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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