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ROAD MAP
� Why study real sector of the economy
� Understanding NIA
� Basic Framework
� Key Issues & Recent Data� Key Issues & Recent Data
� Fiscal Policy
� Basic Framework
� Key Issues & recent data
� Exercise
Real Sector: National Income Accounts
Why Study Real Sector of the Economy?
Real Sector is concerned with the actual production
of goods and services in the economy
� To measure a country’s level of economic activity
(economic power)(economic power)
� To measure a country’s standard of living over
time
� To make comparison among countries
� For policy formulation
How to measure its performance?
� By using National Income Accounts
� Two summary measures are of great importance
� Gross Domestic Product (GDP): is the market value of
all final goods and services produced in an economy all final goods and services produced in an economy
during a year. It is the single most-used economic
measure.
� Gross National Product (GNP): is the aggregate final
output of citizens and businesses of a country in a
year.
� GNP = GDP + Net Factor Income
Calculating GDP-I
� Requires adding together million of goods and services
� All goods and services produced by an economy must be
weighted, i.e., each good and service must be multiplied
by its price to calculate a value . by its price to calculate a value .
� Finally, all the value measures are added to calculate that
year’s GDP.
� GDP counts final output but not intermediate goods.
Calculating GDP-II
� Final output – goods and services purchased for final
use.
� Intermediate products - are used as inputs in the
production of some other product.
� GDP does not measure total transactions in the economy.
� Selling your car to neighbor
� Selling your car through a used car dealer
� GDP is a flow measure (an amount per year).
The Circular Flow
Factor services
Wages, rents, interest, profits
Goods and services
Other countries
Financial markets
Government
Firms (production)Household
Personal consumption
Expenditure Approach-I
Expenditures are shown on the bottom half of the circular flow
Specifically, GDP is equal to the sum of four categories of
expenditures
GDP=C+I+G+(X-M)
When individual receive income, they can:
• Spend it on domestic goods
• Save
• Pay taxes
• Buy foreign goods
Expenditure Approach-II
The portion of income that individuals save leaves the
spending stream and goes into financial markets.
Business spending on equipment, structures, and inventories
is counted as part of gross private investment, together with
household spending on new owner-occupied housing.household spending on new owner-occupied housing.
Economists differentiate between total or gross private
domestic investment, and the new investment that is above
and beyond replacement investment.
Net private investment – gross private investment less depreciation.
Expenditure Approach-III
GDP=C+I+G+(X-M)
When individuals pay taxes, those taxes are either spent by
government on goods and services or are returned to individuals
in the form of transfer payments.
There is a connection between the government and the financial
markets.
If the government runs a deficit, it must borrow from financial markets to make up the difference.
Expenditure Approach-IV
GDP=C+I+G+(X-M)
Exports are added to total expenditures.
These flows are usually combined into net exports (exports minus imports).imports).
This approach is of very important from monetary policy point of view. Why?
Factor Income Approach
The income approach is shown on the top half of the circular
flow.
Firms make payments to households for supplying their services
as factors of production.
National income is the total income earned by citizens and
businesses of a country.
It consists of employee compensation, rent, interest, and profits.
When we add indirect taxes (less subsidies) and depreciation to
nations income, we have GDP.
GDP: Omissions or Under estimation
� Voluntary services (Edhi ambulance, work of housewives)
� Illegal activities (narcotics, gambling, smuggling etc.)
� Undesirable effects of production (pollution, traffic
congestion)congestion)
� No consideration is made for the changes in leisure time
� Defense expenditures are included, but no consideration is
made for the negative impact of higher crimes
� Distribution of national income and wealth
� Non-economic contributors to well-being are excluded
Interpreting GDP
Could be a misleading indicator of economic and human
developments
To be fair, GDP is never intended to be an accurate measure of
a country’s well-beinga country’s well-being
But politicians and economists often place disproportionate
importance on GDP
But maximizing GDP can conflict with other goals such as
promoting social equity or protecting the environment
GD
P g
row
th
0 2 4 6 8 10
GD
P: grow
th-%
-5 0 5 10 15
Agriculture: grow
th-%
0
FY80FY82FY84FY86FY88FY90FY92FY94FY96FY98FY00FY02FY04FY06FY08FY10FY12FY14
-5
FY80FY82FY84FY86FY88FY90FY92FY94FY96FY98FY00FY02FY04FY06FY08FY10FY12FY14
-10 -5 0 5 10 15 20
FY80FY82FY84FY86FY88FY90FY92FY94FY96FY98FY00FY02FY04FY06FY08FY10FY12FY14
Industry: growth-%
0 2 4 6 8 10
FY80FY82FY84FY86FY88FY90FY92FY94FY96FY98FY00FY02FY04FY06FY08FY10FY12FY14
Services: growth-%
Sa
vin
gs &
Inv
estm
en
ts
20 30 40 50 60
Agri
IndustryS
ervices
Share in GD
P-%
10
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
F…
-15
-10 -5 0 5 10 15 20 25
FY80
FY81
FY82
FY83
FY84
FY85
FY86
FY87
FY88
FY89
FY90
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
Gap
Investment
Dom
estic Savings
Savings Investment G
ap (% of G
DP
)
Fiscal Policy and Public Finance
Public Finance & Fiscal Policy
� Public Finance: acquiring income and allocating it to different heads of public expenditures
� Fiscal policy: art of using public finance as a tool to:
� achieve social objectives (income distribution)
� stabilize the economy
� achieve structural adjustment
� Relevance for SBP: Coordination between monetary
and fiscal policies
Fiscal Policy Tools
� Expenditures
� Current expenditures
� Developments expenditures� Developments expenditures
� Revenues
� Tax revenues
� Non-tax revenues
Assessing Fiscal Policy-I
� Fiscal Balances
� Overall balance; (Revenue – expenditures)
� Revenue balance (revenue – current expenditures)
� Primary balance (revenue – expenditures net of interest)
� Analysis of Revenue
� Tax-to-GDP ratio
� Composition of revenues (volatility)
� tax elasticity/ Buoyancy (automatic stabilization)
Assessing Fiscal Policy-II
� Analysis of expenditures
� Composition of expenditures
� Expenditures-to-GDP ratio
� Expenditure Buoyancy
� Policy issues related to expenditures
� Overall size of public sector (how much to spend)
� Priority areas (efficiency & optimal output)
Assessing Fiscal Policy-III
� Financing of deficit
� Monetization of deficits (printing of money)
� Non-bank financing (borrowing from general public)
� Borrowing from abroad� Borrowing from abroad
� Accumulation of arrears (payments delayed)
� Other issues
� Quasi-fiscal expenditures
� Contingent liabilities
� Tax expenditures
Fisca
l Ba
lan
ces
-8 -7 -6 -5 -4 -3 -2 -1 0
Fiscal B
alance (% of G
DP
)-9
FY80FY81FY82FY83FY84FY85FY86FY87FY88FY89FY90FY91FY92FY93FY94FY95FY96FY97FY98FY99FY00FY01FY02FY03FY04FY05FY06FY07FY08FY09FY10FY11FY12FY13FY14FY15
Fiscal B
alance (% of G
DP
)
-5 -4 -3 -2 -1 0 1 2 3
FY80
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14R
evenue Balance (%
of GD
P)
-6 -5 -4 -3 -2 -1 0 1 2 3
FY80
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
FY12
FY14
Prim
ary Balance (%
of GD
P)
Go
ve
rnm
en
t Re
ve
nu
es
12 14 16 18 20
% of GDP
0 2 4 6 8 10
FY80
FY81FY82
FY83FY84FY85
FY86FY87
FY88FY89
FY90FY91
FY92FY93FY94
FY95FY96
FY97FY98
FY99FY00
FY01FY02FY03
FY04FY05
FY06FY07
FY08FY09
FY10 FY11 FY12
FY 13FY 14
% of GDP
Non-Tax
Revenues
Tax
Government Expenditures
20
25
30
% o
f GD
P
0
5
10
15
% o
f GD
P
Development Overall Current Interest Defence
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