Annex I. G20MOD
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.
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 equilibrium employed labor. The equilibrium labor is determined by equilibrium rate of unemployment of the labor force. 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 semi-structural forward-looking 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.
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 to defend its peg.
7. G20MOD captures a complete set of bilateral migration and remittance flows. The population, labor force, and employment distinguish between “domestic” and “foreign” households. The wage differential between the two groups is used as a proxy for the relative productivity of the two groups. The relative productivity of both types of labor are reflected in the potential output of the economy. Expatriate workers are assumed to remit a fraction of their disposable income to their countries of their origin. All expatriate workers are assumed to be liquidity constrained, consuming all their disposable income left after sending the remittances.
8. 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.
9. In Saudi Arabia, oil is the main commodity that is produced and exported, and is a dominant feature of the model. Exports of oil respond largely to Saudi production decisions. A share 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.
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Prepared by Anta Ndoye and Michal Andrle (both IMF), and Tehmina Shaukat Khan (World Bank). Research support was provided by Tucker Stone and Jared Bebee and editorial support by Diana Kargbo-Sical. The authors are grateful to the authorities and participants at the seminars at SAMA and the IMF for their helpful comments.
TIMSS is an international assessment of the mathematics and science knowledge, conducted by the International Association for the Evaluation of Educational Achievement (IEA) every 4 years since 1995. In TIMSS 2015, nationally representative samples of students in 57 countries participated in the 4th-grade assessment, the 8th-grade assessment, or both. PIRLS is also an internationally comparative assessment that measures student learning in reading, and is produced by the IEA every four years since 2001. 50 countries participated in the 2016 PIRLS for students in the grade that represents 4 years of schooling.
In the model, the authorities use government consumption, government investment, and fiscal transfers on the expenditure side and labor income taxes, consumption taxes, capital income taxes, and royalties on commodities to manage the government budget, with a set goal for long-term debt-to-GDP ratio.
Should the expatriate workers desire to keep the nominal value of their remittances unchanged, and thus effectively increase the share of remittances in their lower income, the negative impact on the Saudi economy would be larger.
Economic rent is defined as a payment to an owner of a factor of production beyond the marginal cost of the factor. Economic rents are associated with imperfect competition in product and factor markets.