A macro-econometric model for Lesotho

1. A macro-econometric model for Lesotho DIMMoL Workshop: Database management, modelling and forecasts Igor Lebrun Maseru, Lesotho 30 November 2007 http://www.plan.be

2. A refresher on macro-econometric models http://www.plan.be

3. What is a structural model? • Is a quantitative representation of the economy assembling a number of equations linking economic variables through causal relationships • All relationships between variables operate simultaneously • Synthesises data and knowledge through the use of economic theory and econometric techniques • With a view to explain economic history better and to forecast future developments Also referred to as a macro-econometric model

4. Characteristics of macro-econometric models • Is mainly created and maintained by governmental agencies, central banks and private forecasting institutions • Can be small or big, the number of equations mayvary form a handful to several thousands depending on sectoral detail and country coverage • Can be used for forecasting purposes (from short to long-run horizon) and scenario analysis (“what if”) • Scenario analysis looks at departure from a baseline caused by shocks (internal and external) or policies Although they share common features, different models can produce very different results!

5. Common features among structural models • Two types of variables: • Endogenous variables which are jointly determined by the system of equations (“the model”)  number of equations = number of endogenous variables • Exogenous variables which are considered as given (not derived by the model) • Three types of equations: • Behavioural equations: describe how economic agents behave • Accounting identities: stem for national account definitions • Technical relationships: relations which are neither behavioural nor identities

6. Diversity among structural models • Can vary widely in scale: trade-off between detail and transparency • Endogenisation versus exogenous assumption for some variables • Behavioural equations can have very different specifications • Priority to goodness-of-fit (empirical robustness) or to theoretical consistency (micro-foundations) • Modelling supply constraints or not (depending on horizon)  existence or not of long-term properties • Modelling expectations: backward or forward-looking

7. Building a structural model Four stages: • Design: writing up of the model in the form of a set of equations specifying the relationship between variables based on theoretical priors and distinction between endogenous and exogenous variables • Set up of a data base consistent with the written model • Estimation of the parameters appearing in the equations (through econometric techniques or calibration) • Testing the validity of the model through ex post and ex ante simulations and scenario analysis In practise these four stages are interdependent and require going back and forth.

8. Building blocks in a macroeconomic model • Real-side block: determines household spending, firm’s factor demand and foreign trade with public expenditure being exogenous; value added per industry if supply side modelled • Price block: determines wages formation and price setting • Income bloc: links agents’ incomes to the macroeconomic aggregates  need for technical relationships to compute secondary distribution of income, uses and the capital account of institutional sectors • Financial and monetary block: equations to determine interest rates, money supply, exchange rates and asset prices

9. The modelling strategy for the Lesotho case“Thinking in progress”  meaning open to discussion What follows draws largely on background papers produced by NUL http://www.plan.be

10. Why will be the model used for? The primary objectives of the macro-model in this project: • To dispose of a forecasting tool to be used in the budgetary process • To iterate with the MTFF spreadsheets in order to generate consistent medium-term macroeconomic and budgetary projections • To develop alternative scenarios based on different sets of assumptions (“conditional forecasts”) • To be used complementarily with the Financial programming

11. Starting point: what is driving the Lesotho economy? The economy in Lesotho has been driven by very specific - mainly supply-side - factors: • LHWP • Decrease in remittances from mine workers • Export of textiles and clothing under the MFA and AGOA • Opening of diamond mines • SACU revenue windfalls

12. Which conclusions to draw from a modelling perspective? • The previously quoted factors are impossible to model within the context of a macro-econometric model • The Lesotho economy clearly depart from the traditional view that aggregate demand is the main determinant of growth in the short-run  difficult (impossible?) to disentangle the cycle from the trend  difficult to construct a relevant indicator for Lesotho’s export markets • difficult to estimate a standard aggregate export equation • To make forecasts is also telling a ‘credible story’ and this implies for Lesotho to come up with forecasts per industry (see background paper to the budget)

13. The exogenous variables for the real block The proposed strategy consists of considering the following items as exogenous variables for the macro model: • Exports of goods and services • Net primary income receivable from the rest of the world • SACU revenues and to rely on: • The Financial Programming exercises to forecast future values of exports and remittances • The MTFF for the forecasts of the SACU revenues paid out to the Lesotho government

14. Implications: “Implicit international environment” Comments: • Price-competitiveness effects due to movements in the exchange rate rand/$ have to be taken into account when making assumptions on exports in manufactured goods • Assumptions on trading arrangements • Forecasts for the SACU revenues should be consisted with macroeconomic scenario for the SACU region  This means that indirectly the scenario would entail assumptions on the evolution of the South African and world economy

15. The structure of the real block Net primary income Net current transfers Exports

16. Value added by industry Domestic expenditure The structure of the real block Net primary income Net current transfers Exports

17. Value added by industry Domestic expenditure GDP Imports The structure of the real block Net primary income Net current transfers Exports

18. Value added by industry Domestic expenditure GDP Imports GNI GNDI The structure of the real block Net primary income Net current transfers Exports

19. Value added by industry GDP GNI GNDI Domestic expenditure Imports Households’ disp. income The structure of the real block Net primary income Net current transfers Exports Fiscal Policy

20. Value added by industry GDP GNI GNDI Domestic expenditure Imports Households’ disp. income The structure of the real block Net primary income Net current transfers Exports Fiscal Policy

21. Growth domestic product by activity

22. Computation of GDP in constant prices Primary industry = A + B Secondary industry = MT + MO + E + C Tertiary industry = SP + SG Private sector T = A + B + MT + MO + E + C + SP Total TT= T + G • QVOTT = sum (QVOi) + FSIMO • YO = QVOTT + TXO How to compute TXO (implicit tax rate or MTFF?) and FSIMO remains to be determined

23. Expenditure on the Growth domestic product

24. Computation of GNI and GNDI In current prices: • QVUTT = sum (QVOi*PQVi) + (FSIMO*PFSIM) • YU = QVUTT + (TXO*PTX) • YNU = YU + YXMU • YDNU = YNU + TRXMU In real terms (specific NA definition): • YIO = YO + TTO • YNO = YIO + (YXMU/PYXM) • YDNO = YNO + (TRXMU/PTRXM)

25. Remaining issues (1):Modelling prices • Constructing GDP deflator through production or expenditure side? • If deflators for both value added and expenditure components are modelled then one deflator should be computed as residual • How to model these deflators? • Exporting industries might be considered price-taker (effect of exchange rate movements on export prices in loti) • Industries related to non-traded goods might be influenced by internal factors (like wage costs) but also prices in South Africa • How to determine CPI in a model-consistent way?  Influenced solely by CPI in South Africa or also internal factors (link with monetary policy?)

26. Remaining issues (2):Interaction between real block and fiscal policy • How to construct households’ disposable income? • Need for primary and secondary distribution of income • Compensation of employees traditionally modelled as the product of average wage rate and employment Clearly problems of data availability! • What level of disaggregation for government? • How to model direct and indirect taxes? • How to iterate with MTFF spreadsheets (through DIWAX)?

27. Remaining issues (3):Role of Monetary block • According to “impossible trilogy” no independent monetary policy in Lesotho, so need to model monetary policy or can interest rates be considered exogenous? • Which role for interest rates? • In real block: influence on private consumption and/or investment? • In income block: influence on capital income? • Need to model the account of financial sector? • Model money demand? • Influence on price level?

28. Data requirements Obviously we need the revised national accounts’ series! On top of this prerequisite: • Expenditure side: • Breakdown of exports according to broad categories • Breakdown of gross fixed capital formation according to the institutional sectorsand/or between (residential) building and equipment • Incomeside: • Primary and secondary distribution of income: to be able of constructing the income account of households All required data should be put together in a format suitable for importing in Eviews

29. The model building process:What next? Igor Lebrun Maseru, Lesotho 12 December 2007 http://www.plan.be

30. What are the prerequisites? • Revised annual national accounts series completed: • Detail of the expenditure side compatible with proposed specifications? • Income side: what will be available? • Completion of annual series prerequisite for further model activities • Set up of model data base: • Choice of software to generate the data base (DIWAX or other?) • Bring together various data sources (NA, MS, BoP, SA data..)within a well-structured framework • Select list of variables and give variables names • Write exchange procedures between data software and Eviews

31. Database management scheme • Decision on database management scheme to adopt • Form core group responsible for its implementation • Populate database system with existing data • If DIWAX is chosen: • Setup of Lesotho-specific metadata • Web server set up as a web base for data storage and exchange • Setup linkages between macro-econometric model in Eviews and database • Train core group in using the software • Train model users once first version of model available

32. How to proceed further with model building? • Real block: based on proposal, work in Eviews can start • Fiscal policy: interaction with MTFF to be further worked out • Monetary and price block: structure and specifications still to be determined • Discussion with Dr. Makhetha  need for a new background paper? • Discussion with SA Treasury and SARB (see WP 07/02) • Contribution from CBL (CPI sub-module) But: these three points can be pursued in parallel, model can be built piece by piece as long as overall structure remains coherent

33. How to organise the work? Within MoFDP: • Core group to work on daily basis with DIMMoL team leader and experts • Specific on-the-job training (with DIWAX and Eviews) • Specific training sessions if required • Local team fully capable of performing all tasks related to update and use of the model • Integration of new Ministry unit with DIMMoL • Broader group for attending training and workshop • Informed of work in progress • Responsible for main modelling and technical decisions • Benefit from general training courses organised by DIMMoL to be able to use the model

34. How to organise the work? Other institutions: • CBL economists: • Belong fully to the broader group • Active advice in areas of specific expertise of the Bank? • Full participation in the core group? • NUL economists: • Participation in workshops • Preparation of background papers • Provide training to core and broader group (Eviews, econometrics)? • Integration into the core group?