Annex I. A Summary of the IMF’s G20MOD Module of FSGM
This annex provides a broad summary of G20MOD, a module of the IMF’s Flexible System of Global Models (FSGM). The model is presented in greater detail in Andrle and others (2015).
1. G20MOD is an annual, multi-economy, forward-looking, model of the global economy combining both micro-founded and reduced-form formulations of economic sectors. G20MOD contains individual blocks for the G-20 countries, and 5 additional regions to cover the remaining countries in the world. The key features of a typical G20MOD country model are outlined below, noting any special circumstances that are applied for Saudi Arabia.
2. Consumption and investment have microeconomic foundations. Specifically, consumption features overlapping-generations households that can save and smooth consumption, and liquidity-constrained households that must consume all of their current income every period. Firms’ investment is determined by a Tobin’s Q model. Firms are net borrowers and their risk premia rise during periods of excess capacity, when the output gap is negative, and fall during booms, when the output gap is positive. This mimics, for example, the effect of falling/rising real debt burdens.
3. Trade is pinned down by reduced-form equations. They are a function of a competitiveness indicator and domestic or foreign demand. The competitiveness indicator improves one-for-one with domestic prices—there is no local-market pricing. For Saudi Arabia, most exports are oil, so competitiveness changes play a small role in the model.
4. Potential output is endogenous. It is modeled by a Cobb-Douglas production function with exogenous trend total factor productivity (TFP), but endogenous capital and labor. For Saudi Arabia, potential output also moves one-for-one with the long-run average production of oil (but not cyclical swings in oil production).
5. Consumer price and wage inflation are modeled by reduced form Phillips’ curves. They include weights on a lag and a lead of inflation and a weight on the output gap. Consumer price inflation also has a weight on the real effective exchange rate and second-round effects from food and oil prices. Given that energy prices in Saudi Arabia do not respond to global oil price developments, there is no feed-through from oil price changes to CPI inflation in the Saudi Arabia bloc. While the role of expatriate labor in Saudi Arabia is not directly modeled, the effects are approximated by having a low-weight on the output gap.
6. Monetary policy is governed by an interest rate reaction function. For most countries, it is an inflation-forecast-based rule working to achieve a long-run inflation target. For Saudi Arabia, the monetary reaction function defends its fixed nominal exchange rate against the U.S. dollar. This means in tandem with the risk-adjusted uncovered interest rate parity condition, Saudi Arabia must, in the face of shocks, set its monetary policy interest rate equal to that of the United States in order to defend its peg.
7. There are three commodities in the model—oil, metals, and food. This allows for a distinction between headline and core consumer price inflation, and provides richer analysis of the macroeconomic differences between commodity-exporting and importing regions. The demand for commodities is driven by the world demand and is relatively price inelastic in the short run due to limited substitutability of the commodity classes considered. The supply of commodities is also price inelastic in the short run. Countries can trade in commodities, and households consume food and oil explicitly, allowing for the distinction between headline and core CPI inflation. All have global real prices determined by a global output gap (only a short-run effect), the overall level of global demand, and global production of the commodity in question.
8. Commodities can function as a moderator of business cycle fluctuations. In times of excess aggregate demand, the upward pressure on commodities prices from sluggish adjustment in commodity supply relative to demand will put some downward pressure on demand. Similarly, if there is excess supply, falling commodities prices will ameliorate the deterioration.
9. In Saudi Arabia, oil is the only commodity that is produced and exported, and is a dominant feature of the model. Exports of oil respond largely to Saudi production decisions. Eighty-five percent of oil revenues are assumed to accrue to the government, the remainder to Aramco, the state oil company. This means that oil price fluctuations affect government revenues, but have little effect on household wealth as households have no direct ownership stake in the oil sector. Oil prices also have little effect on households’ and firms’ decisions, as oil prices are held fixed domestically. The government, which has a large stock of financial assets, is assumed to set long-run fiscal policy with the aim of maintaining this asset stock, although in the short-run fiscal policy can result in significant deviations away from this target.
10. Countries are largely distinguished from one another in G20MOD by their unique parameterizations. Each economy in the model is structurally identical (except for commodities), but with different key steady-state ratios and different behavioral parameters. As noted above, the parameterization of Saudi Arabia is strongly determined by the fact that its economy is dominated by oil.
Alghaith, N., A. Al-Darwish, P. Deb, and P. Khandelwal, 2014, “Monetary and Macroprudential Policies in Saudi Arabia” in Saudi Arabia: Tackling Emerging Economic Challenges to Sustain Growth, IMF.
Bjørnland, Hilde C., 2009, “Oil Price Shocks and Stock Market Booms in an Oil-exporting Country,” Scottish Journal of Political Economy 56, pp. 232–254.
Eltony, M. and M. Al-Awadi., 2001, “Oil Price Fluctuations and Their Impact on the Macroeconomic Variables of Kuwait: A Case Study Using a VAR Model,” International Journal of Energy Research, 25, pp. 939–959.
Husain, A. K. Tazhibayeva and A. Ter-Martirosyan, 2008, “Fiscal Policy and Economic Cycles in Oil-Exporting Countries,” IMF Working Paper WP/08/253.
International Monetary Fund (IMF), 2015, “Assessing the Resilience of Saudi Banks to Weaker Economic Conditions,” Saudi Arabia Article IV Consultation Selected Issues, IMF country Report, Washington.
Park, Jungwook, and R. Ratti, 2008, “Oil Price Shocks and Stock Markets in the US and 13 European Countries,” Energy Economics, 30, pp. 2587–2608.
Sheehan, R. and J. Russer, 1995, “A Vector Autoregressive Model of the Saudi Arabian Economy,” Journal of Economics and Business, 90, pp.79–90.
Wang Yudong, C. Wu, and L. Yang, 2013, “Oil Price Shocks and Stock Market Activities: Evidence from Oil-importing and Oil-exporting Countries,” Journal of Comparative Economics, 41, pp. 1220–1239.
Prepared by Goblan Algahtani, Nayef Alsadoum (both SAMA), Tim Callen (MCD), Ken Miyajima (MCM), Dirk Muir (RES), and Ben Piven (MCD).
For example, see Park and Ratti (2008), Bjørnland (2009) who test for the impact on Norway’s stock market. Wang et al. (2013) show that the oil market has a significant impact on the stock market and that the contribution of oil prices shocks on the stock market is stronger in oil exporting countries.
The bankruptcy of two large non-listed conglomerates in 2009 contributed to the increase in NPLs in the 2008–09 period.
NPL ratios are used without a logit transformation. Bank-by-bank data comprises annual data for 12 banks taken from Bankscope for the period 1999–2014.