Rafael Portillo

Public Investment, Growth, and Debt Sustainability: Putting Together the Pieces

We develop a model to study the macroeconomic effects of public investment surges in low-income countries, making explicit: (i) the investment-growth linkages; (ii) public external and domestic debt accumulation; (iii) the fiscal policy reactions necessary to ensure debt-sustainability; and (iv) the macroeconomic adjustment required to ensure internal and external balance. Well-executed high-yielding public investment programs can substantially raise output and consumption and be self-financing in the long run. However, even if the long run looks good, transition problems can be formidable when concessional financing does not cover the full cost of the investment program. Covering the resulting gap with tax increases or spending cuts requires sharp macroeconomic adjustments, crowding out private investment and consumption and delaying the growth benefits of public investment. Covering the gap with domestic borrowing market is not helpful either: higher domestic rates increase the financing challenge and private investment and consumption are still crowded out. Supplementing with external commercial borrowing, on the other hand, can smooth these difficult adjustments, reconciling the scaling up with feasibility constraints on increases in tax rates. But the strategy may be also risky. With poor execution, sluggish fiscal policy reactions, or persistent negative exogenous shocks, this strategy can easily lead to unsustainable public debt dynamics. Front-loaded investment programs and weak structural conditions (such as low returns to public capital and poor execution of investments) make the fiscal adjustment more challenging and the risks greater.

The Macroeconomics of Medium-Term Aid Scaling-Up Scenarios

We develop a model to analyze the macroeconomic effects of a scaling-up of aid and assess the implications of different policy responses. The model features key structural characteristics of low-income countries, including varying degrees of public investment efficiency and a learning-by-doing (LBD) externality that captures Dutch disease effects. On the policy front, it distinguishes between spending the aid, which is controlled by the fiscal authority, and absorbing the aid - financing a higher current account deficit - which is influenced by the central banks reserve accumulation policies. We calibrate the model to Uganda and run several experiments. We find that a policy mix that results in full spending and absorption of aid can generate temporary demand and real exchange rate appreciation pressures, but also have a positive effect on real GDP in the medium term, through higher public capital. Full spending with partial absorption, on the other hand, may stem appreciation pressures but can also induce adverse medium-term real GDP effects, through private sector crowding out. When aid is very inefficiently invested and there are strong LBD externalities, aid can be harmful, and partial absorption policies may be justified. But in this case, a welfare improving solution is to defer spending or - even better if possible - raise its efficiency.

The Short-Run Macroeconomics of Aid Inflows: Understanding the Interaction of Fiscal and Reserve Policy

We develop a tractable open-economy new-Keynesian model with two sectors to analyze the short-term effects of aid-financed fiscal expansions. We distinguish between spending the aid, which is under the control of the fiscal authorities, and absorbing the aid-using the aid to finance a higher current account deficit-which is influenced by the central banks reserves policy when access to international capital markets is limited. The standard treatment of the transfer problem implicitly assumes spending equals absorption. Here, in contrast, a policy mix that results in spending but not absorbing the aid generates demand pressures and results in an increase in real interest rates. It can also lead to a temporary real depreciation if demand pressures are strong enough to threaten external balance. Certain features of low income countries, such as limited participation in domestic financial markets, make a real depreciation more likely by amplifying demand pressures when aid is spent but not absorbed. The results from our model can help understand the recent experience of Uganda, which saw an increase in government spending following a surge in aid yet experienced a real depreciation and an increase in real interest rates.

Some Misconceptions about Public Investment Efficiency and Growth

We reconsider the macroeconomic implications of public investment efficiency, defined as the ratio between the actual increment to public capital and the amount spent. We show that, in a simple and standard model, increases in public investment spending in inefficient countries do not have a lower impact on growth than in efficient countries, a result confirmed in a simple cross-country regression. This apparently counter-intuitive result, which contrasts with Pritchett (2000) and recent policy analyses, follows directly from the standard assumption that the marginal product of public capital declines with the capital/output ratio. The implication is that efficiency and scarcity of public capital are likely to be inversely related across countries. It follows that both efficiency and the rate of return need to be considered together in assessing the impact of increases in investment, and blanket recommendations against increased public investment spending in inefficient countries need to be reconsidered. Changes in efficiency, in contrast, have direct and potentially powerful impacts on growth: “investing in investing” through structural reforms that increase efficiency, for example, can have very high rates of return.

Forecasting and Monetary Policy Analysis in Low-Income Countries: Food and Non-Food Inflation in Kenya

We develop a semi-structural new-Keynesian open-economy model, with separate food and non-food inflation dynamics, for forecasting and monetary policy analysis in low-income countries and apply it to Kenya. We use the model to run several policy-relevant exercises. First, we filter international and Kenyan data (on output, inflation and its components, exchange rates and interest rates) to recover a model-based decomposition of most variables into trends (or potential values) and temporary movements (or gaps) — including for the international and domestic relative price of food. Second, we use the filtration exercise to recover the sequence of domestic and foreign macroeconomic shocks that account for business cycle dynamics in Kenya over the last few years, with a special emphasis on the various factors (international food prices, monetary policy) driving inflation. Third, we perform an out-of-sample forecast to identify where the economy — and therefore policy — was likely headed given the inflationary pressures at the end of our sample (2011Q2). We find that while imported food price shocks have been an important source of inflation, both in 2008 and more recently, accommodating monetary policy has also played a role, most notably through its effect on the nominal exchange rate. The model correctly predicted that a policy tightening was required, although the actual interest rate increase was larger. We discuss implications for the use of model-based policy analysis in low income countries.

The Monetary Transmission Mechanism in the Tropics: A Narrative Approach

Many central banks in low-income countries in Sub-Saharan Africa are modernising their monetary policy frameworks. Standard statistical procedures have had limited success in identifying the channels of monetary transmission in such countries. Here we take a narrative approach, following Romer and Romer (1989), and center on a significant tightening of monetary policy that took place in 2011 in four members of the East African Community: Kenya, Uganda, Tanzania and Rwanda. We find clear evidence of the transmission mechanism in most of the countries, and argue that deviations can be explained by differences in the policy regime in place.

Monetary Policy in Low Income Countries in the Face of The Global Crisis: A Structural Analysis

We develop a dynamic stochastic general equilibrium model with a banking sector to analyse the impact of the financial crisis in developing countries and the role of the monetary policy response, with an application to Zambia. We view the crisis as a combination of three related shocks: a worsening in the terms of the trade, an increase in the countrys risk premium and a decrease in the risk appetite of local banks. Model simulations broadly match the path of the economy during this period. We derive policy implications for central banks, and for dynamic stochastic general equilibrium modelling of monetary policy, in low‐income countries.

Money Targeting in a Modern Forecasting and Policy Analysis System: An Application to Kenya

We extend the framework in Andrle and others (2013) to incorporate an explicit role for money targets and target misses in the analysis of monetary policy in low-income countries (LICs), with an application to Kenya. We provide a general specification that can nest various types of money targeting (ranging from targets based on optimal money demand forecasts to those derived from simple money growth rules), interest-rate based frameworks, and intermediate cases. Our framework acknowledges that ex-post adherence to targets is in itself an objective of policy in LICs; here we provide a novel interpretation of target misses in terms of structural shocks (aggregate demand, policy, shocks to money demand, etc). In the case of Kenya, we find that: (i) the setting of money targets is consistent with money demand forecasting, (ii) targets have not played a systematic role in monetary policy, and (iii) target misses mainly reflect shocks to money demand. Simulations of the model under alternative policy specifications show that the stronger the ex-post target adherence, the greater the macroeconomic volatility. Our findings highlight the benefits of a model-based approach to monetary policy analysis in LICs, including in countries with money-targeting frameworks.

Enhancing Development Assistance to Africa : Lessons from Scaling-Up Scenarios

The pace of progress toward achievement of the Millenium Development Goals (MDG) in many sub-Saharan African countries remains too slow to reach targets by 2015, despite significant progress in the late 1990s. The MDG Africa Steering Group, convened in September 2007 by the UN Secretary-General, designated 10 countries for pilot studies to investigate how existing national development plans would be impacted by scaled up development aid to Africa. This joint publication of the IMF and the United Nations Development Programme reports conclusions drawn from these pilot studies and summarizes country-specific results for Benin, the Central African Republic, Ghana, Liberia, Niger, Rwanda, Tanzania, Togo, Sierra Leone, and Zambia.

Quarterly Projection Model for India; Key Elements and Properties

This paper outlines the key features of the production version of the quarterly projection model (QPM), which is a forward-looking open-economy gap model, calibrated to represent the Indian case, for generating forecasts and risk assessment as well as conducting policy analysis. QPM incorporates several India-specific features like the importance of the agricultural sector and food prices in the inflation process; features of monetary policy transmission and implications of an endogenous credibility process for monetary policy formulation. The paper also describes key properties and historical decompositions of some important macroeconomic variables.