An aggregate-level macro model for the Indian economy

Yoshino, Naoyuki et al. Working Paper An aggregate-level macro model for the Indian economy ADBI Working Paper Series, No. 1201 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Yoshino, Naoyuki et al. (2020) : An aggregate-level macro model for the Indian economy, ADBI Working Paper Series, No. 1201, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: https://hdl.handle.net/10419/238558 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/3.0/igo/ ADBI Working Paper Series AN AGGREGATE-LEVEL MACRO MODEL FOR THE INDIAN ECONOMY Naoyuki Yoshino, Rajendra N Paramanik, K U Gopakumar, Farhad Taghizadeh-Hesary, Ma. Laarni Revilla, and K E Seetha Ram No. 1201 December 2020 Asian Development Bank Institute The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. Some working papers may develop into other forms of publication. Suggested citation: Yoshino, N., R. N. Paramanik, K. U. Gopakumar, F. Taghizadeh-Hesary, M. L. Revilla, and K. E. Seetha Ram. 2020. An Aggregate-Level Macro Model for the Indian Economy. ADBI Working Paper 1201. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/aggregate-level-macro-model-indian-economy Please contact the authors for information about this paper. Emails: [email protected], [email protected], [email protected], [email protected], [email protected], [email protected] Naoyuki Yoshino is Professor Emeritus at Keio University, Tokyo, Japan and Director of the Financial Research Center, Financial Services Agency, Japan. Rajendra N Paramanik is an Assistant Professor at the Department of Humanities and Social Sciences of the Indian Institute of Technology, Patna, India. K U Gopakumar is an Assistant Professor at the Department of Economics of the Sri Sathya Sai Institute of Higher Learning, Prasanthi Nilayam, India. Farhad TaghizadehHesary is an Associate Professor of Economics at Tokai Univ ersity, Tokyo, Japan. Ma. Laarni Revilla is a Research Associate at the Asian Development Bank Institute (ADBI), Tokyo, Japan. K E Seetha Ram is a Senior Consulting Specialist for Capacity Building and Training Projects at ADBI and Visiting Professor at the Center for Spatial Information Science of the University of Tokyo, Japan. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they rep resent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to forma l revision and correction before they are finalized and considered published. Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2020 Asian Development Bank Institute ADBI Working Paper 1201 N. Yoshino et al. Abstract This research piece is an empirical attempt to model the Indian economy at an aggregate level with annual data, ranging from 1980 to 2019. The major theoretical premise of the paper mimics the New Keynesian framework, which is based on the microeconomic foundations of Keynesian economics. The paper proposes a whole economic structure in the form of nine equations. Aggregate demand is modeled with the help of four equations, representing consumption, private investment, exports, and imports. Aggregate supply assumes the form of a simple neoclassical production function where labor, capital, and exogenous technical progress are considered as inputs. Further, inflation is assumed to follow a New Keynesian representation whereas the LM curve has its standard form with income and short-term rate of interest as its determinants. Subsequently, a linking equation, expressing long-run interest rates as a function of short-term interest rates and government investment, is proposed to unify monetary policy and fiscal policy to goods markets. Finally, tax is estimated as a function of per capita income. A structural equation model is employed for the empirical analysis and findings support the theoretical expectations. Consumption follows the absolute income hypothesis and private investment is governed by the accelerator principle. Further, the negative sign of nominal interest rates in the investment function confirms an inverse relation between the former and private capital formation. Exports are found to be influenced by world income, exchange rates, and government capital formation, and import demand is determined by domestic income, the difference between domestic and international inflation, and the lagged exchange rate. From the policy perspective, this paper suggests the suitability of fiscal and monetary policies for increasing growth in the Indian economy. However, the effectiveness of expansionary fiscal policy is observed to have a larger impact on growth than easy monetary policy. This inference is drawn mainly on the basis of a simulation exercise for the proposed structural equation model. Keywords: New Keynesian model, structural equation model, Indian economy JEL Classification: C36, E1, E270 ADBI Working Paper 1201 N. Yoshino et al. Contents 1. INTRODUCTION ............................................................................................................ 1 1.1 Macroeconomic Overview of the Indian Economy Since 1980 ....................... 1 2. DATA AND MODEL ....................................................................................................... 3 2.1 Data and Their Definitions ................................................................................. 3 2.2 The Theoretical Framework of the Analysis ...................................................... 4 2.3 The Empirical Framework for SEM.................................................................... 5 3. EMPIRICAL RESULTS .................................................................................................. 7 3.1 Policy Simulation from SEM ............................................................................ 10 4. CONCLUSIONS ........................................................................................................... 13 REFERENCES ........................................................................................................................ 14 APPENDIX 1: COMPLETE MODEL WITH IDENTITIES AND DEFINITIONS ....................... 16 1 Estimated Model .................................................................................................. 16 2 Definition and Identities ....................................................................................... 16 ADBI Working Paper 1201 N. Yoshino et al. 1 1. INTRODUCTION India embarked on a major reform to liberalize its economy in the year 1991. But there had been a gradual and effective policy-level effort to loosen import and business controls since the 1980s, which reached its culmination a decade later. India’s growth story has been rewritten since then and prior to the current pandemic; India was the fifthlargest economy in terms of size and the fastest trillion-dollar emerging economy in the world. This paper is an empirical attempt to chronicle this four-decades-long dynamic growth in a comprehensive macroeconomic framework, and it also offers a suitable policy prescription to enhance economic growth through appropriate fiscal and monetary policy measures. To attain our aforementioned objectives, we segregated the whole economy into eight major components, each represented by an equation. This holistic framework is premised considerably on New Keynesian theoretical philosophy, where a simple Keynesian consumption function is included along with an investment function, which is motivated by the accelerator principle. However, an augmented version of the Phillips curve is proposed, which incorporates backward-looking inflation expectation to corroborate the Indian experience where inertia plays an instrumental role in deciding the future dynamic of inflation. A two-stage least squares technique, a variant of the structural equation model (SEM), is employed for the analysis in which equations for consumption expenditure, private capital formation, external sector comprising import and export, supply side of the economy, inflation dynamic, tax collection, and money demand function are considered. Further, a bridge equation is also proposed that unifies the fiscal and monetary policy variables in the proposed framework. Finally, to assess the model’s efficacy in predicting the effect of expansionary monetary and fiscal policy interventions, a simulation is carried out for the past 10 years from FY2009‒2010 through 2018‒2019. This is done by reducing the interest rate and increasing government capital formation as well as government consumption expenditure, respectively. Empirical findings from the simulation suggest the effectiveness of both fiscal and monetary policies.1 Expansionary monetary policy, as envisaged by a 100-basis point reduction in the short-term interest rate, leads to around a 4% increase in GDP. On the other hand, increases in two variables, namely government consumption expenditure and public capital formation, are considered as fiscal stimuli. Results indicate that a 10% rise in government consumption expenditure results in a 19.65% increase in output, whereas a 10% higher public capital formation raises output by 24.23%. The fiscal stimulus and economic growth are only sustainable if this can also generate revenue through tax collection. In both cases, tax collection increases by around 50%. Given that tax collection is already low in India, this increase is not surprising. 1.1 Macroeconomic Overview of the Indian Economy Since 1980 The Indian economy’s growth trajectory has been experiencing a gradual and consistent evolution since the 1980s. This dynamic growth can be mainly attributed to change in economic policies, adopted in different phases during the last four decades. A brief snapshot of India’s macroeconomic performance during this 40-year period is presented in Table 1. Internal factors, coupled with global attributes, led this journey 1 The effectiveness of the policies is judged by the average percentage change in the respective variable of interest when compared to its actual value. ADBI Working Paper 1201 N. Yoshino et al. 2 to a distinct destination where India has been recognized as growing from an underdeveloped economy to a promising emerging power on the global economic platform. During the period 1980‒1990, the rate of growth accelerated to an unprecedented level of 5.8% and this figure was surpassed by as few as eight out of 113 countries in the world. Post liberalization, during the period 1990‒1995, the growth rate marginally dipped to 4.70% due to structural changes, but it witnessed a further surge in the last five years of the previous century, i.e., up to 6.84%, followed by a consistent 5.65% growth during the first five years of the new millennium. From 2005 to 2010, the quinquennial growth rate of GDP is estimated at an all-time high of 6.92%. This was the phase in its history when the Indian economy recorded annual y-o-y growth rates close to 8% consistently for about eight years, from the fiscal year (FY) 2003‒04 to FY2010‒ 11, except for FY2008‒09. Following the 2008 subprime market crisis and its global impact, the Indian economy experienced a downward trend in output growth in successive years. This decay was further aggravated by the adverse impact of poor implementation of structural reforms, like demonetization in 2016 and GST in 2017. However, many argue in favor of the long-term benefits of such reforms, which can only be judged in the due course of time. Table 1: Macroeconomic Indicators: Quinquennial Averages from 1980 through 2020 GDP Growth Rate (%) Government Investment Rate (%) Private Investment Rate (%) Private Savings Rate (%) Inflatio n (%) Fiscal Deficit to GDP (%) 1980‒81 to 1984‒ 85 5.47 10.27 8.57 13.32 9.38 5.67 1985‒86 to 1989‒ 90 5.91 10.36 8.76 16.69 8.00 7.44 1990‒91 to 1994‒ 95 4.70 8.69 12.31 20.27 10.65 6.09 1995‒96 to 1990‒ 00 6.84 7.10 15.63 22.67 6.84 5.35 2000‒01 to 2004‒ 05 5.65 6.08 17.70 27.79 4.03 5.08 2005‒06 to 2009‒ 10 6.92 7.43 26.46 33.32 7.44 4.45 2010‒11 to 2014‒ 15 6.60 7.68 30.32 32.43 7.34 4.84 2015‒16 to 2019‒ 20 6.72 7.69 27.76 29.71 3.35 3.60 A granular look at different components of aggregate-level output is a very revealing and informative exercise in assessing the dynamic growth of the Indian economy. Though lately India has been experiencing a consumption-led growth, its initial economic propulsion was fueled by the private investment rate, which consistently rose from a meager 8.57% for the period 1980‒1985 to 30.32% in 2010‒2015. At the same time, public investment in India witnessed a secular downward trend, mainly caused by a sharp decline in infrastructure investment by government at varying levels, including state and central. The emergence of a middle class and transition in the demographic profile led to higher consumption in the last decade and brought down the otherwise strong resilient factor and strength of the economy, i.e., private saving. It registered steady growth from 13.23% in 1980‒1985 to an enviable 33.23% in 2005‒2010, cushioning its financial system against the global turmoil during the 2008 crisis. After the introduction of GST and demonetization, both the saving rate and the private investment ADBI Working Paper 1201 N. Yoshino et al. 3 rate declined, to 29.71% and 27.76%, respectively, during the period 2015‒2019. Further, on the fiscal front, India’s policy follows an orthodox stance to maintain a low level of fiscal deficit, which has ranged between its maximum value of 7.44% during the period 1985‒1990 and its lowest one of 3.60% from 2015 to 2020. Global experience suggests that any emerging nation like India is always susceptible to inflationary shocks, mainly caused by structural factors. Although India’s experience with high inflation, averaging around 9.5%, during the first one and half decades after 1980 was painful, it steered its monetary policy devices efficiently to contain inflation to a more comfortable level of an average of 6.41% in the subsequent two decades, i.e., between 1995 and 2015. The nation’s Apex Bank fixed a target level of a 4% inflation rate for a painless growth, and there is evidence of success and optimism in that direction since inflation was as low as 3.35% for the period 2015–2020. However, towards the end of FY2019–2020 and thereafter, like every other country across the globe, the Indian economy was severely hit by the Covid-19 crisis. The y-o-y growth of GDP in the first quarter of fiscal year 2020‒2021 has declined by 23.9%. The performance of various sectors reveals that all sectors except the agricultural sector have shown a declining trend in Q1 2020‒2021. The growth rates in service components like construction, trade, transport, and tourism have declined by about 50%. The manufacturing and mining industries have marked 39.3% and 23.3% declines, respectively. On the expenditure side, the investment rate during Q1 2020‒2021 has been as low as 22%, compared to an average of 30% in the past 10 years. Amidst this, the retail inflation in India has also surged significantly with its rates touching 7.61% in October 2020 the highest in the last six years. These signs are worrying as the monetary policy has already taken an expansionary stance to mitigate the crisis. On the fiscal front, the crisis has had a significant impact on deficits. According to the controller of general accounts (CGA) reports for September 2021, the fiscal deficit for the first two quarters has already reached 114% of the annual estimate for FY2020‒ 2021. 2. DATA AND MODEL 2.1 Data and Their Definitions The aggregate-level macroeconomic model for the Indian economy is estimated for the time period from 1980 through 2019. The year 1980 marks the inception of gradual liberalization policies for the Indian economy. The rate of inflation is calculated as the growth rates of the GDP deflator at 2011‒2012 prices. Further, the inflation expectation is calculated as the difference between the rate of inflation and the targeted rate of inflation at 4%. All the components of GDP and other variables taken at real prices follow the 2011‒2012 base year. Aggregate supply in the economy is taken as the long-run trend in the growth rates of real GDP derived using the Hodrick-Prescott (1997) filter. In the absence of a definite variable to capture technological growth for the time period, a linear time trend accounts for the technological growth. Capital stock in the economy is the real net capital stock in all three of the agriculture, industry, and service sectors combined. Labor is proxied by the ratio of the number of people in the working age population to the whole population. The shortterm rate of interest is the call money rate (CMR) and lending rates represent the longterm interest rates. Money stock is the M3 and is the stock of money accounted on the last Friday of March for the respective financial year. Real money stock is M3 divided by ADBI Working Paper 1201 N. Yoshino et al. 4 the deflator. Private savings are the total of household and private corporate savings. Food grain production is the total production of rice, wheat, coarse cereals, and pulses in a given year. Exchange rates are the value of the Indian rupee vis-à-vis the SDR based on the value of a basket of currencies, namely the US dollar, euro, yen, pound sterling, and renminbi. Forex reserves are foreign exchange reserves held by India at the end of the financial year. Tax is the total direct and indirect tax collected by the central and state governments. The growth rate of global real GDP is taken from the World Bank National Accounts data and the growth rate of World CPI from the International Monetary Fund’s international finance and statistics files. 2.2 The Theoretical Framework of the Analysis The basis of the theoretical framework for our study follows the New Keynesian macroeconomic approach presented in Figure 1. Aggregate demand is the basic goods market identity; it represents the IS curve. The total expenditure on output (𝑌𝑌) can be expressed as private consumption expenditure (𝐶𝐶), gross investment by government and public (𝐼𝐼), government consumption expenditure (𝐺𝐺), and net exports (𝑋𝑋−𝑀𝑀). In line with the Keynesian argument, consumption behavior fits into the absolute income hypothesis. Investment follows the accelerator principle, where it changes with acceleration of demand (Clark 1917). Further, exports and imports may be brought into this system to account for the performance of the external sector. The exchange rate could turn out to be important here. The money market is introduced through the LM curve specification. The rate of interest (𝑟𝑟) and level of income (𝑌𝑌) link the goods and money market. Figure 1: Framework of the Model Bringing in the key concept of the New Keynesian approach, i.e., the absence of full employment equilibrium, aggregate supply is (𝑌𝑌 �). In the Indian scenario, it is likely that there could be a mismatch between aggregate supply and demand and thus it is important to model them separately (Pandit 2000). Aggregate supply takes the form of a simple neoclassical production function developed by Solow (1957). It is a function of labor (𝐿𝐿) and capital (𝐾𝐾) along with exogenous technological progress (𝐴𝐴). The rate of inflation is represented as a function of past inflation expectations (𝜋𝜋𝑒𝑒) and output gap (𝑌𝑌−𝑌𝑌 �). This follows the New Keynesian Phillips curve representation of the rate of ADBI Working Paper 1201 N. Yoshino et al. 11 Figure 2: Actual ZY vs. Estimated ZY Figure 3: Growth Rates of Actual ZY vs. Growth Rates of Estimated ZY In light of these results, we have undertaken the following simulation exercises: 1. Expansionary monetary policy ‒ where the short-term rate of interest is lower than the actual rate by 100 basis points 2. Expansionary fiscal policy I – where the rate of growth of real government consumption expenditure is increased by 10%. 3. Expansionary fiscal policy II ‒ where government capital formation is taken 10% higher than the existing level. In all three cases, we expect real GDP to increase. The results are as follows. Figure 4 presents the simulated value for ZY for real vis-à-vis baseline ZY from FY2000 to 2001 onwards. ADBI Working Paper 1201 N. Yoshino et al. 12 Figure 4: Results from the Simulation Exercises The results are in line with expectations. In all three cases, the simulated value of ZY is found to increase when compared to the baseline ZY values. A 100-basis point reduction in the short-term rate of interest increases ZY by an average of 3.98%, whereas with a 10% increase in government final consumption expenditure and government capital formation, compared to baseline ZY, the simulated values for ZY are higher by an average of around 19.65% and 24.23%, respectively. Quite naturally, the impact of government capital formation is found to be stronger on ZY when compared to the influence of an increase in government private consumption expenditure and a reduction in interest rates. While lower interest rates drive ZY through higher private investment, expansionary fiscal policy has a direct bearing on ZY through the multiplier process. Moreover, since government capital formation is also a major determinant of exports, it could push ZY through higher exports too. The relative dominance of fiscal policy could be explained by the structure of the Indian economy. From a theoretical perspective, given the slope of the LM curve, fiscal policy is more effective when it is initiated at a low level of output compared to full employment equilibrium. In the Indian scenario, a closer observation of the output gap (𝑍𝑍𝑌𝑌𝑝𝑝−𝑍𝑍𝑌𝑌 �𝑝𝑝) reveals the gap being negative on many occasions, indicating growth actual output being lower than the long-run trend. The sustainability of expansionary fiscal policy is assessed by the tax buoyancy. Under fiscal policy I and II, the total tax collection is found to increase by an average of around 51.23% and 59.33%, respectively. It should be noted that the increase in tax collection shows a higher percentage increase when compared to ZY on account of the lower base for the former. Finally, with respect to the trade-off between growth and inflation, we find expansionary fiscal policies driving inflation higher when compared to the impact of lower interest rates. Inflation is on average 4% higher under fiscal expansion when compared to just about 0.40% under lower interest rates. This again corroborates the Indian scenario, where inflationary pressures from expansionary fiscal policies are quite dominant.3 3 Examples of this could be inflation arising from monetized deficits during the late 80s and early 90s and the episode of food inflation during the period 2006‒2011 when the inflation was widely regarded as demand driven. It was mainly due to a rural wage spiral caused by MGNREGA and stimulus to tackle recession (Rangarajan and Sheel 2013; Reddy 2013). ADBI Working Paper 1201 N. Yoshino et al. 13 4. CONCLUSIONS The current study is an attempt to capture the macroeconomic dynamics in India at an aggregate level. The study covers annual data from 1980 through 2019. The theoretical underpinnings of our analysis follow the New Keynesian framework based on the microeconomic foundations of Keynesian economics. The aggregate behavior of the economy is captured through nine equations forming the SEM. Aggregate demand is modeled under its four components, namely consumption, private investment, exports, and imports. Under this framework, government expenditure and government capital formation are considered exogenous. Aggregate supply takes the form of a simple neoclassical production function driven by labor, capital, and exogenous technical progress. The rate of inflation is taken as a function of output gap, past inflation expectations, and exchange rate. This follows New Keynesian Phillips curve representation. The LM curve specification is determined by income and short-term rate of interest. Linking monetary policy and fiscal policy to the goods market, long-run interest rates are determined by short-term interest rates and government investment. Finally, tax is estimated as a function of per capita income. The results from our empirical results support the theoretical expectations. Consumption follows the absolute income hypothesis. We also find evidence of private investment being driven by the accelerator. This is in tune with results obtained by Jangili and Kumar (2010). Further, the negative sign of nominal interest rates in the investment function depicts an inverse relation between the former and private capital formation. Exports are driven by world income, exchange rates, and government capital formation, whereas import demand is a function of domestic income, the difference between domestic and international inflation, and lagged exchange rate. The positive coefficient for the output gap in the Phillips curve formulation confirms the case of a positively sloped supply curve. In the Indian context, our results corroborate earlier studies like Paul (2009), Dua and Gaur (2010), and Goyal and Tripathi (2015). Finally, the paper offers suitable policy prescriptions for fiscal and monetary authorities to revive the economy. The effectiveness of such policies is evident from the simulation results of our proposed model. An expansionary fiscal policy in comparison to that of a monetary one is critical to the Indian economy’s structure since investment growth, induced by lower interest rates, lost its steam in propelling output due to several frictions and a weaker transmission mechanism. This necessarily implies the need to focus on prudent fiscal stances so as to steer the economy toward a sustainable growth trajectory in the future. ADBI Working Paper 1201 N. Yoshino et al. 14 REFERENCES Clark, J.M. 1917. Business acceleration and the law of demand. Journal of Political Economy 25: 217–235. Dickey, D.A. and W.A. Fuller. 1979. Distribution of the estimators for autoregressive time series with a unit root. Journal of American Statistical Association 74 (366): 427–431. Dua, P. and U. Gaur. 2010. Open economy Phillips Curve in developed and developing Asian countries. 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Yoshino et al. 16 APPENDIX 1: COMPLETE MODEL WITH IDENTITIES AND DEFINITIONS 1 Estimated Model 𝑍𝑍𝐶𝐶󰇗= 0.38 + 0.83∗𝑍𝑍𝑌𝑌󰇗𝑑𝑑 𝑍𝑍𝐼𝐼󰇗𝑃𝑃𝑝𝑝𝑝𝑝 = 1.97 + 1.91∗𝐺𝐺𝐺𝐺𝐺𝐺 󰇗𝑝𝑝𝑝𝑝𝑝𝑝 −1.65∗ 𝑅𝑅𝑅𝑅𝐼𝐼𝐿𝐿𝐿𝐿 + 1.44∗(𝑍𝑍𝑌𝑌󰇗𝑝𝑝−𝑍𝑍𝑌𝑌󰇗𝑝𝑝−1) 𝑍𝑍𝐸𝐸𝑋𝑋 󰇗 = −7.67 + 2.85∗𝑍𝑍𝑌𝑌󰇗𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑤𝑑𝑑𝑝𝑝−1 + 0.37∗𝐸𝐸𝑋𝑋𝑅𝑅 󰇗 + 0.41∗𝑍𝑍󰇗𝐼𝐼𝐺𝐺𝑤𝑤𝑝𝑝𝑝𝑝𝑝𝑝−1 + 0.45∗𝑍𝑍𝐸𝐸𝑋𝑋 󰇗𝑝𝑝−1 𝑍𝑍𝐼𝐼𝑀𝑀 󰇗 = −17.78 −0.56∗𝐸𝐸𝑋𝑋𝑅𝑅 󰇗𝑝𝑝−1 + 2.92∗𝑍𝑍𝑌𝑌󰇗 + 1.24∗(𝜋𝜋−𝜋𝜋𝑖𝑖𝑖𝑖𝑝𝑝) + 0.21∗𝐹𝐹𝑅𝑅𝑅𝑅𝐸𝐸𝑋𝑋 󰇗 𝑝𝑝−1 𝑍𝑍𝑌𝑌 � = 3.98 + 0.05∗𝑇𝑇𝑇𝑇𝑇𝑇ℎ+ 0.10∗𝑍𝑍𝐾𝐾󰇗𝑝𝑝−2 + 1.21∗𝑊𝑊𝑅𝑅𝐾𝐾𝑊𝑊𝑅𝑅𝑊𝑊 󰇗 𝜋𝜋= 3.98 + 0.54∗(𝑍𝑍𝑌𝑌𝑝𝑝−1 󰇗−𝑍𝑍𝑌𝑌 �𝑝𝑝−1) + 0.74∗(𝜋𝜋𝑝𝑝−1 −𝜋𝜋�𝑝𝑝−1) + 10.12∗𝐸𝐸𝑋𝑋𝑅𝑅 󰇗 − 0.08∗𝑄𝑄𝐹𝐹𝐺𝐺 󰇗𝑝𝑝−1 𝑅𝑅𝑅𝑅𝐼𝐼𝐿𝐿𝐿𝐿 = 3.00 + 0.91∗𝑅𝑅𝑅𝑅𝐼𝐼𝑆𝑆𝐿𝐿 + 0.19∗𝑁𝑁𝐼𝐼󰇗𝐺𝐺𝑤𝑤𝑝𝑝𝑝𝑝 ∆(𝑀𝑀 𝑊𝑊 ⁄) = 5297.08 +524.69∗𝑅𝑅𝑅𝑅𝐼𝐼𝑆𝑆𝐿𝐿 + 343.50∗𝑍𝑍𝑌𝑌󰇗 𝑇𝑇𝐴𝐴𝑋𝑋 󰇗= 4.92 + 0.80∗𝑁𝑁𝑌𝑌𝑝𝑝𝑝𝑝 󰇗 2 Definition and Identities GDP and Its Components ZC = ((ZC 󰇗/100 + 1) ∗ZCt−1) ZIPvt = ((ZI󰇗Pvt/100 + 1) ∗ZIPvtt−1) ZIGovt = ((ZI󰇗Govt/100 + 1) ∗ZIGovtt−1) ZGFCE = ((ZGFCE 󰇗/100 + 1) ∗ZGFCEt−1) ZEX = ((ZEX 󰇗/100 + 1) ∗ZEXt−1) ZIM = ((ZIM 󰇗/100 + 1) ∗ZIMt−1) ZY = ZC + ZIPvt +ZIGovt +ZGFCE +ZEX −ZIM ZY 󰇗=�(ZY −ZYt−1)−ZYt−1�∗100 ZY𝑑𝑑= (ZY −Direct tax) 𝑍𝑍𝑌𝑌󰇗𝑑𝑑=��ZY𝑑𝑑−ZY𝑑𝑑t−1�−ZY𝑑𝑑t−1�∗100 NY = (ZY ∗P)/100 NYPC = (NY/POPULATION) ZYpc 󰇗=��NYPC −NYPCt−1�−NYPC�∗100 Prices and Inflation P = ((π/100 + 1) ∗Pt−1) π� = (π−4) ADBI Working Paper 1201 N. Yoshino et al. 17 Capital Stock NIPvt = (ZIPvt ∗PIpvt)/100 NIGovt = (ZIGovt ∗PIgovt)/100 NI = NIPvt +NIGovt NK =(NKt−1 +NI −Depreciation) ZK =(NK/P)∗100 ZK 󰇗=�(ZK −ZKt−1)−ZKt−1�∗100 PIpvt and PIgovt are respectively deflator for private investment and govt.investment Tax Collection Direct Tax = (Direct Tax Ratio ∗Tax)/100 Tax = ((𝑇𝑇𝐴𝐴𝑋𝑋 󰇗/100 + 1) ∗Tax𝑝𝑝−1) Direct Tax Ratio = (Direct Tax/Tax)∗100