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Impacts of External Shocks on Nations’ Policy Responses and Economic growth. —World Economic Synchronization. World Economic Synchronization. World Economic Synchronization. -External Shocks -Policy Responses -Trade as a ‘gear’. Methodology. External Shock Accounting - PowerPoint PPT Presentation
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Impacts of External Shocks on Nations’ Policy Responses and
Economic growth
—World Economic Synchronization
World Economic Synchronization
World Economic Synchronization
-1
0
1
2
3
4
5
6
7
Year
GD
P G
row
th R
ate
%
High income World LDC
World Economic Synchronization
-External Shocks
-Policy Responses
-Trade as a ‘gear’
Methodology
-External Shock Accounting-Differenced-Data Models-Multiple Linear Dynamic Models-Cointegration Test and Chow Test
Bacha’s model-- for External Shock Accounting
Basic form of the model isChanges in Ratio of Current Account Deficit to GDP =
+ Changes in External Shocks
- Changes in Policy Responses
+ Error Term
Bacha’s Model Derivation
Dt (Mt - Et) + (Vt - Tt) (1)
Dt/Yt = PtmjtCt/Yt+ PtmjtIt/Yt + rtFt-1/Yt+ Vt/Yt- Rt/Yt -P
txxtWt/Yt - Tt/Yt (2)
d(Dt/Yt) = jtAt/Ztd(rtm) - xtWt/Ztd(rtx) + Ft-1/Ytd(rt)
- Xtrtxd(Wt/Zt) + rtd(Ft-1/Yt) + d(Vt/Yt) - (Rt/Yt)
- d(Tt/Yt) + jttmd(Ct/Zt) + jttmd(It/Zt) +tmAt/Ztd(jt) -
txWt/Ztd(xt) + ε (3)
Model Components: External Shocks
• [js(As/Zs)dpmt - xs(Ws/Zs)dpxt]… Terms of trade deterioration
• [ - Fs-1/Ysdrt ] … interest rate shock
• [- xspxsd(Wt/Zt)]… retardation of world trade
growth.• [ rsd(Ft-1/Yt)]… burden of debt accumulation• [d(Vd
t/Yt)]… change in net direct investment income to
abroad • [- d(Rt/Yt)]… change in workers'
remittances• [- d(Tt/Yt)]… change in unrequited
transfers
Model Components: Policy Responses
• [ jspmsd(Ct/Zt)]… consumption contraction
• [ jspmsd(It/Zt)]… investment reduction
• [ pms(As/Zs )djt]… import replacement
• [ - pxs(Ws/Zs)dxt]… export penetration
• [+ ε] … interaction effects and adding-up errors.
External Shocks
-- Attribution to LDC Economic Performance
Measured Impact of in External Shocks
Unfavorable Shocks Impacts on GDP
(1991-2005)
Terms-of-trade, 4%
Intereste Rate, 1%
World Trade, -3%
Other Ex. Shocks , 0.01%
Measured Impact of in External Shocks
A Comparison of External Shocks Impacts on GDP Growth
-1
-0.5
0
0.5
1
1.5
2
2.5
3
1987-91 1992-1995 1996-2000 2001-2005
Year
Red
ucin
g G
DP
Gro
wth
%
Terms of Trade Interest Rate World Trade Remaining 4 Minor Shocks
Counterintuitive Relationship between
External Shocks and GDP Growth GDP Growth Comparison
LDC Having Favorable vs. Unfavorable External Shocks
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
1973-77 1978-82 1982-86 1987-91 1992-95 1996-2000 2001-2005
Years
GD
P G
row
th R
ate
favorable unfavorable
Policy Responses
-- Attribution to LDC Economic Performance
Policy Response Roles• Synchronization Transmission Mechanism• Reducing External Shock Impact by
Improving Current Account Balance• ↑ measure of adverse external shocks,
↑ favorable impacts of policy responses• Policy responses correlate with the cycles
in LDC economic growth • Policy responses to the shocks might
cause future structural adjustments
Policy Response to External Shocks
Policy Responses as Economic adjustment
75%
58%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Improve Trade Ratio decreasing spending
Policy Responses
% o
f 30
LD
Cs
Policy Response to External Shocks
A Comparison of Policy Response Impacts
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1987-91 1992-95 1996-00 2001-05
Year
By Improving export penetration By Raising import replacement By Consumption contraction By Investment reduction
Policy Response to External Shocks
• The primary policy response was export penetration, averaging from 4.1% to 6.4%;
• The secondary policy response was import substitution, averaging from 2% to 3.9%;
• The investment reduction was the third and the consumption contraction the fourth;
• ‘Belt-tightening’ would sacrifice economic growth in both the long-run and short-term;
• Trade policies, served as a “gear” of economic synchronization.
A comparison of LDC GDP growth of adopting export penetration policy
A Comparison of LDC with Favorable vs. Unfavorable Changes of Export-Penetration
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
1973-77 1978-82 1982-86 1987-91 1992-95 1996-00 2001-05
YearFavorable Unfavorable
Tests and Analysis on Policy Responses
Methods:-Multiple Linear Dynamic Models-Stability Test and Chow Test
Tests and Analysis on Policy Responses(1)
• A Test of policy sensitivity to external shocks:(PRi = bi + bi ESi + ,)
• Statistic measurements provided by policy parameters
• Export penetration as the primary policy response
A Test of Policy sensitivity to external
shocks: PRi = bi + bi ESi + ,
where PRi = policy responses and ESi = External shocks Export penetration as the primary policy response
Regression Model: PRi = ES + Constant coefficient
(t-ratio for X coefficient)
R Squared
Export-penetration on external shocks
-0.77 -0.43 -6.12 * 0.22
Import-replacement on external shocks
0.5 -0.13 -2.2 0.03
Consumption-contraction on external shocks
-0.01 -0.03 -0.93 0.01
Investment-reduction on external shocks
-0.27 0.04 1.25 0.01
Notes: N = 139; * denotes statistically significant at the 1% level (one tail).
Tests and Analysis on Policy Responses(2)
• Trend analysis of long-run LDC export-penetration responses to external shocks: (EPi = a + bi ESi + )
• The impacts of export penetration policy on current-account balances were rising;
• That response tripled to 91% from 32% through the period of 1992-2005, almost doubled from the period of 1996-00.
LDC export-penetration responses to
external shocks in long-run? Model: EPi = a + bi ESi +
Period Constant (bi ) Coefficient **
(t-ratio) R Squared
1987-91 1.34 -0.32 (-3.04)* 0.22
1992-95 0.9 -0.37 (-4.17)* 0.34
1996-00 -4.84 -0.48 (-2.84)* 0.19
2001-05 -1.18 -0.91 (-5.46)* 0.5
Notes:* denotes statistically significant at the 1% level (one tail); ** Negative sign indicates reactions of domestic policies result in favorable; The impacts of export penetration policy on current-account balances were rising
Tests and Analysis on Policy Responses(3)
• Test the Consistency and the Continuity of Export Orientated Policy:
Chow Test was used:
F = (SSR2/df2)/(SSR1/df1)
Result: No presence of structure break
High-Growth LDC versus Low-Growth LDC(1)
• Export-penetration policy efforts differentiated high-growth LDC (HLDC) from low-growth LDC (LLDC)
• Export-penetration policy was used more by HLDCs than by LLDCs to offset external shocks.
High-Growth LDC versus Low-Growth LDC (2)
• HLDC export oriented policy accounted for 55 cents, offsetting every dollar loss caused by external shocks to the current account balance;
• HLDC export oriented policy measure was 120% greater than the measure of LLDC policy response, accounted for only 25 cents;
• HLDC experienced three times as much external shock as LLDC did in the period 1987-2005.
Why did some LDCs perform better when they were facing more substantial external shocks?
Why..?
• The greater measures of external shocks that LDCs experienced, the more open their economies were
Why..?
• The greater measures of external shocks forced those LDCs to make some necessary economic adjustments, especially, adopting export oriented policies to offset the adverse impact of external shocks.
Why…?
• LLDCs minimized their exposure to external shocks, but also minimized their opportunities.
For Instances:– Lacking of foreign direct investment (FDI)
means lower current-account deficit– Less Trade results less the shock of terms of
trade
Thanks. Questions please.
Martin K. Zhu, Ph.D.
Senior Economist
U.S. Department of Agriculture