metadata: authors: 0: author: Faini,Riccardo
count: Morocco
docna: 0: docna: The macroeconomics of the public sector
            deficit : the case of Morocco
docty: Policy Research Working Paper
subtopic: Macro-Fiscal Policy,Taxation & Subsidies,Economic Adjustment and Lending,Public Sector Economics,International Trade and Trade Rules,Inflation,Public Finance Decentralization and
            Poverty Reduction
teratopic: Finance and Financial Sector Development
abstracts: cdata!: This paper tries to uncover the reasons
            underlying the performance of the Moroccan economy.  The
            author argues that wage moderation and judicious monetary
            policies were instrumental in restraining inflation.  With
            one brief exception in 1983, monetary authorities remained
            firmly committed to eschew any inflationary financing of the
            budget deficit.  This strategy could only succeed however
            because of the wide ranging system of credit and monetary
            regulations which worked to channel domestic funds toward
            the Treasury at relatively low costs.  The prospects for the
            continuation of such a strategy are not favourable however.
            As far as the growth performance is concerned, it appears
            that it can be attributed to an outstanding export response
            to the new trade regime on the one hand and a set of
            favourable supply shocks, including a string of record
            agricultural harvests and the collapse of real oil prices,
            on the other.  The paper studies the evolution of the budget
            and its different components and argues that the reluctance
            by Morocco's policy makers to monetize existing budget
            deficits is well explained by the sharply unfavourable
            trade-offs between higher monetization and inflation
            existing in Morocco.  It analyzes the implications that
            continuing budgetary disequilibria has on investment and
            saving decisions and finds that such implications may be
            substantial, even though they may not work their way
            exclusively through traditional interest rates channels.
geo_reg_key: 517202,119229,517191
repnme: repnme: The macroeconomics of the public sector
            deficit : the case of Morocco
display_title: The macroeconomics of the public
            sector deficit : the case of Morocco
listing_relative_url: /research/1991/03/700048/macroeconomics-public-sector-deficit-case-morocco
topicv3: Inflation m1326709 0870F4727ACED1CF8525815C00471347,Trade m1326924 698,Treasury m1327009 1045,Fiscal Policy m1327144 445,Taxation m1327615 1121
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Finance and Financial Sector Development
origu: Policy, Research & Ect Affairs
no_of_pages: 46
author_keys: 0: author_key: 142030
model_extractions: **Polizy, Research, and External Affairs**

;I IU3s **_-**

**Macroeconomic Adjustment and Growti**

WPS 631 'I'his papcr --- a product of' Itlc Macroeconomic Adjustment and (irowth Dlivision, Countr\ **ILconomn** ics Department -- is parn ol'a PRK research project, 'l'hc Macroeconomics ol lhc Public Sector- Delicit (RI") 675-31). Copies are available f'ree flrom tlhe World Biank, 1818 li Strect NW, Washington 1)DC (0113. Please contact Raquel l.u/, rootm N 1 1-057, cxtenisionl 34303 (39 pa-Cs).

Morocco's reccnt cconomic history rcsemlblcs those of'mansv At'rican countries. Morocco's economic dilf'iculties originated in the comiminodity (phosphate) boom of'tlic mid-1970s, which coincidcd with 1-isinig govenmeint spending and an unprecedented expatnsion of'public investment -- cndilg Morocco's earlier liscal conlservatisilm. A sudden revcrsal of the temis ol' trade in tie late 1970s -- a resull of'a plunge in phosphate prices and thc second oil shockprompted Mor. 'o to resort increasingly to external capital markets to maintain an unabated level of public spending.

But the continued deterioration ol' thc terms of trade and the unexpected rise in international interest rates, together with thc severe droughlt of' 1980-84, croded debt service capacity and precipitated a major forcign exchange crisis in 1983.

In response to this crisis, Morocco launchied a medium-term program of economic rceform and introduced comprehelisive stabilization and structural adjustment measures. Since 1983, Morocco has made great progress in alleviating - botn initernal and extcrnal disequilibria reducing the budget deficit from 9 percent of' GDP in 1982 to 4.5 percent in 1988, and the current account deficit from 12 percent of GDP to 0.4 percent in the same period.

Initerestingly, growth has remained Flairly high in Morocco, at least in relation to other highly indebted countries, and inflation subdued. Morocco's perfonrancc seems to contradict the perceived wisdom that large budget deficits will foster inflation. The inflation record is particularly surprising because Morocco achieved a 20 percent real depreciation in the 1980s.

Faini argues that ;Iage moderation an1d judicious monetary policies were instrumnental in restrainiig inflation. Wilih a brief exception in 1983, monetary autlhoNtics remained firmilv committed to avoiding inflationary financing of the budget delicit, But this sitrategy could succeed only becausc of the A ide-ranging system of credit and monetary rcoulationis thalt chiainncied domestic f'unids toward thc trcasIry' al relatively low cost. But the prospects for conltinuing such a stratcey are not f'avorable.

Grolth perforlimaince canl be attributed to an outstanidinlg export responise to thc new trade regimc anl(d to F1avorable supply shocks -- includinig a strinlg ol' record agricultural harvests and thc collapse of' real oil prices.

Morocco has made gr;eat pro-gress towvard macroeconomic and liscal stability but the autlio recommends:

* An unshaken commimntcii to Fiscal discipline. Increa,sed govermcint spending will probably crowd out investment, The shor-m--un **benclets on** output of suchl spendiiing may be outweighed by its long-runi negative impact on growth.

* A deteimined el'lfol to refborm thc tax and public expcnditure system, so ihe brunit of liscal adjustment wnill not again fall mostl) on public investment.

* Encouraging thc availability ol' credit, which significantily inilueinces the demand for investment.

* Studying thie imnpact ol' macrocconloilic equilibria, especially oi tihe government budget, to assess the best spee(I lfor finalncial liherali;ation.

Thc l'RE Working Ptaper Series dissvninates the findings or \kork under w\av in th. Bank's Po h.\, kewirk h and _E\toniia_ AffairsCompte\. An oh jictivc ofthl s'rics is lo ge tth.sac fmnhngs out e en i rpre. eorains a;. t. rtan thuicktv. ftlltv pot lie d The rindfinvs. intermretins. ncf:md conchiviions in rhese p.IVT'rs d(o not neee-(:riTV represent olh ial 11:ink p,th>

**f1r,.1** ut,\,, **I\s** tie I'Rft. **'lli !lI':.** ('t',:'
# The Macroeconomics of the Public Sector Deficit The Case of Morocco

by Riccardo Faini*

# Table of Contents

|1.|introduction|1|
|---|---|---|
|2.|The Dudget Deficit: Evolution and Financing|3|
||a. The overall trend<br>b. The primary deficit<br>c. Financing the budget deficit|3<br>5<br>7|
|3.|Assets Demand, Seigniorage, and the Inflation Tax|10|
|4.|Investment and Saving Decisions|17|
||a. The investment choice<br>b. The saving decision|17<br>21|
|5|Modelling the Impact of Fiscal Policy|25|
||a. A macroeconomic model<br>b. Simulating the impact of fiscal policy|25<br>28|
|6.|Conclusions|36|
|En|dnotes|37|
|Ref|erences|38|

* This paper is an offspring of joint work with John Porter and Sweder van Wijnbergen. I am grateful to both of them for stimulating discussions and suggestions. I would like to thank Klaus Schmidt-Hebbel and Tobias Muller for providing me with crucial data and a preview of their paper which has been a constant source of ideas and insights. I am finally grateful to Roberto Fumagalli for very skillful research assistance.
1

# 1. INTRODUCTION

Morocco's recent economic hlstory bears strlking resemblances with the one oF many countries in Africa. The origins of Morocco's economic difficulties can be traced to the commodity (phosphate) boom of the mild19<sup>7</sup> 0's which coincided wlth rislng government expenditure and an unprecedented expanslon of the public investment program signallng the end of the conservative Fiscal policies of the past. The sudden reversal in the terms of trade in the late 1970's as a result of the plunge In phosphate prices and the second oil shock prompted Morocco to resort Increasingly to external capital markets In order to malntaln an unabated level of public expenditure. However the continued deterloratlon of the terms of trade, the unanticipated rise in International Interest rates together with the severe drought In 1980-84 eroded debt service capacity and precipitated a major foreign exchange crlsls In 1983. In response to this crisis, Morocco launched a medium-term program of economic reforms and, In consultation with the International Monetary Fund and the World Bank, introduced a comprehensive set oF stabllizatlon and structural adjustment measures. Since 1983 Morocco has made great progress in allevlating both Internal and external disequllibria. The overall budget and current account deficits have been reduced from 9% and 12% of GDP in 1982 tc 4.5% and .4% respectlvely In 1988.

There are several interesting features In Morocco's adjustment experience. Despite the severity of the crisls and the size of the adjustment undertaken, growth has remained fairly high, at least In relation to other highly indebted countries, and inflatlon subdued. As measured by the CPI, inflation was equal to 6.2% in 1983, It Increased to 12.5% in 1984 but then steadily declined to reach 2.3% in 1988. During the same period real GDP growth averaged 4.3%. This performance seems to contradict the received wisdom that large budget deficits will foster inflation. The inFlation record Is particularly surprising if we also consider that Morocco achieved a 20% real depreciation during the eighties.

In this paper we try to uncover the reasons underlying the performance oF the Moroccan economy. To anticipate our concluslons, we argue that wage moderation and judiclous monetary pollcies were instrumental in restraining inflation. Wlth one brief exceptlon ln 1983, monetary authorities remained firmly committed to eschew any
2 inflationary financing of the budget deficit. This strategy could only succeed however because of the wide ranging system of credit and monetary regulations which worked to channel domestic funds toward the Treasury at relatively **lov/** coEt.-. The prospects for the continuation of such strategy are not favou-able however. As far as the growth performance is concerned, it Eppears that it can be attributed to an outstanding export response to the new trade regime on the one hand and a set of favourable supply, s.ucks, including a string of record agricultural harvests and the collapse of real oil prices, on the other.

The organization of the paper is as follows. In the next section, we study the evolution of the budget and of its different components. We also examine how the deficit was financed. In section 3, we argue that the reluctance by Morocco's policy makers to monetize existing budget deficits is well explained by the sharply unfavourable trade-offs between higher monetization and inflation that exist in Morocco. Such conclusions are based on the estimation of a system of assets demand. In the following section, we analyse the implications that continuing budgetary disequilibria entail on investment and saving decisions. We find that such implications may be substantial, even though they may not work their way exclusively through traditional interest rates channels. Frinally in section 5, we assemble the various pieces of econometric evidence collected in the paper to study the impact of fiscal policy in the context of a macroeconometric mGdel. The last section offers some conclusions.
3

# 2. THE BUDGET DEFICIT: EVOLUTION AND FINANCING

# _a) the overaUl trend_

The budget situation in Morocco registers a continuous deterioration during the second half of the seventies. Sorme timid attempts to macroeconomic stabilization provide only temporary restraint to the burgeoning financial needs of the Treasury. However at the beginning of the eighties the fiscal repercussions of the fali in Morocco's terms of trade, the increasing burden of foreign debt attendart on the steep rise oF International interest rates and the growing weariness of foreign commercial banks to provide continuing financing' to the Treasury bring to the forefront the issue of fiscal responsabilit y. As a matter of fact the budget deficit, measured on a cash-basis, shows a slow but steady decline starting in 1981. After increasing, as a percent of GDP, from an average value of 3.2% in 1971-1974 to 153% in 1976-1981, it declines to 8% in 1984-5 and appears to stabi]ize around 5% in the more recent years (Table 1).

Cash-based measures of the budget deficit can be however quite misleading. The Treasury may indeed resort to the use of financial arrears to cope with mounting financial difficulties. This Is indeed what happened in Morocco until 1985. Because cash-based deficits do .ot allow for the accumulation of financial arrears, they will fail to refle the full pressure that fiscal policy exerts on available resources. Conmersely, cash-based deficits will overestimate the size of the fiscal problem whenever financial arrears are being decumulated. Notlce in this respect that, after 1985, adjustment programs in Morocco have involved a sizeable reduction In the stock of a-rears. Overall, It Is more appropriate to treat the accumulation of arrears as a source of (involuntary) finance and measure the deficit on a payment order basis. If this is done for Morocco, the deficit plcture changes substantlally. Both the initial increase and the subsequent decline in the budget deflcit are more substantial when measured on a payment-order basis than on a cash basis (Table 2). This is simply due to the fact that arrears had been accumulated until 1985 and decumulated afterward.

A further correction relates to interest payments. As column 3 of Table 2 shows, the latter have steadily increased as a share of GDP, compounding therefore the budget difficulties. Yet allowance should be
4 made for the fact that, under infltionary conditlons, a pote, allly conspicuous share of Interest payments represents early amortiz, on of outstandlng debt and, as such, should be considered as a (riegative) financing component. For Morocco, historlcally low Inflation rates mean that thls correction is not going to produce dramatic effects. Its impact Is nonetheless substantial, albeit declining. From column 4 of Table 2, we can see that capital gaIns on domestic debt due to Inflation were equal to 3.1% of GDP in 1984. Due to the drop In Inflatlon, they then declined to 1.3% In 1988. As a Xesult the operatlonal budget, whlch only includes real interest payments, reglstered a relatively modest deficit In 198x and a surplus in 1986. We have also corrected for valuation effects In the stock of foreign debts, by multiplying the outstanding stock at the beginning of the perlod by the excess of domestic Inflation (measured by the change In the GDP deflator) over the rate of devaluatlon (taken with respect to the nomlnal effectlve exchange rate). We feel much less confident about this correctlon insofar it overlooks valuatlon changes due for Instance to cross currency fluctuations which appear to have played a substantlal role in determlning the evolution of foreign debt indlcators for Morocco. We nonetheless report the results of such correction (column 5). Its Impact Is baslcally Inslgnlficant in 1984, but grows over tlme as domestlc Inflatlc l is no longer matched by a corresponding devaluation.

The last measure we conslder is the primary deficit, which excludes all Interest payments. By excluding a component whlch Is to a large extent beyond the control of flscal authorlties, It provldes s more accurate Indicator of the effort to redress exlstlng fiscal Imbalances. The evolutlon of the prlmary deficit hlghlights the adjustment effort on the flscal front. The primary deficit was equal to 7.2% of GDP in 1983 a.nd has steadlly declined since then to reach a surplus of 1.9% of GOP In 1988. This amounts to a turnaround equal to nine percentage polnts of GDP. The Improvement In the overall and In the operational deficlts are less signlflcant due to the Increased burden of respectlvely nomlnal and real Interest payments.

Summing up, it Is undeniable that Morocco has taken a declslve step on the road to redress its fiscal Imbalances. The substantlal achievements In the overall budget reflect an even more slgnlflcant Improvement In the primary deficit whlch more than compensated the rlslng burden of nomlnal Interest payments. The favourable evolutlon of
5 the budget was also facilitated by low and even negatlve real Interest rates on domestlc debt. Thls situatlon Is however comlng to an end and the Treasury Is now Forced to offer positive and hlgh real rates oF return to convince domestlc Investors to finance Its deflclt. The average cost of servlilng domestic debt Is likely to rlse qulte rapldly In the near Future, underscorlng the need for contlnulng flscal restralnt.

# _b) the primary deficit._

In this section we shall examine how the slzeable reductlon In the primary deficit was achleved. The relevant data are contained In Table 3. It is apparent how the burden of adjustment fell mostly on publlc Investment which registered a major fall fron 11.54% of GOP at the onset of the adjustment program In 1982 to only 3.61% In 1986 and recovered then, but only marginally, to around 6i In 1987 and 1988. The drop In public investment was therefore the major contrlbutlng factor In the process of fiscal retrenchment. Thls Is an unfortunate feature of the adjustment proc'ess that Morocco shares wlth many other developing countries. We shall find in a later sectlon how the decline In publlc Investment may have negatively affected the prlvate sector propensity to Invest. Table 3 shows how other Items also provlded a sizeable contribution to flscal restraint. Expenditure on goods and services fell somewhat, reflecting mostly the drop in public employees real wages and the more sober trend in public employment. Simple econometric analysis (not reported here) shows that expendlture on goods and services is not related to It ':on, suggestlng therefore that the latter was not paramount in reduL- ig public sector real wages. Finally we find that also the share of subsldies In GDP fell substantially mainly because the decline in Imported food prlces reduced the need for government Interventlo. . This Is Incldentally an interesting example of the direct impact of terms of trade fluctuatlons on the budget.

A comparison between the evolution of the primary deficit, as reported in Table 2, and the behaviour of public expenditure in Table 3 already suggests that taxation did not provide a noticeable cuntribution to the Improvement In the budget. As a matter of fact taxation as a percentage of GDP fluctuates around 21% (Table 4). Had It not been for the windfall revenue attendant on the petroleum levy introduced In 1986, fiscal revenues would have actually registered a major decline over the
6 perioA 1983-'88. There are several causes behind thls unsatisfactory evolutio-i. On the one hand this was a time where, with t'ie support oF the World Bank and the IMF, the Moroccan government Introduced some far-reaching reforms in the system of both direct and indirect taxatlon. For instance the introduction of VAT in 1986 Is expected to represent in the medium-run a more efficient and more reliable source of revenue. Due to implementation problems it was however accompanied upon its Introduction by a revenue shortfall. Similarly the overhaul in the system of direct taxation with the phasing out of a set of Income taxes differentiated according to income sources and thelr consolidatlon Into - unique tax Is not likely to contribute to the budget In the very short-run. Other factors may also have helped to determine the evolution of tax revenues. For Instance it is often argued that high inflation will reduce the real value of tax revenues because of delays in revenues collectlon. This effect is unlikely to be significant in Morocco because of relatlvelv low inFlation levels and may also have been offset by the bracket creeo mechanism where taxpayers in an unlndexed system are taxed **aL** increasing rates because of the Impact of inflation on nomlnal inrnomes. Agaln econometric evidence does not suggest a slgnificant relatlon between the share of tax revenues in GDP and the level of Inflation.

A further noticeable factor which affected the evolution of government revenues was the process of trade reform. In 1984, with the support of the World Bank, the Morocco government, in an attempt to rationalise the trade regime and reduce the protection to importsubstituting productions, chose to substantially reduce Import duties and gradually phase out the so-called special import tax, an across the board tariff. The revenue shortfall attendant upon this measure was estlmated to reach 4% of GDP. Continuing budgetary difficulties prompted a reassessment of the sitjation. In 1987 the special import tariff had its rate inlcreased to 12.5%, from 5%, and its name changed (to fiscal import duty). This policy shift is likely to lead to a growing contribution of trade taxes to government revenues. The last column of Table 4 highlights the impact of terms of trade fluctuations on fiscal revenues. In Morocco production and trade of phosphate products (the main foreign exchange earners for the country) are controlled by the Office Cherifien des Phosphates (OCP), a public eneterprise. The latter contributes to the Treasury budget through tax and dividend payments. As shown in the Table, these contributions
-6a-

# TA3LE 1

|(cash-basis,<br>|BUDGET DEFIrCT<br>before debt relief,<br>ir, p|erzent of GDF)|
|---|---|---|
|Years<br>19''<br>|Years<br>2.9;<br>198:<br> <br>|13.64<br>|
|1972<br>1973<br>|4.01<br>1982<br>2.C:<br>1983<br> <br>|9.22<br>11.51<br>|
|19I4<br>|3.9<br>1984<br> <br>|8.07<br>|
|1975<br>|9.5'<br>1985<br>'<br>|8.57<br>|
|1976<br>|12.C<br>1986<br> <br>|5.69<br>|
|197,<br>|15.84<br>1987<br> <br>|6.11<br>|
|1978<br>1979<br>1S8^|11.28<br>1988<br>15.1-<br>9.0'|5.45|

Scurce: _World Ba-.K_ data<sup>base.</sup> TABLE 2

||BUDGET|DEFICITS: VAR-CUS<sup>DEFINITIONS</sup><br>(as a share of GDP)<br>|
|---|---|---|
||c|sh basis<br>payment order interest<sup>capitalgains</sup>|
|||<br> <br>basis<br>pavments<br>cn dom. debt|
|||0115<br>012I<br>0049<br>na|
|1983<br>||.<br>.<br>.<br><br> <br>C112<br>0061<br>0031|
|1984<br>||0.081<br>.<br>.<br>.<br> <br>0096<br>0062<br>0030|
|1985<br>||0.086<br>.<br>.<br>.<br> <br>0053<br>0059<br>0035|
|1986<br>||0.057<br>.<br>.<br>.<br> <br>0057<br>0059<br>0022|
|1987<br>||0.061<br>.<br>.<br>.<br>00<br>0041<br>0060<br>0013|
|1988||.55<br>.<br>.<br>.<br>|
|||capital gains<br>operational<br>primary<br>on foreig.n debt<br>deficit<br>deficit|
||1983|na<br>na<br>0.072|
||<br>|<br> <br><br> <br>0081<br>0051|
||1984<br>'|0.005<br>.<br>.<br> <br>0066<br>0034|
||198<br>|0.019<br>.<br>.<br>0017<br>0018<br>-0006|
||1986<br>|.<br>.<br>.<br>0034<br>0035<br>-000l2|
||1987<br>1988|.<br>.<br>.<br>0.045<br>0.027<br>-0.0'.)|

Source: 'orld Bar. data<sup>base</sup> TABLE 3

|(b|CENTRAL<br>efore debt|GOVERNMEN<br>relief,|T<br>EXPEND<br><sup>in percen</sup>|ITURE<br><sup>t of GDP)</sup>||
|---|---|---|---|---|---|
|Years<br>1971<br>|Current<br>14.12<br>|Capital<br>3.72<br>|_G_& S<br>12.51<br>|Interests<br>1.01<br>|Subsidies<br>0.60<br>621|
|1974<br>|19.25<br>|5.77<br>|12.20<br>1444|0.85<br>150|.<br>263|
|1977<br>|18.58<br>|18.93<br>|.<br>|.<br>|.<br>221|
|1979<br>|19.46<br>|12.89<br>|15.05<br>|2.19<br>|.<br>530|
|1981<br>|24.60<br>|12.33<br>|15.42<br>|3.88<br>486|.<br>381|
|1983<br>|23.72<br>|9.64<br>|15.05<br>|.<br>608|.<br>429|
|1984<br>|24.00<br>|8.09<br>|13.63<br>|.<br>|.<br>423|
|1985<br>|23.09<br>|7.18<br>|12.63<br>|6.23<br>592|.<br>250|
|1986<br>|20.62<br>|3.61<br>|12.20<br>|.<br>1|.<br>181|
|1987<br>|20.36<br>|6.03<br>|12.64<br>|5.9<br>|.<br>213|
|1983|2^.3:|6.34|12.17|6.01|.|

Sc_rce: Worit Ear k da:a tese.
7 r-earhed a p-ak in _197/1_ Vi, -,-n-onoitantly v. ith the phcsphate. pr.re bo,^om. ThP, hav,e been declining since (except for a **small** rebound in 19B 1), adding therefore substantilc,v _to_ budgetary diffirulties.

# e) _flwru:n 21 the budget_ dlefiit

The impact of budgst deficits on macroeconorm,ie conditions is to a s.gniFicant extent a function of the mode of financing of the deficit Itself. It is therefore essential to take a closer look at the way budget imbalances have : een financed in " e past. Prior to 1983, foreign borrowing flnancea nearly 60% of the Treasury deficit. The avallability of foreign Finance came to Fin abruot halt in 1983, precipitating a major payment crisis. The government was Forced to rely to an unprecedented extent on Central Bank borrowing during 1983 and, to a lesser extent, 1984. This was also the period when, as it was mentioned earlier, the government increasingly resorted to the accumulation of arrears as a source of involuntary finance from the private sector. Yet the increased monetization of the deficit would have unavoidably provided fuel for inflation. It was the firm commitment by monetary authorities to eschew inflationary financing which prompted a major revision in the financing strategy. Starting in 1984 the government increasingly began tapping non-inflationary domestic sources of financing. The Treasury reliance on voluntary domestic lending was enhanced by the need to reduce the sizeable stock of financial arrears. This strategy was helped by .he partial liberalization of domestic interest rates which was associated with a major shift in the private sector portfolio composition from currency to time deposits. At the same time the ceiling on credit to the economy forced commercial banks to channel a substantial part of these financial resources to the Treasury, creating thereby a steady source of finance for government deficits. Another important component of the financing strategy was the direct sales of Treasury bills and bonds to the non-bank sector. The counterpart of this strategy was its increased cost to the Treasury. To make time deposits more palatable to commercial banks, they were excluded from the base on whict obligatory investment in Treasury bonds are calculated. Together with the reduction of arrears and the need to offer att tive (post-tax) returns on direct issues of government bonds, this measure induced a significant increase in the cost of domestic financing for the Treasury. This is -Iearly reflected
in the rapid increase in the average real Interest rate on government domest ic debt, as noticed in the previous paragraph. Further iristitutional developments arz likely to reinforce this trend, iF existing pr-oposals to reduce liquidity and portfolio requirements for tne banking sector are implemented. In the last section of this paper, we shall assess the macroeconomic impact of furthering the process of financial liberalization.

We can try to sum up the main conclusions of this section and draw some implications for the future course of fiscal policy in Morocco. Overall Morocco has been quite successful in coping with VormIdable financial difficulties. The foreclosing of foreign borrowing In 1983 represented a major shock to the economy and to the Treasury, more significant perhaps than the rise in international Interest rates. The two-prong response of M4croccan policy-makers relied on a sharp reduction in the Treasury i,nancing needs and a shift in the composition of finance with a view of eschewing inflationary pressures. A key to the success of this strategy was the availability of relatively cheap sourcs, of domestic finance, mostly determined by a complex system ,t Financial regulations. However the difficulties of relying at the margin on financial repression as a cheap source of funds, together with the relaxing of fiscal discip,ine in the most recent years, have already prompted a reassessment of ex'sting strategies and, perhaps merea crucially, highlighted the shiarp trade-offs that continuing budget disequilibria entail. Today the major question facing Morocco's policymakers is 'shether the fiscal policy stance is consistent with the mainterance of low inflation, the resumption of investment and growth and the external payments constraint.

Consider the not too unlikely case where foreign finance will not increase substantially in the medium-run. Under these circumstances, the failure to oersevere on the road to fiscal discipline may entail severe macroeconomic consequences. Even the perpetuation of present financing strategies of a relatively unchanged budget deficit would soon run into severe problems. First of all the bucget is still evtremely vulnerable to international interest rates and terms of trade shocks. For instance the revenue from the petroleum levy which in 1988 still represented 3.4% oF GDP is likely to vanish under increasing oil prices. Second the cost of domestic finance is likely to rise steeply in the
9 future. Again the Treasury budget would be extremely vulnerable to such evolution. Would the cost oF servicing domestic debt Increase to competitive market rates, this would add to the budget an extra burden equal to around 2% of CDP.

Could Morocco resort at the margin on larger monetlzation of the deficit ? By internatiou,al standards Morocco s inflation Is typlcally low. An increase in the Inflatlon tax may then represent a palatable alternative. However, besides the danger of tampering with monetary policy and damaging the credibility of the Central Bank commitment against Inflation, thero. Is ac-tually little room for a substantial contribution to budget Financlng from Increased monetizatlon of the deficit. We will show in the next sectlon that, for Morocco, estimated elasticities From a system of assets demand indicate an extremely unfavourable trade-off between inflation and monetary financing. Continuing reliance on non-inflationary sources of domestlc finance is thereFore essential to keep Inflation under check. However this strategy could result in large increases In domestic real rates of interest. Besides putting into jeopardy budget equilibria, this would most likely crowd out investment. Moreover even if the increase In interest rates did not materialize and the perpotuation of a system of financlal regulations guaranteed a source of inexpensive finance for the Treasury, the impact of unabated budget deficits on investment and on growth would still be signi ficant because of their effects on credit markets. We shall examine this issue in section 4.
-9a-

TABLE 4

|TAXREVEE|NJES (as<br>a|share of GDP)||
|---|---|---|---|
|Total|Income<br>|Taxes on goods<br> <br>|Taxes on<br>|
|revenue|taxes|and serv.<br>|nt. trade|
|1971<br>0.1'849<br> <br>|0.C282?<br>|0.07604<br>|0.02582<br>|
|1972<br>0.14401<br> <br>|0.02814<br>|0.07402<br>|0.02407<br>|
|1973<br>0.16157<br> <br>|0.03206<br>|0.07454<br>|0.02879<br>|
|1974<br>0.21112<br> <br>|0.03294<br>|0.06797<br>|0.03625<br>|
|1975<br>0.23329<br> <br>|0.07023<br>|0.07320<br>|0.04331<br>|
|1976<br>0.20292<br> <br>|0.04011<br>|0.07688<br>|0.04184<br>|
|1977<br>0.21672<br> <br>|0.05145<br>|0.08326<br>|0.05187<br>|
|1978<br>0.2120i<br> <br>|0.05343<br>|0.08012<br>|0.04993<br>|
|1979<br>0.22246<br> <br>|0.05364<br>|0.07990<br>|0.05477<br>|
|1980<br>0.20506<br> <br>|0.04507<br>|0.07836<br>|0.05562<br>|
|1981<br>0.22570<br> <br>|0.04765<br>|0.07642<br>|0.06190<br>|
|1982<br>0.22046<br> <br>|0.04125<br>|0.08410<br>|0.06235<br>|
|1983<br>0.21272<br> <br>|0.04380<br>|0.08768<br>|0.05307<br>|
|1984<br>0.2v890<br> <br>|0.04438<br>|0.08510<br>|0.05009<br>|
|1985<br>0.20653<br>|0.04337<br>|0.08376<br>|0.04456<br>|
|1986<br>0.18891<br> <br>|0.04040<br>|0.07089<br>|0.03629<br>|
|1987<br>0.20679|0.0.475<br>|0.07656<br>|0.03561<br>|
|1988<br>0.22582|0.34717|0.07793|0.03954|

||petroleum<br>|other<br>|OCP<br>|
|---|---|---|---|
||levy|taxes|contributions|
|1971<br>|0.00000<br>|0.01836<br>|0.00182<br>|
|1972<br>|0.00000<br>|0.01778<br>|0.00176<br>|
|1973<br>|0.00003<br>|0.02617<br>|0.00609<br>|
|1974<br>|0.00000<br>|0.07395<br>|0.06306<br>|
|1975<br>|0.00000<br>|0.04655<br>|0.06776<br>|
|1976<br>|0.00000<br>|0.04408<br>|0.02316<br>|
|1977<br>|0.00000<br>|0.03014<br>|0.01843<br>|
|1978<br>|0.00000<br>|0.02852<br>|0.01450<br>|
|1979<br>|0.00000<br>|0.03415<br>|0.01128<br>|
|1980<br>|0.00000<br>|0.02601<br>|0.01080<br>|
|1981<br>|0.00000<br>|0.03973<br>|0.01641<br>|
|1982<br>|0.00000<br>|0.03276<br>|0.00581<br>|
|1983<br>|0.00000<br>|0.02817<br>|0.00756<br>|
|1984<br>|0.00000<br>|0.02933<br>|0.00979<br>|
|1985<br>|0.00000<br>|0.03484<br>|0.01342<br>|
|1986<br>|0.02444<br>|0.01689<br>|0.00000<br>|
|1987<br>|0.02782<br>|0.02204<br>|0.00290<br>|
|1988|0.03375|0.02743|0.00401|

Source: World Bank data base TABLE 5 <!-- Start of picture text --> IMPACT ON INFLATION CF A 1% INCREASE IN THE GDP SHARE<br>OF MONETARY FINANCING<br>Initial inflation low elasticities High elasticities<br>4% 7.5% 7.6%<br>6% 9.8% 11.1%<br>8% 12.9% 16.9%<br>10% 16.7% 26.4%<br><!-- End of picture text --> Source: own calculaticns
10

# 3. ASSETS DEMAND, SEI-;INORAGE AND THE INFLATION TAX.

Received wisdom argues that, following the drying up of commercial lending after 1982, developing countries had to make a twin transfer of resources: one abroad to foreign creditors insofar as new lending had fallen much below the required service on outstanding external debt; the other internal, toward the governnent, to the extent that in several developing countries the State had taken onto itself the burden of servicing foreign debt. Together with the increase in interest rates and the fall in terms of trade, this has often meant the disruption of budgetary equilibria, already jeopardised in many cases by previous unsustainable fiscal policies. The inflexibility of the tax system, the downward rigiditv of fiscal expenditure (with the noticeable exception of public investment) and the thinnes of domestic financial markets left then little choice to local policy-makers but to monetize the fiscal deficits with sometlmes calamitous consequences on the inflation rate.

Under this interpretation, the exceptional inflation record in Morocco is undoubtedly puzzling. In the previous secticn it was shown how financial repression, by channeling low cost funds to the Treasury, was instrumental in a strategy of relying on non-inflationary sources oF budegt financing. Yet the question remains of why Morocco's pollcymakers remain staunchly opposed to even a limited monetlzatlon of the deficit and a greater reliance on the inflation tax. As a matter of fact inflation in Morocco is extremely low, 2.3% in 1988, even by the most stringent international standards. A recent report (United NationsWorld Bank, 1990), wh le not explictly advocating an increase In Inflation, argues nonetheless that there is some mileage for boosting revenues from the inflation tax. The issue however cannot be solved on purely theoretical grounds as the inflationary implications of deficlt monetization depend on the response of money base demand to changes in inflation and interest rates. In what follows we shall argue that the outlook for greater monetization of the budget deficlt In Morocco Is altogether unfavourable. If we also consider the destabilising effects on Morocco's social fabrics and the loss of Central Bank credlbility that a higher inflation would Imply, we can perhaps understand the firm commitment of the country's policy-makers in favour of prlce stability.

The scope for increased government revenue from seignorage and the
11 inFlation tat< is determined by the private sector's choice of assets. In this paragraph we rely on a standard Tobin's portfolio approach to analyse the demand for currency, demand and time deposits. Other assets are not included in our analysis on the ground that, with the exception of real assets, they play a minor role in the private sector's choices. In what follows we assume that the demand for each asset Is related to its own return, the other assets' returns and the level of income. As a proxy for the return on real assets we use the (expected) inflation rate, which however is not observable. We assume that expectations are formed rationally and depend on the set of inFormatlon available at time t-i, which is defined to include the lagged level of prices, the money supply, the wage rate and the exchange rate. According to our estimates, the last variable does not contribute significantly to the prediction of future prices. This prellminary evidence suggests that, for Morocco, the pass-through from the nominal exchange rate to domestic prices is Fairly weak accounting therefore for the fact that a sizeable real depreciation did not translate into higher inflation. Similarly the significant impact of wages on prices supports the claim that wage moderation (the real minimum wage declined by 7.3% from 1983 to 1988, after increasing by 17% in the three prevlous years) was instrumental in containing inflation.

The fitted value from the price equation is used as an estimate for expected inflation. In the process of estimation, we rely on Pagan's (1984) procedure and use our proxy for expected inflation as an instrument for actual inflation. This procedure is designed to yield consistent standard errors for the coefficients. We still have to determine whether the system of assets demand should be expressed In nominal terms (with prices included among the explanatory variables and the relevant homogeneity assumptions tested) or in real terms. We take the first course for the sake of generality and assume thereby that assets demand do not fully respond instantaneously to changes in prices. We also allow for the possibility of lagged adjustr 1ient to income and interest rates variations. Therefore the estimating equation for a generic asset MW reads as:
12 where p and Y denote the prlce and Income level respectively, **"I"** represents the vector of assets' returns and Tre Is expected Inflatlon. We would expect that in the long-run the prlce elastlclty of assets demand is equal to one, I.e. that assets demands are homogeneous of degree one in prices. Formally this implies t,Lat a 1+a2 =i-a 8 . We can reparametrlze the prevlous equation to test this restrict3on: If long-run price homogeneity holds, we have Eq. (3) shows that Imposing long-run prlce homogenelty In a context where assets are expressed in real terms adds a backward-looklng Inflation term, A In p, to the equation itself. This term however does not reflect any substitution effects between real and financlal assets, but only lagged adjustment to price changes. Traditional money demand equations where Inflationary expectations are simply modelled in a backward-looking fashion may therefore mistakenly Interpret the significance of A In p as evidence of substitution toward real assets, whereas only a process of dynamic adjustment Is Involved. Our approach allows to distinguish between these two effects by separately evaluating the statistical signlficance of A In p and Tr . Admittedly though, the coexistence of these two effects may be difficult to justlfy on purely theoretical grounds.

In the estimatlon process we include in the tector of assets' returns ("i") only the Interest rate on time depo_its, I . Some demand deposits are also remunerated, but their return moves in a almost perfectly collinear way with the one on time deposits. We have therefore Included the remunerated component of demand deposlts in the aggregate of time deposits. We can now describe the results of the estimatlon of the system of assets demand. Our estimation strategy Is as follows. We start from the more general dynamic specification In eq. 3 and restrlct the model to obtain a parsimonious representation of the data generatlng
1 3 process. In what foll-ws ,e only report the F.nal e,quation. All equations are estimated over the 1974-1988 period. The last year however is saved to test For out-of-sample stability. We begin by the demand for currency.

- .70 In (CURt iPtl) DW = 2.01 SER .013 LM - .25 Hendry = 1.47

The demand for currency (CC9E) is significantly related to the interest rate on time deposits (i ) and to income. Actual inflation appears in the equation with a short-run elasticity of .60. This is not necessarily, as mentioned earlier, an indication of significant substitution possibilities between currency and real assets, but may simply reflect the fact that nominal demand for currency fully adjusts to changes in the price level only in the long-run. The coefficient on expected inflation instead is not signiFicantly difFerent from zero and bears the wrong (positive) sign. Jointly estimating the price and the currency equations (and testing for the expectational restrictions) did not improve the results. The variable 7re therefore has been eliminated from the final equation. Finally the hypotheses that nominal demand for currency be unit-elastic in the long run with respect to the price level and to income are not rejected by the data (tio = .94). As diagnostic tools we rely on the Hendry test for out-oF-sample stability and the Lagrange multiplier test for serial correlation. Both are distributed as X (1). They do not provide any indications of misspecification.

We now turn to the equation for demand deposits (DD).

DW = 1.43 SER. = .033 LM = 1.56 Hendry = .81 Demand deposits have been defined to exclude saving deposits.
14 Following this modification, we find that both inflation and the return on time deposits pla>E a significant role in affecting demand deposits. The long-run income elasticity is equal to 1.96 and significantly different from one. Once again expected inflation does not contr'bute in a statistically significant way to the equation. There is no sign of misspecification as indicated by the usual battery of tests.

DW = 1.97 SER = .09 LM = .02 Hendry = .18 As expected, time deposits respond positively, albeit not very significantly, to an increase in their own rate oF return. The dynamic specification of the equation is very simple. There is no evidence of lagged adjustment to prices as indicated by the insignificant coefficient on actual inflation. On the same ground, also expected inflation has been excluded from the final equation. It was not possible to reject the hypothesis that the demand for time deposits Is unit-elastic with respect to income (F1,9 = .54). The LM and Hendry tests Fail to point to some misspecification problems.

Overall the previous results indicate that the demand for monetary assets In Morocco is strongly influenced by the patterns oF returns. The estimated semi-elastlcltles on the interest rate on time-deposits suggest potentially conspicuous shifts in portfolio composition In response to variation of the structure of interest rates. **There** is however less Indication of strong substitution posslbilltles with respect to real assets. Our proxy for expected inflation never proved to be significant In any of the three equations. It is not apparently a problem of multicollinearity insofar as the coefficient on actual inflation was quite well determined even in the more general specifications. It is not either a problem of statistical methodology. Our approach should provide at least consistent estimates oF the coefficients and of their standard errors. As mentioned earlier, more eFficient simultaneous estimation methods which also allow for the expectational restrictions fall to change the basic findings. Perhaps our proxy for expected lnflatlon **Is** not well specified. Alternatively, expectations may to a large extent
15 have an adaptive form. We leave the matter unsettled.

To c,-mpute the amount oF monetary financing the government can count upon, we must allow for the fact that in Morocco a distlnction must be made between reserve requirements, which apply only to demand deposits, and liquidity requirements, which force commercial banks t,- invest a fixed share oF their deposits in low yield treasury bills. Recent financial sector reForms have however substantlally inc reased the interest rate paid on liquidity requirements which now approaches market rates levels. We include therefore liquldity requirements in the domestic public debt. The narrowly defined monetary base (MB) is thereFore equal to: where rrdd is the reserve requirement coeFficient for demand deposits. At any point of time the amount oF monetary financing **is** equal to the change in the monetary base. As a share of nominal GDP, the amount of monetary Financing, A MB t/(pt **Yt)** is equal to the rate of change of monetary base, (A MBt/MBt), times the GDP share of MB, (MBt/ptYt).

We can now use eq. 4, together with our estimates of the demand of currency and demand deposits, to evaluate the relationship between inflation and the amount oF monetary financing. We focus on a steady state situation and arbitrarily impose that demand deposits be unitelastic with respect to income. As a result, the growth rate of MB will be equal to the sum of output growth (n) and inflation (Tr). Similarly the GDP share of MB will depend on the level of nominal interest rates and, possibly. of inflation: where the coefficients A and a (B and 6) are computed from our estimates of the currency (demand deposits) equation. In assessing the value oF a and 6 we face a basic ambiguity. Changes in the inflation rate can have a direct impact on the demand for monetary base to the extent that they lead to cor.-esponding variations in nominal interest rate. We assume this to be fully the case. But changes in Tr have also a direct effect on the demand for currency and deposits. However if we interpret
16 the signiFicant coefficient of actual inflation in our estimates as simply evidence of lagged adjustment, then this effect should not reasonably play a role in this steady state kitid of analysls. If alternatlvely we believe that expectations are adaptive and our results reflect the existence of significant substitution possibilities with real assets, then inflation should have an indipendent effect. Notice that, In the latter case, changes in inflation will exert a larger Impact on the demand for monetary base. In what follows we allow for both posslbllltles.

We can use eq. 5 to compute the effect of a one percent change In the inflation rate on the quantity of monetary financing as a share of GDP. We take GDP growth to be equal to 4 percent. From eq. 5, it Is clear that this derivative is a function of the Initial share In GDP of currency and time deposits, which in turn depends on the Inflation rate Itself. We can also compute the inverse derivative, which measures the Ir-rease in the inflation rate attendant on a one percent Increase in the GDP share of monetary financing (Table _5)._ Our estimates suggest that the inflationary impact of higher monetization Increases very rapldly and the trade-offs between Inflation and inflation tax worsens zubstantially as inflation increases. This provides considerable support to the cholce of Moroccan policy-makers not to rely on inflationary forms of deficit finance.
17

# **lN. I\L'KTM-'N** AN' **`AVINi** A 'I LLIIIDN

AN h'sth rat-~ -I in.-~?tm;nr--r e-.ents a **basic** condit'ion fo-r ru-taine' **!n.x-agc~** in ec-nomn,gr-oxth -,e the long-term. Since 1992 ho\ever the fGUrre-nt Fpicer 'p chare of invostment in Moro-cco has been stoa1i'. falling %,ith the o _nl,_ e<-eption of 19_RS'. raising increasing c2Dncer nr about th"- long-run perFs-pecives oF the **economy.** L,oo.king at tho >:-nstant price ratio bet.v.Feen int-stment and iGP wouldi onlP accentuate tr.Fall' in in .est`ien, beause .' the irncrease in the real price of in. estmentF goods .attesndant on the real deprecdation. More wsiorry,ingly porhaps, the drop ir .acital a-cuTnlation is a generalised cne, in.dylving bot,h pub:i> andr pr-i'ate in.estment. Contra-v to initial e<pectati':ns, the fi-a1' rtrenchment v<.h;,ch to-k a toll or public investment **_was_** not - rnsa -nEtE,d , a matc-hing irr.zrac-in private investment. Is the Fall in :n'. eatmont ailEnlficart cause F,or -c,ncern 7 Surely enough, it co-uld be a-rgue-d that m '-t :)F the Fa'l in .rEvestment can be predicated, on the high^er c,-st **cap** epr tal. enco uaging less capitalintensiv,e projects (ardi remo>Xving the pre.icus Fbias a&falnst labourintensive productions:', an i-crease in the of c-apital wou **allow the** same level of grow>th to be ae;ed ith a l. er volume oF investment. LUnder this nt-rpretIatln thD ropi in inestunt would on.;, represent the out-ome F atcusting to a no.. constellatioDn of factor prices. Empirical evidence -r a roJatiel> large samFle co developing countries (Faini and de !-:-. 199s **rufLggesto** that CcsDt ,-F capital considerations can account on'. f-r a small fraction of the fall in investment and other factors t!he-ref-re must be- at .%vork. In ,,,hat follows:, We shall assess the r>-.-s,>F9--f thlis aFproach for the --ase of Morocco.

We- ro -r. a smzer m.de' rf a Firm. The fir,m is assumed to a **m:<1-!7e** itS rne-t v-. -rtk. sub c-- 1- a standard nsoolasK' p'-oluctio-n-ai r--t.r-cr.t.-a-t . tlthe itionalt s-t-up hov-.e,vr. financ,ial a--sl ' h a shFi -'iant boearing on real ' d E o **mr-'.-<'** th>e 9.mQ>a-t I f 9nancia, variables by assuming that e<ternal -suit`. fiErancing is una,.ilaHle and the firm must rely on two alternative **c-.urmzcs** oF in.-stmo-nt F1 narde, i.e. retained earnings and bank's debt. von that the entreproeu rs' discount rate is assumed toD) be larger than the rik-Fr-ee int-reFt rate (otherwise the Firm would accumulate
**18**

**fr.naa % acs.tt** . doLt; is', theF favoured **ErUri oef** in\eswtmcnt f:nan,re. prl;>.tF au-- Ferhap _.f_ ta :nsiderat ios). Ar internal sciin fc:r the optimal dett choice of the firm still! e<1-ts. though. prnxbided that v.e assume that h!gher debt, relativel',y tD the<sup>firm's</sup> capita! stor k, is as,lt '.52th increasing agenc, costs. Emal'l, because **of** -oQnstraints in the credit market, at each point of time the adebt<sup>tocapital r.ticfk</sup> rati,- of the firm is b.ound by an upper ronstraint. Formally,:

s.t.

'x.here. in standard notations, Y, N, K and I represent the level _of_ pr oduction, employment, capital stock and investment respectively, whereas B denotes the outstanding stock of debt. The function et ! with c >0. cjj') and c2<0, is the agency cost function, which is. assumed to be quadratic. The output price is indicated as p, the wage as w, the price oF investment goods as q, while r and i denote the interest rate and the discount rate respectively. We assume that I+i= (l+r) (I+k) N.here k is a multiplicative risk premium. Finally d is the depreciation rate. Eq. 6 is the leverage constraint whi-ch defines the madmum amount of debt as a time varying proportion (E*) cf the capital stock, while eq. 7 and 8 describe the production relationships and the capital accumulation identity respectively. Suppose first that the debt constra;nt is not binding. It can be easily shown<sup>that, at an optimum,</sup> debt Vill be a fixed proportion , say y, of nominal capital stock. In turn v is a function of the risk premium k and oF the parameters aFfecting the position of the agency<sup>cost function</sup> **2** Notice that y does not depend on the interest rate. As matter of fact, variations in r (or in the discount rate i) affect the level of<sup>investment,</sup> not the con.position of its financing. The choice oF y in turn afFects the demand<sup>for capital</sup> which is otherw.ise determined in a standard way. IF _we_ consider the case where the debt constraint is binding (i.e. B*<y), financial conditions have a direct impact on the demand for capital. Under linear
1 9 '''-'r-lit. ':n9>i:n''r inr F:r--:i,ti.:n. it c-arn **t: >,** shown that the optimll -> ta*. **¶t>'K** ..:'. **i:.** n a furw't .-r of zutrut.-F the r,aa cost o-f capit-l **rini** the Aa.la liti--f d4t:t. FsrniaJiv: KC K Y . -4 i (1 **4I** p arameters r **and** p den.:te the :--rprt> ta rate and the percentage reduction in q indiuct. the s **-** ,r fiscal and financial in-entives available t, investors in Mi.-r~-r-. Fu'l details For the calculations of r arnd p are provilr-l in W-Drlid **dlk** (1990?.

**fJne** -r'2,blem .w;ith the Formulatio-n of eq. 10 is that it containr one oh' i-uF'] Ssndigenous variable, the le,el of output Y . In what follows we rel; lr th- Following procDedure. It is assumed that, because oF delivery lags, flrms must determine their desired level of output, and therefore their investment, one period in advance. They will need therefore to predict, based on available inFormation, the optimal level of capaoity outrut For the Following period. This will in turn determine their demand fo r investmenrt gcods. We alsco assume that expectations about thp determinants of the output decision can be simply modelled by a Fir-st-o-rder autoregressive process. The expected, optimal level of cutput (t- Iy t ' ,,iJll thereFoDre be equal to:

w.here the inFormatilon set has been augmented1 **to** include both Ipub (the level cF public investnment on the ground that this may affect the pro-ducti,on relationship > and MS (the stock of money, **as** a further predictor of prices). In estimating eq. I 1 we must allow For the fact that t Yt is not observatle. Howeve-, under rational expectations, it will YVfetr From actual output Y only for a random term uncorrelated w\.ith an'. available informaticn at t-I. We can therefore use the actual product :-n level Y Es the dependent variable and take the Fitted '.alue oF eq. I I as the estimate of expected output.

2'. estimating eq. 11, it is now possible to take into account the endogeneity oF Y in eq. 10. We follow again Pagan's (198t suggestion and take the estimated value of Y (Y.F) in eq. 1I as an instrument For the actual level oF output in eq. 10. We present First the estimates of
20 w,here- dil iF a dummy variab-e which takes a '.r!ue of I in coDrrespcndanm2e of the agricultural negative supply shocks in 1981, 19.33 and 1937. The wage rate dc1es rot pro. tide a **si-ni6ant** ccntributicn to the equation. This may be attributed to- measuremenrt errors (\We use an indicator of the minimum wage) or to the fal-t that labcur does represent a signifIcant ccnstrdint. T he cocst of c acpital instead appears to plaY a more significant rcle together with public inv,estment and the money supply. As a diagnostic t-ol, we relv on the Lagirange Multiplier test for serial correlati:n, **_which_** does not indicate any significant problems. Mloving> nov.' to the investment equation, we find that: whe;re I represents private investment. E /Y, the ratic oF firms credit to ';Ci7, is used as a pro<y of the stringerFcv at an aggregate lev,el of the debt constrain:. The equation hIs b-een estimiatd by an inst-umental .ar abl9e pFrcedure, with the fitted value frorr eq. 11 as an instrunmonn _f-r_ Y. The restriction that investment be unit-elastic w,ith rspect **tu** _utFut has Leen tested **(tI2z** .5) and imposed or the data.

The estimation of eql. 10 yields two interesting results. First investment is signiFicantly affected by the real cost of capital. Fiscal policy can therefore affect the investment decision through its impact
21 cn interest rates or, more directly, by changing the set of fiscal and finanrial incentives available to investors. Second the level of InN estment in the economy will also depend on the availability oF credit. The joint presence of both the cost of capltal and oF credit avallability mak appear redundant (or even contradictory), until we recall that investment in this model is not fully determined by the stock of credit that financial intermediaries are willing to extend to firms. Even if Firms are credit constrained, a change In the interest rate r wlll still affect investment through its impact on the discount rate i and thus on the choice cf retained earnings. By varying their retention behavlour firms can relax somewhat the credit constraint. Fiscal policy therefore will aFfect investment by influencing either the Interest rate or credit availability. This latter channel, as we shall see later in the paper, can play a crucial role in determining the macroeconomic outcome oF different fiscal Folicies. It is also plausible of course to interpret ths joint significance of credit and Interest rates in eq. 10 as implying that only a subset of firms is credit constrained. Finally, by putting together the estimation results for eqs. 10 and 11 we can argue that public investment bears a complementarity relationship with private investment. Indeed an increase in public investment will lead to higher capacity output (eq. 11 and, through this channel, to higher private investment. By severely cutting public investment, fiscal policy may have contributed in the past to the stagnation of private investment.

# _b) the saving decision_

A steady supply oF domestic saving will ensure that a sustained rate of investment would not be incompatible with existing constraints on the external payments front. It is essential thereFore to gather an adequate understanding oF the determinants oF saving behaviour. Unfortunately the measurement of saving is beset with difficulties, to the extent that consumption is computed residually in Morocco's national accounts. We can rely on two alternative measures of private seving, one derived as the difference between private disposable income and private consumption, the other based on the saving-investment identity for the economy. Because of statistical inconsistencies, the two procedures do not yield the same result. In what follows we use the first measure. We find that, after peaking during the phosphate price boom and declining aFterward, the average propensity to save has been steadily increasing during the 1980's.
_2) L_ '~ lthb **e** havcur cf sa we first \ing, take a simple permanent acrroach. Under well-known ccnditons the maximization oF inter4emporal utilit'y by the representative consumer %ill Imply that aSgr-Fate ccrnsumption (denoted as C) is simnpl equal to a proportion of permanent in-ornme (YR), i.e.: Note that C should be defined to inloude only the consumption of nondurable commodities. Lack of data preclude this important refinement. For estimation purposes, at least two issues need to be addressed. First we must specify an indicator of permanent income. In what follows, we simply regress the actual value of real disposable income on a time trend and take the fitted value from such equation as an estimate of YP. Secondjlv we need to recognize that the parameter k will not in general be Ficed, but will depend on the real interest rate and, possibly, the real exchange rate. The impact of both variables on the propensity to consume is however theoretically ambiguous. Our estimated equation reads as: where r and X denote the real interest rate and the real exchange rate respectihely. The latter is defined so that an increase in X implies a a real depreciation. In the estimation, the restriction that the long-run eiasticitv of consumption with respect to permanent income be equal to cne has been tested and imposed in the equation (t 14 = .81). Our results indicate that an increase in the real interest rate and a real depreciation will both lead to a decline in the propensity to consume.

This approach highlights two channels through which fiscal policy **wE.** affect private saving and consumption behaviour. First, fiscal policy ma. influence, through taxes and transFers, the volume of disposable income the conaumers can spend. In this framework a temporary tax increase will have a more limited eFfect than a permanent increase. Second. fiscal policy may aFFect private sawing bv inFluencing the level cF irnterest rates. Our estimates suggest that an expansionary fiscal
_2_ 3 poIi'-', '4,~i. cr-,'~. iq ot thr :ush the intZFA rte- cha!nnel .L-th rcn!.-unmption and in.estmPnt d-mand. A third -hann,e (n.t allowei for in the previous estimatesi may be howe er as v ,-r if rati-na! Fri'.ate agents takie fully into a,-count the future ta< liatijities ass--ciated with bornd-financed defic~it. The impli-cati-n Is tha' a shift from ta< to debt finance of a given volume of public e<enditure should be neutral insoFar as it would be mat-hed bY offs`,tting priaete agents behaviour. This is because private agents would be perFectly aware of the future tax liabilities and the consequent reduction in their permanent disposable income that the increased deficit entails and would correspondingly reduce their consumption. This is known as the Ricardian equivalence hypothesis. There are several reasons whv this pr oposition may not hold, among which it is worth mentioning the possibility that private agents may discount the future at a different rate than the government and the presence of capital market imperfections which hinder the intertemporal smoothing of consumption by private agents. Evidence on these issues for developing countries is limited (see however Rossi, 1988, Nam 1989, Haque and Montie!, 1989, Deaton 1990 and Haque, 1990). In what follows we amend the previous specification to allow for the possibility that, by reducing perceived disposable income, government deficits may have a negative impact on consumption. We do not expect this effect to be particularly strong in Morocco, because of the absence of a consumer credit market and the likely pervasiveness of liquidity constraints on households. To capture this effect we introduce liquid assets (currency plus bank deposits) in our equation. We also allow for inflationary effects on the ground that a high level of inflation will lead to capital losses on liquid assets and impart a downward bias to the traditional measure of disposable income. An increase in inflation should also be associated with greater uncertainty and lead, through this channel, to an increase in precautionary saving. If we estimate this more complete model, we find that: A In Ct = .46 (In Y - In C,_ ) + .06 (n Mt - In Ct) -. 09 In X (.056) (.02) (.02) -.12 A In pt - .13 (deF/(CODP) (,07) (.05) R<sup>2</sup> = 83 DW = 2.16 SER .012
_24_

**V.hCFC.** in standard notation, F indicates the price Ie el (so that A In p appFroimates the inflation rate-, M1 denctes the stock of liquid assets and depf/GDP indicates the ratio of the budget deFicit to GDP. In this specific-ation, which closely follcsv Hendry and von Ungern Stenberg (1981), consumers adjust theIr expenditures to ensure constant steady state equilibrium ratios of consumptiun to disposable income and to liquid assets. These long-run equilibrium ratios are affected by the level of the real exchange rate, by inflation and by budget deficits. The significant impact of budget deficits on consumption in Morocco may seem surprising, but was already found in work by Montiel and Haque (1989) and by Schmidt-Hebbel and Muller (1990). We have tried to assess whether this efFect could be attributed to the fact that government expenditure on goods and services substitutes for private consumption, but the high collinearity between the deficit variable and government expenditure prevented such a test. Finally both higher inflation and a depreciating real real exchange rate have a negative impact on consumption. The real interest rate instead is no longer statistically significant and has been excluded from the equation. We can only speculate why the real interest rate no longer seems to be a significant determinant of consumption behaviour. One possible explanation could be that in the previous specification the real interest rate variable was actually picking up the efFect oF budget deficits. Indeed, as our last estimates suggest, a larger budget deficits lowers consumption and Is also likely to be associated with rising interest rates. Overall this new specification appears to indicate an even stronger role for fiscal policy in influencing consumption behaviour.
25

# 5. MODELLINGi THE IMPACT OF FISCAL POLICY

A comprehensive analysis of fiscal policy requires an economy-wide model. In this section, building on the estimates already presented and on previous work by Faini, Porter and van Wijnber gen (1989), we present a simple macroeconometrlc model which will then provide the basis for an evaluation of fiscal policy In Morocco.

A full presentation oF the model goes beyond the scope of this paper and can already be found in Faini et al. (1989). In what fo.ows we only present a stylized description of the main features of the model. The latter is based on a simple variant of the aggregate supply-aggregate demand open economy framework. Noticeable features of the model include the emphasis on supply behaviour, the modelling of import demand under rationing and the analysis of both external and domestic debt dynamics. The presentation is organised by economic agents (firms, households, goverment, etc.) rather than by the more usual approach based on a distinction between markets (goods, labour, and money markets). This should permit a more critical evaluation oF the microeconomic foundations of the model.

# _a)_ a macroeconomic model

Table 6 can used as a guide to the maln relationships comprised In the model. The first block of equations focusses on the firm. The approach used to specify the behaviour of the representatlve firms was described in the previous paragraph when analysing the investment decision. In eq. 1 in the Table investment (I) is a Function of expected output (Ye), the cost oF capital (c) and the availability of credit (B ). The cost of capital (eq. 2) is a function of tax (,u and r) and depreciatfon (8) parameters as well as oF the ILnterest rate r and the price of investment goods, p. In turn p (eq. 3) is equal to a weighted average of the price of domestic (pI ) and imported capital goods, with the latter depending on the real exchange rate (X, defined as the ratio of foreign to domestic prices) and on the tariff rate on domestic capital goods (r .). The specification of expected output is taken from eq. 11 in the textm'After choosing total investment, the firm decides how to allocate it between domestic and foreign capital goods as a Function of their relative prices and of the extent of quantitative restrictions on
26 imForts of capital goods. q1 (eq. 51. Short-run choices can be be described as fcIlows. Output Isupplv (Yi depends on total capital stock and the real e<-hange rate, where the latter acts as a proxy for variable costs. A real depreciation, i.e. an increase in A, will boost wage and intermediate inputs costs and lowers supply. Given that capital stock data are not a,ailable In Morocco, we take a first quasi difference of the origina'l supply funxtion and estimate equation 6. In the estimation we take the primary and the government sector output levels to be exogenous. After output supply is determined, the demand for intermediate inputs (M ) and the supply of exports (X) can be simply described in eqs. 7 andn8 respectively as a function of Y, the wage rate (w) and the relevant price variable (p and p ). We do not however assume the country to be small in expoRnmarketX. The price of exports p depends therefore on exports volumes, world demand (WD) and foreign competitors' prices (p*). This completes the description of the firm's behaviour.

Households' choices are described in the second block of equations. We make a separability assumption where consumers first determine the level oF saving and aggregate consumption and then allocate total consumption between domestic and foreign commodities. Aggregate private consumption is modelled as in the previous section (eq. 10). In the present version of the model we take the seciFication where private consumption depends on disposable income (Y), real interest rate (r) and the real exchange rate ()\). The allocation oF aggregate consumption between domestically and Foreign produced commodities is described by a simple (constrained) linear expenditure system. We allow for the fact that a subset of foreign consumption goods cannot be freely imported and study the impact of these rationing measures on total Import of consumption goods. Our approach parallels the one used for investment imports and draws on Bertola and Faini (1990). As with investment goods, we do not allow for any rationing effect on aggregate consumption. The resulting equation is highly non-linear, but can be simply described (eq. 11) as stating that imports of consumption goods depend on total consumption, relative prices and the extent oF quotas on such import category (q_). Eq. 12 defines disposable income as the sum of GCDP, net factor irncome from abroad (NFI), interest on public domestic (GOINT) and foreign (OXINT) debt, transfer (TR) minus total taxes (Ti and monetary financing (MF). Note that interest payments on foreign debt (i XINT) are already included, with a negative sign, in NFI.
27 Then NFI+±CX1N is a measure cf net factrr payments from abroad accruing to the private sectc*r (mainly ',vorkers remittancesi. Finally eq. 13 deFines private saving.

The behaviour of the gc vernment sector is described very simply by a set of accounting and technical identities. As far as taxation Is concerned, we distinguish between trade (eq. 14) and income (eq. 16) taxes. Import duties are estimated endogenously in the model by applying the relevant duty rate to imports of consumption, investment, intermediate and other commodities. We also allow for the temporary levy on petroleum (eq. 15), which was introduced in 1986 and should be gradually phased out over the next few years. Information on the revenuF likely to be generated by this levy was provided by IMF source-. Finally the income tax rate is determined r esidually from total revenue data. Eq. 17 defines total tax revenue. Government expenditures are also fairly disaggregated. We distinguish between government investment (eq. 19), government current spending on goods and services (eq. 20), current transfers (eq. 18) and interest payments on both domestic (B in eq. 21) and foreign (XD in eq. 22) debt. We can therefore acccdnt in our simulatlons for debt dynamics. The accumulation of foreign debt is determined by the current account deficit and by real exchange rate variations which induce a capital gain or loss in the value of outstanding external debt (eq. 25). The change In domestic debt (A B ) is equal to that part of the budget deficit which cannot be financed aroad (eq. 26). Simply manipulations show that A B can be also expressed as the difference between private saving and pgivate investment. The last item in the consolidated government Central Bank budget identity is revenue from seignorage and the inflation tax (eq. 24).

Government revenue from seignorage and the inflation tax is determined by the private sector's choice of assets. Following the analysis in section 2, the demand for currency (eq. 27), for demand deposits (eq. 28) and for time deposits (eq. 29) is simply modelled as a tf,nction of income, inflation **(7r)** and the interest rate on time deposits (i **).** In eq. 30 monetary financing (MF) is defined as the change of narrowly defined monetary base, i.e. of currency and of demRpd deposits the latter multiplied by the required reserve ratio (rr **).** Finally conditions in the money market will help determine, through the banks balance sheets identity, the equilibrium in the credit market. The
28 sUm of demand and time deposits define total commerclal banks liabilities, which are allocated on the assets side among compulsory reserves (R), credit to the private sector (B ) and credit to the government (B ) (eq. 3 1 It is assumed that bnks do not hold free reserves. Crecgt to the government has already been determined by the governement budget constraint for a given current account deficit and an inflationary target. From eq. (31) we find that credit to the prlvate sector is determined residually. It will In turn affect, as was mentioned earlier, the demand for investment. Therefore, as clalmed, fiscal policy will affect Investment not only through Its impact on interest rates, but also, more directly, by influenclng the availabillty of credit.

To close the model we need to specify the equllibrium condition In the goods markets (eq. 33) where total demand, I.e. the sum of consumption, Investment, government spending on goods and services and the resource balance (i.e. total exports X mlnus total Imports M) **3,** must be equal to aggregate supply (Y). A second condition relates to the current account constraint (eq. 34) which is Identlcally defined as the sum of the resource balance and net factor Income from abroad (NFI). It can be easily checked that: i.e. the sum of private, government and foreign savlng (the negative of CA) is, in equilibrium, equal to total investment.

This completes the description of the model. In the next section we shall discuss some stylised properties of the model whlch will then be used to perform some simple comparative static exercices on the Impact of fiscal policy.

_b) simulating the_ impact of fiscal _policy_ Table 7 presents the complete model In summary form. There are **34** equations and 35 endogenous variables (33 left-hand slde variables, allowing for the Fact that Y appears twice, plus the real exchange rate and the real interest rate). In this sectlon we present a number of simulations on the impact of fiscal pollcy. The common assumption underlying all the simulations Is that the economy Is rationed on
29 international markets. As a result the financeable current account deficit is given at each point oF time, I.e. CA Is exogenous. Notlce that also the inflation rate is exogenously determined, at a level set by the Central Bank. Control on the money supply allows the Central Bank to achieve its inflatlon target.

As in the model by van Wljnbergen (1989), two equllibrium conditions play a cruclal role In determining the equlllbrium In the economy. One is the goods market equillbrlum (eq. 33 In the Table), which can be read as requlrlng that demand and supply for domestically produced goods be equal. The second condltlon Is the current account constraint, where the excess of prlvate and publlc saving over total investment must be equal to the exogenously glven level of the current account. This condition can be derived by comblnlng eqs. 12- 13, 25-26 and 33-34. The real exchange rate and the real Interest rate wlll move to equllibrate the goods markets and ensure that the current account constraint is not violated.

Some further observations on the role of credit constraints and the interest rate are in order. It was shown earlier how both these factors will afFect investment. Suppose that the credit constraint Is blnding, i.e. B*<y in the notation of sectlon 2. Suppose also, but only for a moment, that investment, and banks llabilltles, are given. Then an increase in the interest rate would not move the credit market closer to equilibrium. As shown In section 2, the composition of Investment finance (as desired by the flrm) does not depend on the Interest rate but only on the risk premium. However, in the context of our model, the increase in r will reduce Investment, until all of it can be financed from available sources. The firm, though, Is stlll off Its notlonal demand for credit, being unable to achieve the deslred composltlon of Its investment finance. Desplte the exlstence of credit constraints, interest rate variations still play a role In bringlng into equilibrlum saving and investment.

We pursue three simple simulation exerclces. Column 1 In Table 7 presents the base solution. In the first comparative static exercice (column 2) we study the impact of an increase In government spending by MDH 3000. Foreign financing and domestic Inflation are assumed to be unchanged. From eq. 26 in Table 6, we then see that most of the financing will rely on domestic debt. The increase in goverment spending
30 v.11i bcth cause an escess demand for domestic goods and lead to a derline in sa\wing and thus a current account imbalance. As expected, In the new equilibrium (cclumn 2 in Table 7), the real exchange rate will appreciate (because of the excess demand for domestic goods) and the real interest rate will increase (because of the fall in saving). Growth increases somewhat, but the impact of the expansionary fiscal policy Is mostly reflected in a crowding out of Investment. Capital accumulation falls partlv because of higher interest rates (whose effect on the cost of capital is however mitigated by the real appreciation) and mainly because oF lower availability of credit.

Suppose now that the increase in government expenditure Is financed from abroad. We model this by assuming that the current account is allowed to deteriorate by an amount equal to the increase in publlc consumption. The outcome oF this simulation is presented in column 3. The higher current account deficit is equivalent to an increase in foreign saving. We would then expect the interest rate to Increase less than in the case where no extra financing from abroad was available. This Is not however what we Find in the third column of Table 7. The real interest rate is now equal to 3.7% against 2.9% in the previous simulation. The reason for this somewhat surprising result hinges on the crucial role the credit market plays in this model. What is ha.pening is that the possibility for the goverment to finance a larger pcrtlon oF its deficit abroad reduces the pressure that government borrowing p 's on credit markets, leaving a larger share of total domestic credit to the private sector. Investment therefore is not crowded out through credit rationing and declines less than in the previous simulation. A larger increase In the interest rate as well as a more sustained real appreciation are required to bring equilibrium in the goods market. When, as in the First simulation, the government higher expenditure was financed domestically, most of the crowding out of investment took place through credit rationing with more limited effects on the interest rate. The difFerences in outcome between the two simulations highlight the crucial rcle that conditions in the credit market play in determining the impact of fiscal policy.

Finallv in the last column oF Table 7 we consider the case where a foreign financed increase in government expenditure Is accompanied by a process of financial liberalization. We model this process as a reduction in the liquidity requirement imposed on demand deposits.
31 TABLE 7 The complete modell _a) the firms_

|(1)|1 = j(Ye cB)<br>private investment<br>demand|
|---|---|
|_(2)_|c = p1 (1-,p) [r (1-r) +_6_<br>cost of capital|
|(3)|PI<br>Pd Pdi + (1-$d) (1+tmi)<br>X<br>invest. goods price|
|(4)|ye<br>Ye(w(_1), c(-1), Ipub(-1), MS(-1))<br>expected output+|
|_(5)_|MI= M1(1 Pdi/Pmi'<br>q1)<br>imports of investment<br>goods|
|(6)|Y=**Y(**Y(-1),**1,**X,X(-1))<br>supply of goods|
|(7)|Mn = Nn(Y, W/Pmn)<br>imports of intermediate<br>goods|
|(8)|**X**=Xs(Y, px/w)<br>export supply of manuf. goods|
|(9)|px<br>p P(X,<br>WD, p*)<br>export demand of manuf. goods|
|_b_|_)_the households|
|(10)|<br>C=C(Yd,r,X)<br>private consumption|
|(11)|<br>Mc =<br>C(C, Pdc/Pmc qc)<br>imports of consumption goods|
|(12)|yd<br>-<br>Y+NFI+GDINT+GXINT+TR-T-MF<br>disposable<br>income|
|(13)|S =yd<br>c<br>private saving<br>p|
|c|) the government|
|(14)|TM.=r. k M.<br>import taxes (i=n,c,o,i)|
|(15)|TP = tp Y<br>petroleum<br>tax|
|(16)|TY = t<br>Y<br>other taxes|
32 total taxes transfers public Investment govt. expendlture on goods and services Interest payments on dom. debt Interest payments on forelgn debt Interest rate on domestlc debt government savlng external debt govt. budget constraint

- (17) T = z TM + TP + TY

- (18) TR = t Y

- (19) I= 1p **Y** b

- (20) 0 _=_ g Y

- (21) ODINT = idd Bg(-1)

- (22) GXINT = ixd XD(-1)

- (23) A Idd = A r + A Tr

- (24) S = T-GDINT-OXINT-TR-G+MF

- (25) XD = XD(-1) X / X(-1) - CA

- (26) A Bg - CA = Ipub - Sg

c) the credit and _the money_ markets

- (27) CUR = CUR(Y, Itd, Tr)

- (28) DD = DD(Y, itd , 7r)

- (29) TD = TD(Y, ltd, _ir)_

(30) MF A CUR + rrdd A DD (31) Bp DD+TD-(R+B )

- (32) A itd = A r + A Tr

demand for currency demand for demand deposlts demand for time deposits monetary financlng credit to the private sector Interest rate on tlme deposlts _d) natlonal_ income fdentitles

- (33) Y = C+G+X-M+I+I pub-- TM

- (34) CA = X - M + NFI

goods market equilibrlum current account
33 Notes: + not implemented In the present version of the model Other symbols: \: real exchange rate r: real interest rate MS: money supply q.: extent oF QR's on Imports of type I EB2 : credits to firms ? mj foreign currer.cy price oF Imports of type j Pmj domestic currency prlce of Imports of type j Pdj domestic price of good j px: export price r tariff rate on good j r: corporate tax rate w: wage rate WD: world demand NFI: net Factor Income from abroad 7r: inflation rate R:dbanks reserves rr = reserve requirement for demand deposlts
34 There are certalnly beneficial influences from a more competitive and less heavily regulated financial sector, which are not however modelJed in our set-up. But there are also some macroeconomic costs as shown In column 4 of Table 7. The direct Impact of the reductlon In the **liquldity** requirement Is to Increase Interest expenses on public domestic debt and force the government to rely to a larger extent on domestic credit markets. The consequent decline In Investment relleves the pressure on the domestic goods markets (Indeed the real exchange rate appreciates by less than In the second simulatlon), but does not mitigate the Impact r-n Interest rate of hlgher public spending. Agalnst the long-run benefits n financial liberalization, some allowance should therefore also be ie for the macroeconomic costs stemming from a further .erioratlon In the situation of the government budget.
35 TABLE 7 Slmulatlng the Impact of fiscal policy

||base run<br>(1)|domest. financed<br>increase in G<br>(2)|foreign financed<br>increase in C<br>(3)|financial<br>liberaliz.<br>(4)|
|---|---|---|---|---|
|r|2.7|3.1|4.3|4.4|
|X|100|96.7|87.5|86.5|
|i/Y|18.4|16.1|16.5|15.8|
|BD/Y|-4.8|-6.8|-7.3|-8.1|
|l"|6.7|7.1|8.3|8.4|
|Bp/Y|21.4|19.2|19.4|18.6|
|GDINT/Y|2.5|2.6|2.7|3.4|

Legenda: r: real interest rate, X: real exchange rate, I/Y: GDP<sup>share</sup> of prlvate Investment, BD/Y: GDP share of budget deficit; Y':<sup>growth</sup> rate, B /Y: GDP share of credit to the prlvate sector, GDINT/Y: GDP sh&re of goverment Interest expenses on publlc domestic<sup>debt.</sup> Slmulatlons:

- 1: base case.

- 2: Increase ln government current consumptlon of MDH<sup>3000.</sup>

- 3: as in 2, plus a current account deterloratlon of MDH<sup>3000.</sup>

- 4: as In 3, plus abolition of the llquldlty requlrement on demand deposits.
36

# 6. CONCLUSIONS

Morocco has made great pro ress toward macroeconomic and fiscal stabllity. Yet the need to consolidate and broaden the achievements to date remains paramount. We have argued In this paper that even the financlng of a relatlvely unchanged tudget deficit may pose major problems. It is unlikely that foreign finance wlll increase substantially in the medlum-run. Monetary financlng does not seem to be a palatable alternative given its highly inflatlonary impllcations (sectlon 3). Flnally lncreaslng rellance on domestic financlal markets ls likely to lead to a steep increase In Interest costs for the Treasury wlth a destabillsing effect on the evolutlon of the main publlc debt Indlcators. Our slmulatlons also suggest that an Increase In government current expenditure crowds out Investment. The short-run benefits on output of such a pollcy may then be outweighed by Its long-run negative Impact on growth. It ls essential therefore that the commltment toward flscal disclpllne remalns unshaken. At the same tlme a determlned effort Is requlred to Implement an effectlve reform In the tax and public expendlture system, wlth a vlew of avoldlng that the brunt of flscal adjustment falls agaln mostly on public Investment.

At a more general level, we have argued that the effects of budget deflclts cannot be measured by looklng only at the Impact they exert through changes in the Interest rate on aggregate demand. As shown by Blinder (1987), Bernanke and 2linder (1988) and Blinder and Stlglitz (1983), a large part of the Impact of flscal pollcy may work Its way through the credit market. An expanslonary flscal pollcy may exac_rbate the pervasiveness of credlt ratlonlng effects on Investment demand wlth limited Impact on the level of the Interest rate. Our estlmates support the clalm that, even after controlling for the cost of capital, the avallabllty of credlt plays a slgnlflcant role In Influenclng the demand for Investment. As suggested by our slmulations, the credlt channel In turn will be a cruclal factor In determilnlng the macroeconomlc outcome of different flscal policles. Flnally we argue that the Impact on macroeconomlc equlllbria, In partlcular on the government budget, should be a relevant factor In assesslng the speed of financlal liberallzatlon.
37

# ENDNDT ES

I F^r a seminal contribution to the emplrical evaluation of the relationship between capital market Imperfections and investment decisions, see Fazzari et al. (1988).

2 The formal solution tc the firm's optimization problem is available from the author.

3 In the empirical implementation of the model only manufacturing expcrts on the one hand and investment, intermediate and consumption goods imports on the other are endogenous. All the other components of the resource balance (mainly exports of phosphate rocks and agricultural goods, imports of food and petroleum, net tourism receipts) are assumed, in the present version of the model, not to depend on price incentives and are, as a result, projected exogenously. Some of these components, in particular tourism receipts, may be endogenised in a new version of the model. Simllar remarks apply to the flow of workers' remittances (a component of NFI) which should not be treated as exogenous, but should be related to the level of the interest rate and the (expected) movements of the exchange rate.