12. Absorption is taken to represent the sum of private consumption, domestic investment, and government expenditure (IMF 1987).

13. It is also possible to base the analysis on the balance sheet of the central bank instead of that of the banking system as a whole. The policy variable would then be changes in the net domestic assets of the central bank and not domestic credit expansion. The balance sheet identity would be stated in terms of reserve money (the currency held by the public and the reserves of commercial banks). The total money supply would then be a function of the reserve money. See Polak (1998) and IMF (1987) for details.

14. When calculating the quantity of money in an economy, M1 stands for currency, plus the demand deposits held by nonbank institutions. M2 is based on a broader concept and is equal to M1, plus savings and time deposits in commercial banks.

15. This extended Salter-Swan model is commonly known as the 1-2-3 model because it represents one country, two sectors of production (exports and domestic goods), and three commodities (exports, domestic goods, and imports).

16. The use of a CET production-possibility frontier may be viewed as a reduced-form interpretation of the framework. Devarajan, Lewis, and Robinson (1990) show how to specify the model as a standard CGE model with the explicit use of production functions and a consideration of factor markets.

17. There is an inverse relationship between the demand for a commodity and the price of the commodity.

18. It is important to keep in mind that the core model here is the 1-2-3 model that is used to derive the aggregate income and key relative prices. Nothing prevents the analyst from adopting a different configuration for the other components. For the macro-framework, a government development plan can be used, or other growth regressions such as Barro’s can be employed. For the poverty module, one could use POVCAL or PovStat or even a microsimulation model.

19. Easterly (1999) refers to the current version of the growth model employed at the World Bank as the “financing gap model” in view of the fact that its most important uses involve determining growth prospects and the associated financing shortfalls.

20. One could add a fourth asset: bonds issued by the government to borrow money from the general public. This addition would not alter the basic logic presented in the text.

21. In a critique of the use of this model in short-term growth analysis, Easterly (1999) notes that, in both the neoclassical and endogenous growth models, the ICOR can be constant in a steady state. In the neoclassical framework, this steady state ICOR is equal to the ratio of the investment rate to the sum of population growth and the rate of laboraugmenting technical progress. Furthermore, this constancy does not imply a causal and proportional relationship between investment and growth. Finally, he argues against viewing the ICOR as an indicator of the quality of investment.

22. This is possible because, once imports are known, all other components of this identity are determined except private investment. In particular, real GDP is determined from the ICOR and the total investment during the previous period. Exports are projected exogenously. Private consumption is specified as a fraction of disposable income, and government consumption and investment are each a fraction of GDP.

23. The current level of the overall price index is equal to the money supply multiplied by the velocity of money, divided by nominal income.

24. The simplest version presented in textbooks is commonly called the Keynesian cross.

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