Part 3: “Hands-on”

IMMPA:

Integrated Macroeconomic Model

for Poverty Analysis

Workshop EAE 5918

IPE/USP – 2009

Alejandro Izquierdo and

Eduardo Haddad

l Government

è Sets tax rates on domestic sales, imports,

income and profits.

è Allocates public expenditure to current

consumption and investment (infrastructure,

health, education).

è Public spending has three types of effects.

4Conventional aggregate demand effects

(impact on consumption);

4 Effect on private investment (complementarity

between public investment in infrastructure and

private capital formation);

4Supply-side effect. Private production

(agriculture and urban formal sectors) depends

on the stock of government capital in

infrastructure and health.

è Deficit financing

4 Various options are possible.

4 Prototype: financing is given from “below the

line.”

4 Flow budget constraint determines lump-sum

transfers.

4 Implications: focus on the income effects of

induced changes in the budget;

4 No changes in distortionary taxes and

incentives.

Debt Relief: Savings allocated to

Transfers

• Immediate demand effects:

YHh Ch , Hh (money holdings)

• Effects on government: Reduction in confiscation risk:

IF * FL_G , TAXREV Z

• Effects on credit market:

Z DL_P PR IL

• Pk has not increased as fast lower net worth

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Effects on goods market:

• Agric. Traded:

IL effective wage for U-AT,

So U-AT X-AT

• Agric. Non-Traded:

U-AN (fall in product wage ) X-AN

• Short run though, fall in X-AN. Why? K-G (I-G, PQ-P)

• Private formal:

Z K-P MPS S

S MPU-P U-P (product wage )

Final result: X-P

Effects on goods market, ctd:

• Short-run, though, fall in X-P. Why?

• P_US> P_T2 w-s to keep effort levels S. Then, U-P

• Also, K-G short-run K-P

• Informal:

• Short run: U-P U-I X-I

• Long run: U-P (S) U -I X-I (but increases product wage and consumption wage)

• Exports: E-A (less output given higher labor costs), E-P (higher domestic consumption)

• Imports: M-A, M-P

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Migration:

• EwA<EwU MIGR

• This eventually puts upward pressure on

W-I/P_UU

Skills acquisition:

• EwS<EwU SKL

• UNEMP?

• Short-run: S-P UNEMP

• Long-run: S-P UNEMP (even with SKL)

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Financial Markets:

• Higher money holdings, including as share of total assets (transactions effect)

• Higher loan interest rates

• Increase in loans for higher investment financed with higher foreign bank loans (increase in deposits not sufficient, rem. DD/W)

• Increase in foreign exchange reserves (lower trade balance more than compensated by private banks capital inflows)

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Actual stock of loans is demand determined, and

banks borrow on world capital markets the required

“shortfall” given their domestic sources of funds.

Welfare:

• Per capita real consumption goes up (CPC-AN, CPC-AT, CPC-I, CPC-S, not CPC-UF)

• Consumption-based Poverty Headcount, short, medium and long-run

• Income-based Poverty Headcount, short and long-run

• Poverty gap decreases in short, medium and long run-run (for both consumption and income-based measures)

• Share (U-AN+U-I)/POP eventually falls (inc. in short run, “rough poverty measure”)

Debt Relief: Savings allocated to

Infrastructure

• Typical demand effects, but also supply-side effects:

K-I K-G MP of all factors in rural traded, rural non-traded and private formal sectors U-AT, U-P, S-P, Z

• Additional effect on investment via government: Reduction in confiscation risk:

IF * FL_G , TAXREV Z

• Effects on credit market:

Z DL_P PR IL (In short run. In long run, IL because higher K-P)

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PR

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DLNWPR pr

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PPcprpr

pr

PPPP FLERDLKPKNW

Effects on goods market:

• Agric. Traded:

IL, but negative effect of loan rate on effective

wages and output is offset by productivity gains

X-AT (whereas transfer case X-AT fell)

• Agric. Non-Traded:

MPU-AN X-AN

• Private formal:

Z K-P MPS S-P

S-P MPU-P U-P (product wage )

K-I K-G MPU-P, MPS-P,

MP_K-P U-P, S-P, Z

Final result: X-P (notice much higher values than

transfers case)

• Notice UNEMP (S) much lower than transfer case

• Informal:

U-P U-I X-I (but increases product

wage and consumption wage)

• Exports: both E-A, E-P (previously both

down). Why? See shift in transformation curve

• Imports: M-A, M-P . Why? See shift in

Armington function.

Migration:

• EwA<EwU MIGR

• This helps explain W-I/P_UU

Skills acquisition:

• EwS<EwU SKL

• UNEMP?

• S-P UNEMP (even with SKL, both short run and long run)

Financial markets:

• Higher money holdings, including as share of total assets (transactions effect)

• Higher loan interest rates initially, but lower in the long run. Why? Value of collateral increases as K-P increases

• Increase in loans for higher investment financed with higher foreign bank loans (increase in deposits not sufficient, remember DD/W)

• Increase in foreign exchange reserves exceeds that of transfers scenario (higher trade balance but almost the same private banks capital inflows)

Welfare:

• Notice transfers to households eventually larger

than under transfer scenario. Why? Higher tax

collection due to increased activity.

• Per capita real consumption goes up for some

sectors (CPC-AN, CPC-I, CPC-S, not CPC-UF,

CPC-AT). For growing CPC groups, long-run

effects are bigger than transfers case

• Consumption-based and Income-based Poverty

Headcount, especially in the long run. Long-run

measures outperform transfers case by a factor of 2

Welfare, continued:

• However, in the short run, transfers outperform

infrastructure investment! Importance of

dynamic model

• Consumption-based poverty gap decreases in short,

medium and long run

• Gini coefficients, though lower than in base, are

higher than transfers case. Makes sense, given not

all sectors are affected equally by infrastructure

increases

Policy Rankings

Total PovertyHeadcount

Infrastructure Education Transfers

Urban PovertyHeadcount

Education Infrastructure Transfers

Rural PovertyHeadcount

Infrastructure Education Transfers

- Infrastructure is PPF enhancing

- Education increases the supply of skilled labor but

there may be unemployment

- Has direct effects in urban areas

- Policy mix? Better than Education only

Why?

Concluding Remarks

A great variety of fiscal policy measures can be analyzed with IMMPA:

l 1. Revenue neutral income/sales tax reform (taxation of profits, labor income).

l 2. Tariff reform (neutral or not); link between trade liberalization and fiscal adjustment.

l 3. Adjustment in public sector wages and employment (lay-offs).

l 4. Changes in payroll taxation on unskilled labor.

l 5. Changes in the level or composition of lump-sum transfers (redistribution to low-income households).

l 6. Fiscal sustainability rules (e.g. IMMPA-Brazil,

link between interest rate premium on public bonds

and the stock of public debt). Endogenize either

government spending or tax rates.

l 7. Changes in the mix of public investment:

changes in the allocation of investment between

infrastructure, education, and health.

l 8. Changes in the price of public sector services.

l 9. Changes in the degree of congestion of public

services in the urban sector.

l Issue 7: key question in the context of a poverty

reduction strategy: what is the public “investment

mix” that has the greatest effect on poverty?

l Particularly important for low-income countries that

are benefiting from debt relief, but with the

understanding that the savings must be reallocated

to poverty reducing measures.

l IMMPA: a flexible tool that can be amended or

extended in various ways.

l Example: adverse effect of external debt

è High public external debt may also lead to private

capital flight.

è Debt reduction may not only stimulate private

investment but also private capital inflows.

è Endogenizing these flows would provide another

source of positive externalities.

Other types of adjustment policies that can be

analyzed with IMMPA:

l Monetary and financial policies

è Changes in domestic credit to government; study

of crowding-out effects.

è Financial liberalization (increase in bank deposit

rates).

è Private capital outflow.

è Change in world interest rates.

è Changes in reserve requirement rates.

è Nominal exchange rate devaluation.

è Monetary policy rules (inflation targeting).

l Labor market reforms.

è Changes in minimum wages.

è Switch to flexible wages in the formal sector.

è Incentives for skills acquisition.

è Changes in payroll taxation (both skilled and

unskilled labor).

è Unemployment insurance.

Country applications

l Country applications under way: Brazil, Cameroon,

Morocco, Senegal, Turkey.

l New countries: Benin, Bolivia, Côte d’Ivoire, Tunisia.

l Updates: IMMPA website, IMMPA Newsletter.

http://www.worldbank.org/immpa