A policy model for Tunisia with real and financial flows

|Policy, Planning, and Research WCRKING PAPERS Pubic Economics Country Economics Department The World Bank January 1989 WPS 157 A Policy Model for Tunisia with Real and Financial Flows Martha de Melo, Marc Leduc, and Setareh Razmara Country economists and developing country decisionmakers can use this model to analyze fiscal, debt, and incomes policies - and to derive implications for the exchange rate and for the availability of credit to the private sector. The extended model generates a complete flow of funds for each time period, along with projections of national accounts in current and constant prices. Elements of the extended model can be suppressed, changed, or further extended, making it a flexible tool for country economic analysis. The Policy. Planning, and Research Complex distributes PPR Wodting Papers to disseminate the fndings of work in progress and to enoourage the exchange of ideas among Bank staff and all others interested in development issues. These papers carry the names of the authors, reflect only their views, and should be used and cited accordingly. The findings, interpretations, and conclusions are the authors'own. hey should not be attributed to the World Bank. its Board of Directors, its management, or any of its rembercountries.  Polac,Pnning, and Research | Public Economics I This model was developed to provide a macro- duced goods. It is basei on a social accounting economic framework for Tunisia's structural matrix and distinguishes government budgetary adjustment program and a flexible tool for receipts and expenditures from such flows in the further country economic analysis. As currently rest of the economy. A link with the Bank's specified, it is designed to analyze fiscal, debt, country debt model is provided by assuming a and incomes policies, while deriving implica- fixed dollar resource gap for the projected years. tions for the exchange rate and for the availabil- ity of credit to the private sector. Several policy The extended model generates - for each experiments are carried out to illustrate this time period - a complete flow of funds, along focus, and suggestions are offered for variations with projections of national accounts in current in model closure and detail. and constant prices. It distinguishes seignorage, or the growth in real money demand, from the The core model is a one-sector computable inflation tax and can be used to define the general equilibrium model that assumes imper- growth i base money consistent with a target fect substitution in production for export and price level or, alternatively, an endogenous price domestic use - and imperfect substitution in level consistent with growth in base money. e 'enditure on imports and domestically pro- This paper is a product of the Public Economics Division, Country Economics De- partment. Copies are available free from the World Bank, 1818 H Street NW, Wash- ington DC 20433. Please contact Ann Bhalla, room NIO-061, extension 60359. The PPR Working Paper Series disseminates the findings of work under way in the Bank's Policy, Planning, and Research Complex. An objective of the series is to get these findings out quickly, even if presentations are less than fuDy polished. The rindings, interpretations, and conclusions in these papers do not necessarily represent official policy of the Bank. Produced at the PPR Dissemination Center  A POLICY MODEL FOR TUNISIA WITH REAL AND FINANCIAL FLOWS Table of Contents PAGE List of Figures and Tables ii I. Introduction 1 Origin and purpose of the model 1 Overview of the model 3 II. The Real Model 18 The SAM and other data 18 Model specification 20 Variations in closure and detail 32 Policy Analysis 34 III. Incorporating Financial Flows 36 Data needs and data adjustments 36 Model specification 40 Variations in closure and detail 42 Policy Analysis 43 ANNEX A - Estimating money demand 46 ANNEX B - Sectoral disaggregation 50 ANNEX C - Description and listing of the computer program 54 Bibliography 65 * The authors would like to thank Jaime de Melo and Alberto Giovaninni for advice on the model specification. John Brondolo assisted in the preparation %,f Annex A, and useful comments were received from Bela Balassa, John Holsen, and Javad Khalilzadeh-Shirazi.  ii List of Figures and Tables PAGE Figure 1: Diagram of the Tunisia Model--Dynamic Flow 4 Figure 2: Financing the Budget Deficit 15 Figure 3: Diagram of the Tunisia Model--Static Solution 21 Table 1: Tunisia Policy Model: Flow of Funds Projections 6 Table 2: Aggregated Social Accounting Matrix for Tunisia 1986 19 Table 3: The Core CGE Model for Tunisia with Budget and External Flows 23 Table 4: Within-Period Policy Experiments for the Core Model 34 Table 5: The Extended CGE Model with a Complete Flow of Funds 37 Table 6: Policy Experiments over the Plan Period, 1986-91, with 44 Real and Financial Flows  A POLICY MODEL FOR TUNISIA WITH REA'. AND FINANCIAL FLOWS I. Introduction Origin and purpose of the model 1. This paper describes a policy model for Tunisia with real and financial flows. The model was developed to provide (i) a macroeconomic framework for Tunisia's structural adjustment program; (ii) an analytical tool for a forthcoming case study on fiscal aspects of external debt; and (iii) e country model for the responsible Country Operations Department. The main purpose of the model is to introduce important analytical and policy variables into a consistent accounting framework which could be used to provide projections of real and financial flows. In particular, the model is designed to analyze fiscal, debt, and exchange rate issues. it can also be used to derive an endogenous price level and to distinguish seignorage and the inflation tax. 2. The model consists of a core computable general equilibrium (CGE) module which is extended to incorporate the existing tools of the country economist--namely, the detailed debt projections of the Revised Minimum Standard Model (RMSM) and the Holsen-type flow-of-funds model. The full model was developed as a practical tool--capable of reproducing the Tunisian Government's projections for the VIIth Plan (1987-90) and generating a number of counterfactual scenarios. It may, therefore, be of interest to others who plan to develop an economy-wide model for practical country-economic work.  -2- 3. In particular, the model was used to project a realistic macroeconomic scenario and provide a consistent set of indicators for monitoring Tunisia's structural adjustment program.1 The indicators focus on three sets of goals--economic growth, external balance and debt reduction, and internal balance (employment and inflation). The projected assumptions about government policy and the external environment are defined so that the actual outcome can be explained and compared to the projected results. In addition, the model was used to explore the likely effects of alternative external and internal-policy developments. Several policy experiments illustrate this use. 4. To facilitate exposition, a more aggregated version of the original model is presented here. It omits the sectoral detail of the original model, but nevertheless distinguishes exports, imports, and non-traded goods. It also omits some of the disaggregated budgetary and external payments flows. An explanation of the closure rules chosen for Tunisia is accompanied by an indication of alternative closure rules and variations in modeling detail. One variation involves a more careful specification of the inflation tax, and Annex A provides an econometric estimate of the demand for money in Tunisia that can be used in projecting the increase in base money consistent with a target inflation, or the inflation implied by the increase in base money. Annex B describes some of the data and specification issues that arise I/ The indicator tables developed with the model are included as Annex II in the President's Report on a Proposed Structural Adiustment Loan to Tunisia (May 20, 1988) Report No. P-4808-TUN.  -3- with sectoral disaggregation. Annex C provides a short description of the computer software used for the model and a listing of the program for the base year. Overview of the model 5. The interest of this model is that it integrates key policy variables into a single, economy-wide model that conforms to the Bank's analytical needs to support a structural adjustment program--including detailed debt and debt service projections--and typical country-level data availabilities. This is facilitated by a link between the RMSM debt model and the core CGE model of the real economy, which provides current and constant price projections of the national accounts. Core model projections are made by obtaining successive within-period solutions after updating factor stocks, productivity parameters and exogenous variables. The extended model provides a complete flow-of- funds accounting system. 6. Figure 1 is a diagram of the model. The rectangle represents the input from RMSM; the square, the CCE core model; and the circle, the flow-of-funds extension. The key constraint in the within-period model is the level of foreign resource flows, which must be set a priori for any given scenario. Elements of the extended model can be suppressed, changed, or further extended, making it a flexible tool for country economic analysis. In particular, the model can be implemented in the core or the extended version, for one time period or multiple periods, for one sector or multiple sectors, and with or without econometric estimates for key parameters such as seignorage or investment demand.  FICURE 1: DIACRA" OF TIIE TUNISIA MODEI.-DYNAKIC FLOW ----- 1986 1987