# The Moorish Wanderer

## The Big Picture – Part 5

Posted in Dismal Economics, Flash News, Moroccan Politics & Economics, Morocco, Read & Heard by Zouhair ABH on May 16, 2012

evidence shown on my last piece points out to foreign trade as a major factor in output cycles and its growth. The initial proposed model has therefore to be readjusted accordingly, through the TFP process, and the relation it bears with the Balance of Payments; and so:

$\log z_t = \rho z_{t-1} + \tau bp_{t-1} + \epsilon_{t-1}$

$\log bp_t = \rho bp_{t-1} + \tau z_{t-1} + \upsilon_{t-1}$

where $\rho$ is the persistence parameters, and $\tau$ the cross-persistence parameter that captures transmission shocks between TFP and balance of payment; both processes displays the following properties:

$E(z_t) = \rho E(z_{t-1}) + \tau E(bp_{t-1}) + E(\epsilon_{t-1}) = 0$

and that is so because the empirical data shows it: the long-run shows both the Balance of payments and the Solow Residuals converge to a zero.

$var(z_t) = \rho^2 var(z_{t-1})+\tau^2 var(bp_{t-1})+ var(\epsilon_{t-1})+ 2 cov(z_{t-1},bp_{t-1})$

equivalently,

$E(bp_t) = \rho E(bp_{t-1}) + \tau E(z_{t-1}) + E(\upsilon_{t-1}) = 0$

and

$var(bp_t) = \rho^2 var(bp_{t-1})+\tau^2 var(z_{t-1})+ var(\upsilon_{t-1})+ 2 cov(z_{t-1},bp_{t-1})$

Both parameters $\rho$ and $\tau$ are then estimated by computing the TFP residuals on HP-filtered data. Recall:

$\log y_t = \alpha \log k_t + (1- \alpha) \log n_t + z_t$

we also have: $cov(z_{t-1},bp_{t-1}) = corr(z_{t-1},bp_{t-1})\sigma_{z}\sigma_{bp}$

Balance of Payments and the Exchange Rate exhibit a strong positive correlation, starting from the mid 1970s.

The graph makes the case for the constructed balance of payments to capture the effects of international trade – starting from the mid 1970s, the discrepancies between Investment and Savings captured by the Balance of Payments, and the exchange rate with the Dollar have locked up in a strong positive co-movement; the exchange rate isn’t set arbitrarily: it has real impact on input cost, on growth projections and consumption across the board. We have now a good insight on how foreign trade impacts growth performance. (The data still does not incorporate government expenditure)

Computations on parameters $\left( \rho .\ \tau .\ \sigma_{z} .\ \sigma_{bp} \right)$ yield:

we get:

$\tau = .4324$

$\rho = .2723$

we observe the condition for $\left| \rho+\tau \right| < 1$ is acquired, and the results might, at this point, explain the discrepancies pointed out earlier: the persistence parameter is significantly weaker as the Balance of Payment shocks are incorporated into the structural process before they get into the economy; we observe the variance-covariance matrix displays the following values:

Variables       e         u
e            0.004600  0.006510
u            0.006510  0.009214

It makes sense, since these in turns carry part of the unobservable shocks in a closed-economy, and because foreign inflows of capital are critical to the national investment, and thus to output growth, the cross-persistence parameter is more significant; yet another piece of evidence that any sensible public policy to boost growth is NOT to shut down foreign trade (a gentle wink to the protectionist left-wingers out there). We do notice that Capital accumulation in Morocco relies heavily on foreign inflows, and by implication, output growth as well. Structural shocks, to that effect, are a kind of a buffer between exogeneous, unexpected shocks, and the economy: transitory shocks are captured by structural shocks rather than those attached to the

the results are very much in line with prediction on standard RBC, only this time numbers fit a lot better, as they show below. There are still some problems on the Labour side, and public finances’ effects on cycles are yet to be estimated; but so far, the picture looks great 🙂

   Data   |σ       |σj/σy  |Corr(y,j)|
----------+--------+-------+----------
Y_GDP     |0,08030 |1       |1       |
----------+--------+-------+---------+
Con       |0,07013 |0,87339|0,82150  |
----------+--------+-------+---------+
Capital   |0,09167 |1,14159|0,4448   |
----------+--------+-------+---------+
Investment|0,24127 |3,00463|0,83690  |
----------+--------+-------+---------+
Labour    |0,09806 |0,81888|-0.8670  |
----------+--------+-------+---------+
Government|0,22035 |2,74415|0,49970  |
--------------------------------------
RBC     |σ      |σj/σy |Corr(y,j)|
------------+-------+------+----------
Y_GDP       |0,06596|   1  |    1    |
------------+-------+------+----------
Consumption |0,04715|0,7148|  0,5092 |
------------+-------+------+----------
Investment  |0,20460|3,1018|  0,8766 |
------------+-------+------+----------
Government  |         No Data        |
------------+-------+------+----------
Labour      |0,00002|0,0003|  0,0238 |
--------------------------------------
New RBC   |σ      |σj/σy |Corr(y,j)|
------------+-------+------+----------
Y_GDP       |0,0631 |   1  |    1    |
------------+-------+------+----------
Consumption |0,0455 |0,721 |  0,9515 |
------------+-------+------+----------
Capital     |0,1268 |2,009 |  0,7060 |
------------+-------+------+----------
Government  |         No Data        |
------------+-------+------+----------
Labour      |0,0126 |0,199 |  0,7183 |
--------------------------------------