Transcript Macroeconomic Policy in Countries with Natural Resource Wealth APPENDICES Jeffrey Frankel Leading Economic Growth Program February 14, 2013

Macroeconomic Policy
in Countries with Natural Resource Wealth
APPENDICES
Jeffrey Frankel
Leading Economic Growth Program
February 14, 2013
Appendix I: Channels of
the Natural Resource Curse



How could abundance
of commodity wealth be a curse?
What is the mechanism
for this counter-intuitive relationship?
At least 5 categories of explanations.
2
5 Possible Natural Resource Curse Channels
1.
Volatility
2.
Crowding-out of manufacturing
3.
Autocratic Institutions
4.
Anarchic Institutions
5.
Procyclicality
1.
2.
3.
including
Procyclical capital flows
Procyclical monetary policy
Procyclical fiscal policy.
3
(1) Volatility
in global commodity
prices arises because
supply & demand are
inelastic in the short run.
4
Commodity prices have been especially
volatile over the last decade
Source: UNCTAD
5
Effects of Volatility

Volatility per se can be bad for economic growth.




Hausmann & Rigobon (2003), Blattman, Hwang, & Williamson (2007),
and Poelhekke & van der Ploeg (2007).
Risk inhibits private investment.
Cyclical shifts of labor, land & capital back &
forth across sectors may incur needless costs.
=> role for government intervention?


On the one hand, the private sector dislikes risk as
much as government does & takes steps to mitigate it.
On the other hand the government
cannot entirely ignore the issue of volatility;

e.g., exchange rate policy.
6
2. Natural resources may
crowd out manufacturing,



and manufacturing could be the sector
that experiences learning-by-doing

or dynamic productivity gains from spillover.

Matsuyama (1992), van Wijnbergen (1984)
and
Sachs & Warner (1995).
So commodities could in theory be a dead-end sector.
My own view: a country need not repress the
commodity sector to develop the manufacturing sector.

It can foster growth in both sectors.

E.g. Canada, Australia, Norway… Now Malaysia, Chile, Brazil…
7
Econometric findings that oil
and other “point-source resources”
lead to poor institutions





Isham, Woolcock, Pritchett, & Busby
Sala-I-Martin & Subramanian (2003)
Bulte, Damania & Deacon (2005)
Mehlum, Moene & Torvik (2006)
Arezki & Brückner (2009).
(2005)
The theory is thought to fit Mideastern oil exporters well.
8
What are poor institutions?
A
typical list:
 inequality,
 corruption,
 rent-seeking,
 intermittent
dictatorship,
 ineffective judiciary branch, and
 lack of constraints to prevent elites &
politicians from plundering the country.
9
An example, from economic historians
Engerman & Sokoloff

Why did industrialization take place in North America,





(1997, 2000, 2002)
not the South?
Lands endowed with extractive industries & plantation crops
developed slavery, inequality, dictatorship, and state control,
whereas those climates suited to fishing & small farms
developed institutions of individualism, democracy,
egalitarianism, and capitalism.
When the Industrial Revolution came, the latter areas
were well-suited to make the most of it.
Those that had specialized in extractive industries were not,

because society had come to depend on class structure & authoritarianism,
rather than on individual incentive and decentralized decision-making.
10
4. Anarchic institutions
1.
2.
3.
Unsustainably rapid
depletion of resources
Unenforceable
property rights
Civil war
11
(5) Procyclicality


The Dutch Disease describes unwanted
side-effects of a commodity boom.
Developing countries are
historically prone to procyclicality,


especially commodity producers.
Procyclicality in:



Capital inflows; Monetary policy;
Real exchange rate; Nontraded Goods
Fiscal Policy
12
The Dutch Disease:
5 side-effects of a commodity boom

1) A real appreciation in the currency

2) A rise in government spending

3) A rise in nontraded goods prices

4) A resultant shift of production
out of manufactured goods

5) Sometimes a current account deficit
13
The Dutch Disease: The 5 effects elaborated
 1)


taking the form of nominal currency appreciation
if the exchange rate floats
or the form of money inflows, credit
& inflation if the exchange rate is fixed;
 2)

Real appreciation in the currency
A rise in government spending
in response to availability of tax receipts or royalties.
14
The Dutch Disease: 5 side-effects of a commodity boom

3) An increase in nontraded goods prices
relative to internationally traded goods

4) A resultant shift out of
non-commodity traded goods,


esp. manufactures,
pulled by the more
attractive returns
in the export commodity
and in non-traded goods.
15
The Dutch Disease: 5 side-effects of a commodity boom

5) A current account deficit,

as booming countries attract capital flows,
 thereby
incurring international debt that
is hard to service when the boom ends.

Manzano & Rigobon (2008): the negative Sachs-Warner effect of

Arezki & Brückner (2010a, b): commodity price booms lead to higher
resources on growth rates during 1970-1990 was mediated through
international debt incurred when commodity prices were high.
government spending, external debt & default risk in autocracies,

but do not have those effects in democracies.
16
Summary of channels

Five broad categories of hypothesized channels
whereby natural resources can lead to poor economic
performance:





commodity price volatility,
crowding out of manufacturing,
autocratic institutions,
anarchic institutions, and
procyclical macroeconomic policy, including




capital flows,
monetary policy and
fiscal policy.
But the important question is how to avoid the pitfalls,

to achieve resource blessing instead of resource curse.
17



Some developing countries have avoided
the pitfalls of commodity wealth.

E.g., Chile (copper)

Botswana (diamonds)
Some of their innovations are worth emulating.
The lecture offers some policies &
institutional innovations to avoid the curse.
18
19
Appendices
on recommendations for
dealing with the natural resource curse
Appendix II.1: Elaboration on proposal to make
monetary policy less procyclical – PPT, using
GDP deflator to set annual inflation target.
Appendix II.2: Elaboration on proposal to make
fiscal policy less procyclical – emulate Chile,
setting structural targets with independent
fiscal forecasts
20
Appendix II.1:
Product Price Targeting


Each of the traditional candidates for nominal
anchor has an Achilles heel.
The CPI anchor does not accommodate
terms of trade changes:

IT tightens M & appreciates when import prices rise
not when export prices rise,
 which is backwards.
 Targeting core CPI does not much help.

21
Empirical findings

Simulations of 1970-2000



Gold producers:
Burkino Faso, Ghana, Mali, South Africa
Other commodities:
Ethiopia (coffee), Nigeria (oil), S.Africa (platinum)
General finding:
Under Product Price Targets, their currencies
would have depreciated automatically in 1990s
when commodity prices declined,
 perhaps avoiding messy balance of payments crises.
Sources: Frankel (2002, 03a, 05), Frankel & Saiki (2003)
22
Price indices

CPI & GDP deflator each include:

an international good
import good in the CPI,
 export good in GDP deflator;





And the non-traded good,
with weights f and (1-f), respectively:
cpi = (f)pim +(1-f)pn ,
p = (f)px + (1-f) pn .
23
Estimation for each country of weights in national price index on 3 sectors:
non tradable goods, leading commodity export, & other tradable goods
Leading
Non
Other
Comm.
Oil
Tradables
Tradables
Export
CPI
0.6939
0.0063
0.0431
0.2567
ARG
PPI
0.6939
0.0391
0.0230
0.2440
CPI
0.5782
0.0163
0.0141
0.3914
BOL
PPI
0.5782
0.1471
0.0235
0.2512
CPI
0.5235
0.0079
0.0608
0.4078
CHL
PPI
0.5235
0.0100
0.1334
0.3332
CPI
0.5985
-0.0168
0.3847
COL*
PPI
0.5985
-0.0407
0.3608
CPI
0.6413
0.0002
0.0234
0.3351
JAM
PPI
0.6413
0.1212
0.0303
0.2072
CPI
0.3749
-0.0366
0.5885
MEX*
PPI
0.3749
-0.0247
0.6003
CPI
0.3929
0.1058
0.0676
0.4338
PRY
PPI
0.3929
0.0880
0.0988
0.4204
CPI
0.6697
0.0114
0.0393
0.2796
PER
PPI
0.6697
0.040504
0.021228
0.268568
CPI
0.6230
0.0518
0.0357
0.2895
URY
PPI
0.6230
0.2234
0.1158
0.0378
* Oil is the leading commodity export.
Total
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
1.000
“A Comparison of Product Price
Targeting and Other Monetary
Anchor Options, for CommodityExporters in Latin America,"
Economia, vol.11, 2011
(Brookings), NBER WP 16362.
Argentina is
relatively closed;
Mexico is
relatively open.
The leading export
commodity usually
has a higher weight
in the country’s PPI
than in its CPI,
as expected.
(Jamaicans don’t
eat bauxite.)24
In practice, IT proponents agree central banks
should not tighten to offset oil price shocks


They want focus on core CPI, excluding food & energy.
But

food & energy ≠ all supply shocks.

Use of core CPI sacrifices some credibility:



If core CPI is the explicit goal ex ante, the public feels confused.
If it is an excuse for missing targets ex post, the public feels tricked.
Perhaps for that reason, IT central banks apparently
do respond to oil shocks by tightening/appreciating,

as the following correlations suggests….
25
Table 1
LAC Countries’ Current Regimes and Monthly Correlations
Exchange
($/local
currency)
withcurrency)
$ Import
Price
Table 1: of
LACA
Countries’ CurrentRate
Regimes Changes
and Monthly Correlations
of Exchange
Rate Changes ($/local
with Dollar Import
PriceChanges
Changes
Import price changes are changes in the dollar price of oil.
Exchange Rate Regime
Monetary Policy
1970-1999
2000-2008
1970-2008
ARG
Managed floating
Monetary aggregate target
-0.0212
-0.0591
-0.0266
BOL
Other conventional fixed peg
Against a single currency
-0.0139
0.0156
-0.0057
BRA
Independently floating
Inflation targeting framework (1999)
0.0366
0.0961
0.0551
0.0524
-0.0484
CHL
Independently floating
Inflation targeting framework (1990)*
-0.0695
CRI
Crawling pegs
Exchange rate anchor
0.0123
-0.0327
0.0076
GTM
Managed floating
Inflation targeting framework
-0.0029
0.2428
0.0149
GUY
Other conventional fixed peg
Monetary aggregate target
-0.0335
0.0119
-0.0274
HND
Other conventional fixed peg
Against a single currency
-0.0203
-0.0734
-0.0176
JAM
Managed floating
Monetary aggregate target
0.0257
0.2672
0.0417
NIC
Crawling pegs
Exchange rate anchor
-0.0644
0.0324
-0.0412
PER
Managed floating
Inflation targeting framework (2002)
-0.3138
0.1895
-0.2015
PRY
Managed floating
IMF-supported or other monetary program
-0.023
0.3424
0.0543
SLV
Dollar
Exchange rate anchor
0.1040
0.0530
0.0862
URY
Managed floating
Monetary aggregate target
0.0438
0.1168
0.0564
IT
countries
show
correlations
> 0.
Oil Exporters
COL
Managed floating
Inflation targeting framework (1999)
-0.0297
0.0489
0.0046
MEX
Independently floating
Inflation targeting framework (1995)
0.1070
0.1619
0.1086
TTO
Other conventional fixed peg
Against a single currency
0.0698
0.2025
0.0698
VEN
Other conventional fixed peg
Against a single currency
-0.0521
0.0064
-0.0382
* Chile declared an inflation target as early as 1990; but it also had an exchange rate target, under an explicit band-basket-crawl regime, until 1999.
26
The 4 inflation-targeters in Latin America
show correlation (currency value
in $
, import prices

>0;

> correlation before they adopted IT;

in $)
> correlation shown by non-IT
Latin American oil-importing countries.
27
Why is the correlation between the import
price and the currency value revealing?


The currency of an oil importer should not
respond to an increase in the world oil price
by appreciating, to the extent that these
central banks target core CPI .
When these IT currencies respond by
appreciating instead, it suggests that the
central bank is tightening money to reduce
upward pressure on headline CPI.
28
Appendix II.2:
Official over-optimism
& Chilean fiscal institutions
29
Poll ratings
of Chile’s
Presidents
and Finance
Ministers
And the
Finance
Minister?:
August 2009
In August 2009, the
popularity of the
Finance Minister,
Andres Velasco,
ranked behind only
President Bachelet,
despite also having
been low two years
before. Why?
Chart source: Eduardo Engel, Christopher Neilson & Rodrigo Valdés, “Fiscal Rules as Social Policy,” Commodities Workshop, World Bank, Sept. 17, 2009
30
5 econometric findings regarding bias toward
optimism in official budget forecasts.

Official forecasts in a sample of 33 countries
on average are overly optimistic, for:



(1) budgets &
(2) GDP .
The bias toward optimism is:



(3) stronger the longer the forecast horizon;
(4) greater in booms
(5) greater for euro governments under SGP budget rules;
31
US official projections have been over-optimistic on average
32
Greek official forecasts have always been over-optimistic.
33
Chile’s official forecasts have not been over-optimistic.
34
The optimism in official budget forecasts is
stronger at the 3-year horizon, stronger among
countries with budget rules, & stronger in booms.
Frankel, 2010, “A Solution to Fiscal Procyclicality:35
The Structural Budget Institutions Pioneered by Chile.”
5 more econometric findings regarding bias
toward optimism in official budget forecasts.

(6) The key macroeconomic input for budget forecasting in
most countries: GDP. In Chile: the copper price.

(7) Real copper prices revert to trend in the long run.
But this is not always readily perceived:


(8) 30 years of data are not enough
to reject a random walk statistically; 200 years of data are needed.

(9) Uncertainty (option-implied volatility) is higher
when copper prices are toward the top of the cycle.

(10) Chile’s official forecasts are not overly optimistic.
It has apparently avoided the problem of forecasts
that unrealistically extrapolate in boom times.
36
In sum, institutions recommended
to make fiscal policy less procyclical:

Chile is not subject to the same bias toward overoptimism in forecasts of the budget, growth, or
the all-important copper price.

The key innovation that has allowed Chile
to achieve countercyclical fiscal policy:
not just a structural budget rule in itself,
 but rather the regime that entrusts to two panels
of experts estimation of the long-run trends
of copper prices & GDP.
37

The crucial institutional innovation in Chile

How has Chile avoided over-optimistic official forecasts?


The estimation of the long-term path
for GDP & the copper price
is made by two panels of independent experts,


especially the historic pattern of
over-exuberance in commodity booms?
and thus is insulated from political pressure & wishful thinking.
Other countries might usefully emulate Chile’s innovation

or in other ways delegate to independent agencies
estimation of structural budget deficit paths.
38
Application to other countries

Any country could adopt the Chilean mechanism.

Suggestion: give the panels more institutional independence

as is familiar from central banking:


laws protecting them from being fired.
Open questions:


Are the budget rules to be interpreted as ex ante or ex post?
How much of the structural budget calculations are
to be delegated to the independent panels of experts?


Minimalist approach: they compute only 10-year moving averages.
Can one guard against subversion of the institutions (CBO) ?
39
”On Graduation from
Fiscal Procyclicality,”
Frankel, Végh &
Vuletin; J.Dev.Econ.,
2013.
40