Gabriel Di Bella IMF Resident Representative February 2016

 Today’s Discussion: A flow-stock consistent model with an application to a country similar to Russia.  Next Week’s Discussion: The international context and outlook, with some methodological considerations.

 Balance Sheet Approach. It ensures that stock and flows match across sectors.  Never Forget the Budget Constraint. It must hold for each sector at all times.  Market Clearing. If Demand is different than Supply, then prices, quantities, or both, should change so equilibrium is restored.  “Walras Law”. At a Macroeconomic Level, excess supply (ES) in some markets must match the excess demand (ED) in some other, so aggregate disequlibria is zero.

 Budget Constraint Income (I)+ Var. Debt (  L)= Expenditure (E)+ Var. Assets (  A)  Excess Demand (ED) ED = Demand > Supply (so if ED 0)  “Walras Law” Sum of ED across all markets in the economy =0

 Economic Sectors: 1. Government 2. Central Bank 3. Commercial Banks 4. Oil/Gas Producers 5. Non-Tradable Producers (Services) 6. Households 7. Rest of the World  A significant share of fiscal revenues and exports is linked to oil  Price stickiness in non-tradable goods market.  Floating Exchange Rate but with some intervention

 Shock. Oil Prices decrease by 50 percent.  Task. Using “Tool-Box” analyze the main effects of this shock on an oil exporter (many familiar elements with situation in Russia).

Each line in the matrix represents a market. The excess demand column adds demands (E) and supplies (I) across sectors. In the initial situation all markets clear (ED=0 for all markets). The budget constraint (I)+(  L)= (E)+(  A) holds for all sectors (Control Line). Flows for the External Sector (“Rest of the World”) represent the Balance of Payments.

Sectors’ Budget Constraints Walras Law

 “Accommodative” Fiscal Policy. The example will allow the fiscal deficit to increase following the shock.  Monetary and Exchange Rate Policies. The example will assume that the exchange rate is allowed to depreciate, but with some international reserves sold in the market to attenuate the ER depreciation.

 Foreign Exchange Market – ED. Given the floating ER system, the ER will depreciate.  Non-Tradable goods Market – ES. Assuming price stickiness, results in decrease in production.  Credit Market – ED. It should result in an increase in interest rates.  Monetary Base – ES. By “Walras Law” if ED=0 in all other markets, then this market also.

 The Type/Size of Shocks Matter. They affect the magnitude and nature of disequilibria and how large the price/quantity response will be.  The Policy Reaction Matter. It can ease or make the adjustment worse. The “policy mix” can be discretionary or related to the “policy framework” (i.e., Floating vs. Fixed ER, Fiscal Rules).  Stocks and Flows must always balance ex-post. Analysis should focused on what quantities or prices will change so markets clear.