1. SETTING THE BASELINE/ CREATING A FORECAST USING MFMOD- A SHORT GUIDE

2. Outline 1. Baseline setting framework in MFMOD 2. Understanding economic context pre-MFMOD 3. Baseline setting steps in MFMOD 4. Consistency checks, tips & tricks 5. Hands-on exercise

3. 1. Baseline setting framework in MFMOD 1. 2. 3. Before using mode: understand current economic context Check & revise historical data Always go from the most exogenous to most endogenous • Exogenous-global: commodity prices, trading partner growths/EXR/inflation, U.S. interest rates (policy & debt interest rates)  PXKEY/PMKEY, XMKT • Exogenous-country: Inflation Target Technical assumptions: always set Change in Inventories, Statistical Discrepancies and Net Taxes on Production as 0% contribution to growth OR fixed %GDP Fiscal expenditure: use government budget Use model suggestions & add-factors to identify structural breaks, outliers, business-as-usual behaviors … • Prices (t)  NIA-Expenditure: G, X, I, C, M  NIA-Production  Fiscal revenues  Balance of payments Forecast 1 year at a time Near years: forecasters have a lot of current information the model does not have  utilize outside information to form “judgment-assisted” forecast Outer years: model has more “economic intelligence” to offer  use model suggestion to form “model-based” forecast 10. Check, discuss, and revise forecast 4. 5. 6. 7. 8. 9.

4. 1.1. Understand the Economic Context: Pre-MFMOD 1. Discuss with colleagues working on macroeconomic monitoring/forecasting or previous users of MFMOD: • Any models (outside of MFMOD) that can be used to develop sound forecast/assist judgement: nowcasting, VARs, trend analyses … • Any specific tips/characteristics to look at in MFMOD? Check historical data before starting using MFMOD Understand key “economic dynamics” and “rules” of the economy • Growth over the past 5 years pre-COVID • Potential output? Current output gap? • Any fiscal rule and/or debt limit? • Inflation target/ price stability? 2. 3.

5. 1.3&4. Use MFMOD to get a baseline: exogenous variables & technical assumptions Set all sheets into Exogenous All mode  Solve  Check if anything is moving • If no  continue working • If yes  check model creation for identities, add factors, large values. Still in Exogenous All mode: set contribution to growth of Change in Inventories & Statistical Discrepancies to 0 in forecast period  Solve • Forecast should not be driven non-fundamental variables Still in Exogenous All mode: set %GDP of Net Taxes on Production to fixed shares in forecast period  Solve • Ideally the last historical value • If shares changing  substantiated by change in tax policy 1. 2. 3.

6. 1.3&4. Use MFMOD to get a baseline: exogenous variables & technical assumptions Reflect commodity price forecast from external sources in “commodities” tab  Solve • For NP, Oil most important  must update, at the minimum • Also update Oil Production volume • Current source: World Bank Commodity Markets Set foreign variables (growth, inflation, exchange rates) in “global” tab  Solve • Sources: IMF-WEO, WB-MPO Set Exchange Rate based on understanding of inflation, monetary policy, and past trends  Solve • Exchange rate: very hard to forecast  safe bet: set forecast values to the last historical value • NPL has a pegged exchange rate to India  skip Solve. 4. 5. 6.

7. 1.5. Use MFMOD to get a baseline: government budget Add Fiscal Expenditures based on budget and past execution rates to get realistic forecast  Solve • Ideally solve in “l” or “g” mode for variables affecting NIA via quasi-identities 7.

8. 1.5. Use MFMOD to get a baseline: NIA 8. Prices • Prices should converge to inflation expectation in the long-run; short-run dynamics reflect output gap, external conditions, and policy interventions. Exports & Imports: can use PXKEY & PMKEY (function of global commodity price) to help you  Exchange rates normally play a role, but not in NPL ∆??,?= ∆?????,?  Term-of-trade (TOT) is proportional to real exchange rate movements (i.e a TOT improvement implies a real exchange rate depreciation) ?? ?? C, G, I deflators should move in line altogether  Can use high-frequency CPI data to inform forecast  Good idea to solve G & I deflators in endogenous mode (as functions of C deflator) • ∆ ∝ ∆???? •

9. 1.5. Use MFMOD to get a baseline: NIA 9. National Income Account - Expenditure • After setting budget and prices, we already have G & ??defined. • Exports: 3 approaches  Take model suggestion  Take dynamic path of the model suggestion, not the values  Put in the path based on your own judgement (for example, OPEC’s oil production projection) • Consumption: f(wage, employment)  Long-run nominal wage grows in line with prices and productivity (measured as TFP); prices are set and TFP given  nominal wage set.  Short-run nominal wage depends on unemployment gap (??? − ???∗).  Employment:  Long-run : ? = ?? − ???∗(??).  Short-run depends on differential between wages & domestic prices  Public sector dominant in Iraq  use government plan to derive short-run employment.

10. 1.5. Use MFMOD to get a baseline: NIA 9. National Income Account - Expenditure • Private Investment  Long-run:  Short-run: Private Investment aims to close the gap between user cost of capital (UCK) and marginal product of capital (MPK)  If UCK > MPK  Investment should fall, and vice versa  If the economy has dominant public sector  can link Private Investment to Government Expenditure ?? ??)  Use model suggestion to guide your forecast • Make sure output gap closes over time ? ?= ∆????+ ? • Imports: f(domestic demand, relative prices

11. 1.5. Use MFMOD to get a baseline: misc. 10. National Income Account - Production • Remember these binding identities: ?????= ?????− ?? ? = ?????− ??? − ???  Use real-time production data to drive forecast 11.Fiscal revenues • ??? ??????? = ????? ??? ???? ∗ ????????? ??? ????  Proxy tax bases are already calculated in nominal GDP components  done • Non-tax revenue: use model suggestions or constant %GDP as first-pass 12. Balance of payments: • Goods and non-factor services: already determined in nominal GDP  what we can do here is to determine the composition of merchandise vs. services. • Primary and secondary incomes: adjustment tools to get desired Current Account Balance • Financial and capital account: safe bet is to preserve %GDP; use higher-frequency BOP data for adjustment

12. 4. Check, discuss, revise Check main baseline results in “Reports” tab  Narrative clear? Any economic inconsistency? • Growth vs. inflation • Fiscal vs. debt • Fiscal expenditure vs. government consumption • Trade in National Income Account vs. Current Account Balance Discuss with colleagues for feedback/views Compare current forecast with other agencies/institutions Adjust as necessary 1. 2. 3. 4.

13. 4. Consistency checks Gaps (over medium term) • Output gap closing? • Unemployment gap? Prices (over medium term) • Do prices converge? • Terms of trade consistent with real exchange rate movement? Growth rates (over medium term) • GDP at market price and GDP at factor cost grow in line? If not  check Net Taxes as % GDP • Services in line with Consumption? • Imports in line with domestic demand? • Exports in line with foreign demand? • Nominal wage in line with inflation? • Consumption in line with GDP & real wage bill? If not, savings either rising or failing • Tax revenues in line with respective tax bases?

14. 4. Consistency checks Elasticities For most countries, the income elasticity of consumption and imports are roughly equal to 1. Elasticity of consumption to output should be roughly = 1 Elasticity of services to consumption should be roughly = 1