumption
-
40 -
APPENDIX2 ECONOMY-WIDE ACCOUNTING CONSISTENCY
This
appendix combines the public sector's flow budget constraintwith
those of the domestic private sector and the foreign sector, to provide an economy-wideframework of accountingconsistency. First the domesticprivate sector's budget constraint is introduced. Then the public and the national private sectors are consolidated in order to derive the foreign resource constraint, the balance of payments identity and the macroeconomicidentity between domestic savings and domestic investment. Economy-widefinancial and macroeconomicconsistencyis summarizedin a flow of funds table.
1.
Private Sector The domestic private sector is comprised by three subsectors: owners of
factorsof production(consumersor families),privatebanks (which include all non-publicowned financialinstitutions),and private firms. 15 Consumers own labor and equity of the two other private sub-sectors.
The source and use of funds identity for consumers - factor owners is the following:
(B.1) [LG + LCB + LPFI + ELPEj + LPRB + ELPREj ] + UDPRBc+ EUDPREj + i BB + + i
(DPFI + DPRB ] + V + SB + A [LC
+ TDIR+iL
LCPFI + LC
+ APRB + EAPEJ + ACB
] + E i LZ
+ APFI
+ LC
+
+ E LC ] U
B EP Q. +
+ BC + DPFIc + DPRBc +
+ EAPEjc]
15 No distinctionis made here between capitalistsand workers.
- 41 -
Factor income received by consumers corresponds to their ownership of labor, bank and private firm equity, and financial assets (bonds and bank deposits). Other sources of income are transfersand social securitybenefits receivedfrom the general government. People use their funds for consumptionexpenditure,direct tax payments, and servicingtheir domesticand foreigndebts. Direct taxes are assumed to be paid entirelyby consumersand not by enterprises. Net accumulationof assets (assetsminus liabilities)reflectsan increase or improvementin the consumers'net position,as definedby their balance sheet introducedin appendix 3. The budget constraint of private banks is similar to that of publi_ financialinstitutions(see eq. 3): (B.2)iRRES
PRB
+ iBB
PRB PRB PRB + LC ]+A + iL [ELPEj + ELPREj
PRB
~~~~PRB
*
. DPRB + E LPRB + APRB] E W L
+ i DPRB + E i
LPRB
DCPRB +
+ UDPRB +
IPRB + iDCPRBDCBRB+ + SCPRB + P.Q
A (CU
+ RES
+ B
+ ELPEP
+
+ ELPREjPRB+ LCPRB] identityfor the consolidatedprivate Finally,the use- and source-of-funds firms of sector j (j = X, M, N, S), which is very similarto eq. (4) for public enterprises,is given by: (B.3)
(1 - t ) P;
+ LPREjPFI
RE + B BJ
+ LPREjP
+ DPRBJJ
+ iD [DPREi
+ E LPREJ
+ APREJ]
E
W LP
] +
A [DCPREJ +
+ SCPREJ +
- 42 -
+
DCPREJ + iL[LPREj PFI + LPREj PRB] + E i
+ i
EPjQj
i J DCPRE L~~PRE + UDPREj + A (CUPREJ+ BPREJ + DPFI PRE+ profits
distributed
Substituting
DP
PREj
(UD) of private
enterprises (from equations (B.2) - (B.3))
into
LPREj* +
commercial
the consumers'
banks
and private
budget
constraint
(equation (B.1)), the followingbudget equation for the consolidatedprivate sector is obtained:
A [DCPRB + EDCPREj] + A (ELPRE;PB+ LCB] + A [DPRBG + EDPR?Ej
(B.4)
a
PRB + EBPREj +
A (ACBC+ APFIC + EAPE.]
BC
-
J (CUPRB +ECUPREj
+ CUC + RESPRB
PRB
***C
A (ELPE. J + E
-
(LC + LPRB
+ SCPRB + E SCPRE. + E tjP QPRE_
J
-
EDPFI REj + DPFIC
+ ELPRE.]
E P.Q. + TDIR +
E
W [LG + LCB + LPFI
E PE;
ii i
- SB - EP QPRE + EP. [QIPRB + E Q IPREjI + [iDCPRBDCPRB +
i J
i~~
CR
J
+ EDO? i ~~PFI G + + iDCPRE EDCPREj] + iL (ELPRE. + LCPFI ] + iD (DPRB *
+ EDPRB -L
j
-
i(B
.
PRB + EBPREj + BC
ELPE RB] + E i
i
(E DPFIDPREj + DPFI ]
-
[LC* + LPRB* + ELPRE*]
The consolidateddeficit of the private sector can be financed by selling private liabilitiesto the public sector,sellingpublic liabilitiesback to the public sector,purchasingless equity from the public sector or selling private liabilitiesto the foreign sector. Obviously,portfolio changes related to public liabilitieshave thbirexact counterpart,with oppositesign, in equation
43 -
-
(5) (the consolidatedpublic sector). It is likewisewith expenditure and income flows that involve transactionsbetween the private and public sectors, as reflected in the right hand sides of equations (5) and (B.4).
2. Foreign Constraint Now we can consolidate the domestic private and public sectors. Combining equations (B.4) and (5), the identitybetween the country'suses and sourcesof funds is obtained: E A (ACB + APFI
(B.5)
*
*
*
*
+ EAPE. + L
*
-
R ]
ICB + Q IPB + EQIPEj + EQIPREj + Q. +EP
Ei
T
(UDPRB
+ E UDPRE* + L
~~~~C IF EP.Q. + E P.[Q. +
E
QG
(
QPE Q
QPRE + E. Q
-R]
This is obviously the foreign sector budget constraint or the balance of payments identity. L* is total foreigndebt defined as: *
*
(B.6) L
LG
*
*
+ LCB + LPFI
*
*
+ ELPE. + LC
*
+ LPRB
*
+ ELPRE*
The fact that (B.5) is the balance of payments identityis more transparent when replacing the aggregate demand components (private consumption, gross domesticinvestment)by its commonlyknown symbols (C, I, and G) and output by GDP, and rearranging (B.5) in terms of foreign reserve accumulationas the dependentvariable:
(B.7)
E A R + EAL
E
+ E
GDP - (C + I + G) + E [UDPRB + EUDPRE.1 + E i
A [ACB + APFI
+ EAPEJ
(L
- R ]+
- 44
-
which defines internationalreserve accumulationas the excess of GDP over domesticabsorption (the trade balance)plus the sum of the financial service balance and the capital account balance.
3. Macroeconomicand FinancialConsolidation The fact that the excess of GDP over absorptionis equal to net exports of goods and non-factor services is seen more clearly when substituting into equation (B.7) the following equilibriumconditions for the markets of nontradablegoods and public services,respectively: (B.8)PN QPE (B.8) N
N
PRE =
PE (B.9) P
N QCN
C
Q
=
Q
=
N
Qx-
~X
QI N
N
QGN
G +
P Q
Hence obtaining: PE +
(B.lO)E &R* I - QM -
RE _
+~
-
Ic XE G
G*
*
QM] + E [UDPRB + E UDPRE]
+ E A(ACB
+ APFI
+ E i
RE
+ PM *
(L
+
C -
QM
** -
R] + E
L
+
+ EAPE3]
Finally, let's put all the pieces together to derive financial and macroeconomic consolidation for the entire economy.
This is done by
representingbudget restrictionsof all sectors (equations(1). (2), (3), (4), (B.1), (B.2), (B.3), and (B.10))in flow of funds Table B.1. Its first line representsthe differencebetweeneach domesticsector'sinvestmentand savings (the latter summarizingall current account transactions),which is equal to foreign savingsor minus the current account surplus (CAS):
-
(B.11)
+ PB
+ Es PEj + sc+
45
-
+ j1FI + E1PEJ + IPRB +
SP
+ EsP]
+ [G - T] _
I _ (Sr + SB -?REJ
+ S?FI +
- CAS
Each sector'sexcess of investmentover saving goes into net financialasset accumulation. These compriseall capital account transactions(other than real capital accumulation),and are listed in line II of table B.1. Mutual consistency of financialasset transactionsis explicitly reflected by having asset flow demands equaled to flow supplies. Ove,-allmacroeconomic and financialconsistencyis ensuredby having the sum of the domesticsectors' 16 budget constraintequal to the balance of payments.
16 Note that the signs of the variablesin lines I and II and columns A-C of Table B.1 are defined such that the sums in each line and column are equal to zero.
46
-
Table 8.1
le1f-Wl Public
A.
a
1.
Savinpa-Inv.atment
II. Financial
p
Attet
Adjustment
3.
Depoita
in Public
4.
Deposits
in Private Banks
Lost,
-
SC
6aCU
2.
6.
S.
Central Bank ICB -
SCB
PFI
PE
Public Fin. Inatit.
Public Enterprisem
IPFI - 5PFI
Financial
Credit
from Central
from Public
Financial
Instit.
-aCU
aCtPFI
-&RES
&RESPFI
*DPFIC
awPFI
hDPRB Bank
ADCC
hoC
Inatit.
DCPRI ?LPFI
7. Loans from Private ankas
S. Public Bonds 9.
Public
Sector
(IPEJi - SPEj)
P-;,ate
C
Sector
C.
PRB
PRE
Private Baks
Pr;'ato
-SC
IPR-
E(IPREj - SPREj)
aCUC
&CUPRM
Consumers
- SPRB
Equity
-68
ABCs
LACS
-Ace
IUPFI
6gPFI
l CUFEj
CAS
ECPFIPEJ
WDPFIC
EPRUPEj
kOPRoC
-EADCPEj
E^pPFIPREj -hDPR8C
EhDfRSREj
-&DCPRB
-EADCPREj
-ELjpEjPFI
_6LCPFWI
-ELPEjPRB
-_lLCPR
aLPRB
_rAPREjPRB
EgPE
68 C
a
AEPRS
E8PRE
6APRB
-&APRB
-LPREj
-ELC Reserves
PFI
-L&APEj
£MAPREj Loons
cjPREj
ARESMO
10. Private Sector
12. International
Enterprises
-AAPFI
EAMj
11. Foreign
Eaternal
Accumulation:
1. Currency
5. Dometic
Sector
C8
Ceneral Oovernment
E FLOWOF RN16 TABLE
-EILPFIe * EAR"
-EtLPFI*
-EiLPEje*
-EhLCe
-EAPREj -ELP R
EkLe -EMO
Sector
-
APPENDIX 3:
47 -
0 BALANCE SHEETS OF PUBLIC AND PRIVATE SECTOQ S
Table C.1 BALANCE SHEETS OF THE PUBLIC SECTOR (In domestic currency)
General Government Assets
Liabilities
Central Bank Assets
Liabilities
CUG
B
B CB
CU
DPFIG
DCG
DCG
RES
DPRBG
E LG
DCPFI
ACB
NWG
DCPRB
APFI
2DCPEj I
fAPE
fDCPREj
KF
E R
Public Financial Institutions Assets
Liabilities
H
H
KCB
LCB ACB
Public Enterprises of Sector j Assets
Liabilities
CuPFI
DCPFI
CUPEj
DCPEj
RESPFI
DPFI
BPFI
E LPFI
BPEj DPFI PEj
LPEjPFI LPEj PRB
fLPEjPFI
APFI
DPRBPEj
E LPEj
fLPREj PFI i LiPFI K FI
KPEj
APEj
- 48 -
Table C.2 BALANCE SHEETS OF THE PRIVATE SECTOR (In domesticcurrency)
Consumers Assets
Private Banks
Liabilities
Assets
Liabilities
CUC
LCPFI
CUPRB
DCPRB
BC
LCPRB
RESPRB
DPRB
DPFIC
E LC
BPRB
E LPRB
ILPEJ PRB
APRB
NWC
APRB
fAPREJ
|
iLPREJ LCPRB
Private Enterprisesof Sector j Assets
Liabilities
cuPREJ
DCPREj
B PREj
LPREJ PFI
DPFIPREJ
LPREJPRB
DPRBPREj
E LPREj
KPREJ
APREj
_ 49 APPENDIX 4
ECONOMICAND POLICY DETERMINANTSOF THE PUBLIC DEBT OUTPUT RATIO
This appendix derives a decomposition of the public sector deficit consistentwith accrualsbase. This impliesconsideringcapitalgains and losses on public sectors asset and liabilityholdings. Hence the cash-flow deficit measure of eq. (25) in section III is substitutedby the change in real net liabilitiesof the public sector (as a fractionof GDP), reflectingchanges in net wealth poistions of the consolidatedpublic sector. As in Buiter (1988), no differenceis made between average and end-of-periodvaluationof assets and liabilitiesin what follows. (For a detailedcompatibilization of cash flow and balance sheet accounts which distinguishesbetween average and end-of-period price levels and exchange rates see Khadr and Schmidt-Hebbel(1989a,b)). The differencebetween the procedure followedhere and eq. (25) is that the change in nominal asset (or liability)holdingsdividedby nominal GDP (the left-hand side of eq. (25)) is rewrittenas the change in the corresponding asset (or liability)-outputratio, plus the capital losses (or gains) from domestic inflation and nominal exchange rate devaluation,plus the change in the ratio due to real GDP growth. For instance,the changes in nominal public bonds and net external debt, each divided by nominal GDP, are written as:17
(D.1)
_____
PRS
=ThbPRs + b(cr+ n)
17 The productsof the correspondingrates are assumed to be zero.
- 50 _ (D.2)
ADEN - Aden + den(i
E
-
6 + n)
where bPRS - BPRS/(pY) and den - (E DEN)/(PY)are the liability-outputratios. Consistentwith balance sheet or accualsbase, rewrite the public deficit as the change in net liability-output ratios,which implieshaving on the righthand side the correspondingcapital gains and losses, ratio changes due to growth, and interest payments. For all terms involvirg bPRS and den, this implies the followingexpression:
+ ...
(D.3) Ab
PRS
b- - (
+ Aden + n) + (r + r)b
PRS ...
*PRS
...
+ [(]den + (r - n][bt
-+ den(r - e + n) +(r
+ den] +
[
+ J )*den+
* PRS - r ][b ] +
Substitutingthe remaining three sources (other than MAC and AA*) of financingon the left-handside of eq. (25) by expressionssimilar to (D.1) and (D.2), and rearrangingas in (D.3), obtain the followingdecompositionof the increasein the net public debt/outputratioaccordingto its economicand policy determinants:
(D.4)
Ab
+ Ah + Aol PRS_ Aoaps + Aden
-
*
*
PX
txPxQx p ~y
tH-HM M H PR [PM P r][ )+
+
=-1
AAC_
E
xQx
PxQx
py
p y )-
-
-
(
-
__XQ__
HM GMMQH
PMQH
(-P-Y-)
A
P
p y
IPS )]
+
A d SbSdS
[u
]
[u
Ai [)
-
sb]
Mb]-
-
A d )
H
-
A d
[
+
( AaA.d)_
A Sdld
0
d bxd XXX b
SdI ^
"]
AdAd A+-
x bxd
+ +
[AAd) Xbx bd
ea
dXb
SdI
(..LL) Ad
)
-
~LL)
(d. U( +
-
d
0
-
,d A
) + (
Ad
Alb
-
3
j]
) bXa
d
a R R
)RA
bd b dI
[(] +
)] [l]
+ n
A a NdS, XXX
-
A d
+ (-
dA
Ad~Ad
dR
v
)ad
d] + [ Ns)
dx' b bSd
d3E1d____
A -p TSd
_
d
bd
lA_A_
[u
)]
+
nd
(A
+ [(
z4
T_I)-
Sd
bd
XW bX¢X Nc
ba%
A d+
Ad
Nb
-
Nb NI
[]
52 -
-
PEpQXPA
I1X
n] j( XpXy)l
~
PE
PE
yM)
(~FEPP
[QNE * n
N-)
PE
( n 3 lh + ( W L )
-
MI
I
_
I[QP -n
(1I , P,Y
_- n]
V
+
WLY
A-
ESCPRE
SCPRB
SB )
+
Y)+S-
S
I(
GPQ+
+
G ;p
+
) (ay
-
1)] +
(L
P QG -G G (QGnn] I( pHM~ y )] ++ 1QN
]
((
G
-
n]
PIA[G
1( p y )
QS
]
QG PP5 Y
XpS IPS +(IPS
Qi
-
n]
(-
xQ
NyN
~
A
] +
ip
nf 1
V
^IPS n]
N
+
P14QHI 4
P(Y
v~'P IK
p y
+
IV
-
Wir
+
~~~~~f cr,IY, SB p + [SB - r] [(p y )] - (AT] [(
w) ar,
~~SCPRB r] [( p , )] -
[(
A
A
-
[SCPRB -
- [ t yMPMQMRE PRE At
txxQxAA
)
]
-
AECPSREIJ-
E[SCPREj T f]
P
t t
)
QPRE NN N
+
-
SI
te
tfer ,rI,
+£ + Jr
py.
- rI ol
y
p y )+ E t L
)1 +
SCPRB)
+
(01Pro P[l
-
_
-
-
ECPSREJ,
l
X
)
p
+ t V.)
QPEt
q
)
£tj
(
p
-
PE
+
PRS + olPRS- oaps + den] + [rB- r ] [b '
- rI ~~~~oaps
(oaps)
The main differencesbetweenequations (35) (basedon cashflows)and (D.4) (based on accruals)are: (i)
Equation (D.4) refers to the ratio between tha public debt stc-k and
output. Thereforeit adds to eq. (25) all variationsin the total debt/output ratio due to domesticinflation,output growth and, in the case of foreigndebt, nominal devaluations. (ii) In equation (25) the financialdeficit is separated into the base period deficitand its currentperiod increase. Here, however,the currentperiod level of the financialdeficit is maintained,althoughinterestpayments are divided into real interestrate and inflationcomponents. (iii) Therefore,equation (D.4) modifiesequation (25) accordingto the impact of the followingvariables on the ratio between total public debt and output: - real devaluation(which increasesden), - domestic inflation (which reducesh), - domestic growth (which reducesh),
-
54 -
- the differencebetween the real foreigninterestrate and domesticgrowth (which increasestotal public debt, net of monetary base), and - the differencebetween the real domesticand foreign interest rates (which increasesthe domesticpublic debt net of monetary base).
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