## _wp09117

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---

### I. INTRODUCTION
- Purpose: Calibrate the global integrated monetary fiscal (GIMF) model (Kumhof and Laxton, 2008) with a commodity sector and a managed floating exchange rate regime to capture Argentina in 2003–2007.
- Key model features:
  - Incorporates fiscal policy to enable combined fiscal–monetary policy experiments.
  - Includes non-Ricardian features amplifying domestic demand responses.
  - Separately models and shocks a commodity sector to assess terms of trade shocks.
  - Endogenous capital formation to track investment dynamics.
  - Model is not log linearized around a constant steady state, allowing policy exercises with different steady states and transition paths.
- High-level result:
  - Without an active monetary policy, fiscal policy must be highly countercyclical to offset stimulative effects of a strong terms of trade shock and to contain inflation.
  - Combined monetary and fiscal policy substantially reduces output costs of containing inflation.

### II. LITERATURE
- Elosegui and others (2007):
  - Small open economy model extended for intervention; four monetary regimes studied: fixed to dollar, fixed to a basket, pure float inflation targeting, and managed floating.
  - Managed floating dampens real exchange rate appreciation and interest rate responses.
- Escudé (2007, 2008):
  - Small open economy with tradable/non-tradable sectors, nominal and real rigidities, direct foreign exchange intervention, banking sector, and a primary goods sector to capture terms of trade effects.
  - Calibrated for the Argentine economy (calibration left for future analysis in 2007; 2008 work includes calibration).
- Neumeyer and Perri (2004):
  - Dynamic general equilibrium for a small open economy exploring real interest rate contribution to output volatility.
  - Finding: eliminating country risk lowers Argentine output volatility by 27 percent; stabilizing international rates lowers it by less than 3 percent.

### III. THE GIMF MODEL
- Model structure:
  - Two-country dynamic general equilibrium model with multiple nominal and real rigidities; nominal rigidities limited to final goods production and labor markets.
  - Non-Ricardian features: overlapping generations (OLG), life-cycle income profiles, liquidity constrained consumers, distortionary taxes.
- Agents and sectors:
  - Households: (a) OLG with finite horizons and habit persistence; (b) liquidity constrained households.
  - Firms: produce tradable and non-tradable goods; face real investment adjustment costs; domestic sales to distributors; foreign sales via domestically owned import agents located abroad.
  - Distributors: assemble domestic non-tradable with domestic and foreign tradable goods; face adjustment cost on imported inputs; combine private output with publicly owned capital (infrastructure) and foreign output to produce domestic final output; subject to sticky prices.
  - Retailers: monopolistically competitive; flexible prices with adjustment costs on sale volume changes.
- Growth and assets:
  - World economy growth: exogenous constant trend.
  - Asset markets: complete home bias in government debt (nominal, one-period domestic-currency bonds); only internationally traded assets are nominal one-period foreign-currency bonds; firms owned domestically; households receive lump-sum dividends; commodity sector owned by both domestic and foreign households.
- Risk premia specification:
  - Foreign exchange risk premium formula structure (as presented):
    - fxpremy_t = 1_fx_y + 2_fx_y*(ca_t/y_gdp) + 3_fx_y*(ca_t/y_gdp)^2 + 4_fx_y*(ca_t/y_gdp)^3
    - Note: premium curve becomes extremely steep as current account-to-GDP approaches 1_fx_y (some negative number).
  - Government debt risk premium formula structure (as presented):
    - gbpremy_t = 1_gb_y + 2_gb_y*(B_t/y_gdp) + 3_gb_y*(B_t/y_gdp)^2 + 4_gb_y*(B_t/y_gdp)^3
    - Note: premium becomes prohibitive as debt-to-GDP approaches 4_gb_y (some positive number).

### IV. CALIBRATION
- Aggregate and demographic calibration:
  - Argentina: 0.6 percent of world population and 1 percent of world GDP (PPP adjusted).
  - Long-run world real interest rate: 3 percent per annum.
  - Real world growth rate: 2 percent per annum.
  - Population growth rate: 1 percent per annum.
  - Long-run inflation: 3 percent in Argentina, 2 percent in the rest of the world.
- Risk premium calibration:
  - Calibrated to produce about 390 basis points premium over international interest rates at steady state net foreign liabilities to GDP ratio of 0 percent and government debt-to-GDP ratio of 60 percent.
  - Premium is 250 basis points with steady state debt-to-GDP ratio of 40 percent.
- Household and income parameters:
  - Liquidity constrained agents: 50 percent of the Argentine and world population.
  - Share of these agents in dividend income: half of their share in the population.
- Labor, sectoral, and fiscal shares:
  - Labor shares: 55 percent in Argentina; 66 percent in the rest of the world.
  - Share of non-tradables: 56 percent for Argentina (based on CPI basket); 50 percent for rest of the world.
  - Steady state investment share of GDP: 20 percent for both economies.
  - Steady state government spending share of GDP: 16 percent in Argentina; 18 percent in the rest of the world.
  - Government consumption: 12 percent in Argentina; 15 percent in the rest of the world.
  - Transfers: 9 percent of GDP in Argentina; 10 percent in the rest of the world.
  - Tax revenue composition in Argentina: 55 percent consumption tax revenues, 16 percent capital income tax revenues, 23 percent labor income tax revenues.
  - Tax revenue composition in rest of the world: 30 percent consumption, 10 percent capital income, 30 percent labor income tax revenues.
- Commodity sector calibration:
  - Argentina’s commodity output: about 17 percent of GDP.
  - Commodity exports: 10.2 percent of GDP.
  - Commodity revenues distribution: 70 percent to domestic factors of production; 15 percent of the remainder to foreign private sector; rest to the government.
- Trade flows (shares of GDP):
  - Exports of intermediate goods: 5.44 percent of GDP.
  - Exports of final goods (excluding commodities): 1.36 percent of GDP.
  - Imports of intermediate goods excluding commodities: 8 percent of GDP.

### V. POLICY ANALYSIS — Baseline Scenario
- Policy and institutional assumptions capturing Argentina 2003–2007:
  1. Monetary policy: constrained by relative stability of the peso vis-à-vis the U.S. dollar.
  2. Fiscal policy: targets a constant overall surplus via a variant of a balanced budget rule.
     - Overall surplus policy rule (as presented):
       - gs_t − φ = (tax_t − d_tax) + (com_t − d_com), where notation corresponds to the formula presented in the source (policy targets a constant overall surplus when tax_d and com_d are set to zero).
     - In the baseline, the response of the cyclical surplus to excess tax and commodity revenue (i.e., tax_d, com_d) are set to zero, implying fiscal policy targets a constant overall surplus.
     - Government instruments: uses lump sum transfers; government consumption and investment kept constant as shares of GDP.
  3. Economic context captured by four components:
     - A strong terms of trade shock.
     - Increase in government revenues from the commodity sector through higher export taxes.
     - A consumption boom and positive output gap.
     - A real exchange rate initially below its long-run equilibrium.
- Implementation in simulations:
  - The simulation is started away from long-run equilibrium and includes a shock to world commodity demand, which drives up commodity prices.

### Baseline scenario (debt reduction / change in steady state)
- Shock description:
  - 1.5 standard deviations (around 8 percent) and increases consumption, investment and output.
  - The government’s take from the commodity sector is increased by one percentage point of GDP to simulate the impact of higher export taxes.
  - An exogenous boost to private consumption is included—through a temporary increase in the rate of time preference—to capture strong consumption demand.
  - A reduced mark-up in the non-tradables sector is used to simulate a real exchange rate below its long-run equilibrium.
- Fiscal path and mechanism:
  - Public debt is assumed to decline from 60 to 40 percent of GDP.
  - This implies an initial increase in the overall government surplus of 1.2 percent of GDP, achieved through a reduction in transfers.
  - Short-run: domestic demand contracts and GDP falls due to the transfer reduction.
  - Medium-run: lower debt reduces the risk premium, real interest rates fall, and domestic demand settles at a higher level in the new steady state.
  - Private sector agents offset some of the fiscal tightening; the current account surplus responds less than one-to-one to the higher overall surplus.
- Key dynamics and outcomes:
  - High commodity prices increase private wealth and raise consumption.
  - Increased government take from the commodity sector is distributed via higher transfers to maintain the overall surplus target, further stimulating consumption.
  - Inflation increases, pushing down real interest rates (since nominal rates are linked to world interest rates under the fixed exchange rate regime), adding to both investment and consumption over the short-term.
  - Trade balance and current account move into surplus initially due to the terms of trade shock; over time higher imports reduce the surpluses.
  - The currency appreciates in real terms; suppression of margins in non-tradable sectors helps to slow the appreciation.
  - The baseline captures features in Argentina during 2003–2007: strong economic growth, an appreciating real exchange rate, albeit with some degree of undervaluation.

### A. Quantitative items from the baseline setup
- Debt-to-GDP path: 60 to 40 percent of GDP.
- Initial overall government surplus increase: 1.2 percent of GDP.
- Government take from commodity sector increase simulated by: one percentage point of GDP.
- Shock size described as: 1.5 standard deviations (around 8 percent).

### B. A more active monetary policy
- Monetary policy specification:
  - Policy instrument: interest rate; more independence because exchange rate policy is set in line with a forward-looking policy reaction function.
  - Policy reacts to expected inflation, the output gap, exchange rate depreciation, and smooths interest rates.
- Policy rule parameters (exact values used):
  - μ (degree of interest rate smoothing) set equal to 0.5.
  - πμ (response to deviation of one year ahead year-on-year inflation from inflation target) set equal to 1.1.
  - yμ (response to output gap) weight of 0.1.
  - eμ (response to variations in exchange rate depreciation) varies by regime: in a pure floating exchange rate regime eμ is set to zero; in a managed floating exchange rate regime eμ is set to 1.
- Pure floating exchange rate regime (eμ = 0):
  - Exchange rate flexible, determined through uncovered interest parity.
  - Monetary authority raises nominal interest rates in response to higher inflation and an economy above potential; the currency appreciates in nominal terms.
  - Investment initially declines, stimulus to consumption is reduced.
  - GDP and inflation increase by less than in the baseline; inflationary pressures are virtually halved in comparison to the baseline.
  - Overall: a more activist monetary policy reduces swings in both inflation and real activity by much more than the baseline.
- Managed floating exchange rate regime (eμ = 1):
  - Monetary policy reacts to exchange rate depreciation: nominal interest rates initially reduced in response to exchange rate appreciation pressures, then raised in response to higher inflation and positive output gap.
  - Stimulus to consumption and investment reduced compared to baseline, but demand pressures still higher than in flexible ER regime.
  - Inflationary pressures lowered, but not as much as in the pure floating case.

### C. Countercyclical fiscal policy
- Scenarios assessed (steady state: public debt at 40 percent of GDP):
  1. Structural Surplus Rule and Fixed Exchange Rate: fiscal surplus raised above potential and lowered in downturns. In the fiscal policy reaction function, taxd and comd are both set to 1.
  2. Activist Countercyclical Fiscal Policy and Fixed Exchange Rate: stronger countercyclical response; taxd and comd are both set to 2.
- Effects:
  - Under the structural surplus rule, overall and primary surpluses increase in response to positive shocks, moderating the consumption boom somewhat.
  - Fiscal reaction increases investment in the short-run relative to baseline; output boom only modestly contained; inflationary pressures slightly lower than under the overall balance rule.
  - Even with considerably more countercyclical fiscal policy, the impact on volatility of inflation and output is muted.
  - Asymmetry note: response to negative shocks would not be symmetric, particularly with high debt-to-GDP ratios—countercyclical policy could reduce overall surplus, increase debt accumulation and risk premium, reduce investment and consumption. The degree of countercyclicality and impact depend on initial conditions regarding debt and current account.

### D. Combination of fiscal and monetary policies (coordinated)
- Setup:
  - Baseline scenario repeated with both the structural surplus rule (Section C) and activist monetary policies (Section B) operating together (both pure and managed floating exchange rate regimes).
- Mechanisms and outcomes:
  - Monetary policy reacts quickly to inflationary pressures and is supported by countercyclical fiscal policy.
  - Nominal exchange rate allowed to appreciate over the short-term (less so for managed floating regime), quickly lowering tradable goods prices.
  - Higher real interest rates contain consumption and investment.
  - Tighter fiscal policy ensures a greater portion of the commodity windfall is saved.
  - Inflationary pressures decrease quickly and substantially.
  - Economy converges to new equilibrium with significant reduction in both output and inflation variability.
  - When monetary and fiscal policy work together, the amount of interest rate increases needed is much less than with active monetary policy alone.

### E. Volatilities of main variables under alternative policy scenarios (table excerpts as presented)
- Baseline (debt = 40):
  - Standard deviation: Real GDP 0.24, Inflation 0.33, Nominal Interest Rate 0.04
  - Maximum: Real GDP 1.72, Inflation 3.77, Nominal Interest Rate 0.05
  - Minimum: Real GDP -0.18, Inflation -0.70, Nominal Interest Rate -0.21
- Flexible ER (debt = 40):
  - Standard deviation: Real GDP 0.22, Inflation 0.27, Nominal Interest Rate 0.26
  - Maximum: Real GDP 1.50, Inflation 2.72, Nominal Interest Rate 1.81
  - Minimum: Real GDP -0.12, Inflation 0.00, Nominal Interest Rate -0.01
- Managed ER (debt = 40):
  - Standard deviation: Real GDP 0.23, Inflation 0.25, Nominal Interest Rate 0.10
  - Maximum: Real GDP 1.63, Inflation 3.04, Nominal Interest Rate 0.64
  - Minimum: Real GDP -0.15, Inflation -0.12, Nominal Interest Rate -0.09
- Structural Surplus Rule (SSR) (debt = 40):
  - Standard deviation: Real GDP 0.25, Inflation 0.28, Nominal Interest Rate 0.05
  - Maximum: Real GDP 1.63, Inflation 2.99, Nominal Interest Rate 0.06
  - Minimum: Real GDP -0.21, Inflation -0.48, Nominal Interest Rate -0.26
- Structural Surplus Rule (SSR, d=2) (debt = 40):
  - Standard deviation: Real GDP 0.26, Inflation 0.23, Nominal Interest Rate 0.06
  - Maximum: Real GDP 1.57, Inflation 2.37, Nominal Interest Rate 0.07
  - Minimum: Real GDP -0.23, Inflation -0.39, Nominal Interest Rate -0.30
- Combination of policies (SSR and Managed ER) (debt = 40):
  - Standard deviation: Real GDP 0.23, Inflation 0.18, Nominal Interest Rate 0.09
  - Maximum: Real GDP 1.60, Inflation 2.05, Nominal Interest Rate 0.49
  - Minimum: Real GDP -0.18, Inflation -0.01, Nominal Interest Rate -0.58
- Combination of policies (SSR and Flexible ER) (debt = 40):
  - Standard deviation: Real GDP 0.20, Inflation 0.15, Nominal Interest Rate 0.21
  - Maximum: Real GDP 1.36, Inflation 0.99, Nominal Interest Rate 1.23
  - Minimum: Real GDP -0.17, Inflation 0.00, Nominal Interest Rate -0.01

### Overall conclusions and policy implications
- Using either an activist monetary policy or countercyclical fiscal policy alone to respond to strong growth in domestic demand would have only a partial effect on inflationary pressures.
- Relying on monetary policy alone to contain inflation would require a dramatic increase in nominal interest rates; relying on fiscal policy alone would require a highly countercyclical fiscal stance—both imply larger output costs.
- Coordinated use of both fiscal and monetary policy tools can help contain domestic demand growth and reduce inflation with a relatively small output cost.
- Policy effectiveness and costs depend on initial conditions such as debt and current account positions; responses to negative shocks would be asymmetric, particularly at high debt-to-GDP ratios.

### APPENDIX 1. CALIBRATION — Parameters and Scenarios
- Parameters (as listed):
  - Size of GDP (PPP adjusted) in world GDP 0.6
  - Size of population in world population 1
  - World real interest rate 3
  - Risk premium at 60 percent debt to GDP 390 basis points
  - Risk premium at 40 percent debt to GDP 250 basis points
  - Real world growth rate 2
  - Population growth rate 1
  - Steady state world inflation  2
  - Steady state inflation  3
  - Share of liquidity constrained agents in world population 50
  - Share of liquidity constrained agents in Argentine population 50
  - Labor share (world) 66
  - Labor share (Argentina) 55
  - The share of non-tradables (world) 50
  - The share of non-tradables (Argentina) 56
  - Share of investment spending in GDP (world and Argentina) 20
  - Share of government spending in GDP (world) 18
  - Share of government spending (Argentina) 16
  - Share of government consumption (world) 15
  - Share of government consumption (Argentina) 12
  - Share of transfers in GDP(world) 9
  - Share of transfers in GDP(Argentina) 10
  - Share of consumption tax revenues in total (world) 30
  - Share of consumption tax revenues in total (Argentina) 55
  - Share of capital income tax revenues in total (world) 16
  - Share of capital income tax revenues in total (Argentina) 10
  - Share of labor income tax revenues in total (world) 23
  - Share of labor income tax revenues in total (Argentina) 30
  - Share of commodity output in total GDP 17
  - Share of commodity exports in total GDP 10.2
  - Share of domestic factors of prod. in total commodity revenue 70
  - Share of exports of intermediate goods in GDP 5.44
  - Share of exports of final goods excluding commodities in GDP 1.36
  - Share of imports of intermediate goods excl. commod. in GDP 8
- Scenarios tracked (as described):
  - Changing Steady State — 20 percentage point decline in debt-to-GDP ratio
  - Commodity price shock — One and half standard deviation commodity price shock
  - Increase in government's commodity revenues by one percentage point of GDP
  - Consumption boom — One percent increase in time preference
  - Decline in mark-up in the non-tradable goods sector — One percentage point decline in mark-up in NTG sector
- Common tracked variables across scenarios include:
  - Macro: GDP Chain-Weighted; GDP Current; Consumption; Nominal Interest Rate; Investment; Inflation; Real interest Rate; Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER; Exports; Imports; Oil Exports
  - Fiscal: Tax Revenue/GDP; Gov. Spending/GDP; Transfers/GDP; Commodity Revenue/GDP; Interest Expenditure/GDP; Primary Deficit/GDP; Government Deficit/GDP; Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate; Government Debt/GDP
  - Trade: Trade Balance (Chain Weighted)/GDP; Foreign Interest Earnings/GDP; Current Account Balance/GDP; NFA/GDP

*Source: _wp09117 (IMF working paper content as provided in the supplied content).*

### References..............................................................................................................

### _wp09117 - References..............................................................................................................

### I. INTRODUCTION
- Purpose: Calibrate the global integrated monetary fiscal (GIMF) model (Kumhof and Laxton, 2008) with a commodity sector and a managed floating exchange rate regime to capture Argentina in 2003–2007.
- Key model features emphasized:
  - Incorporates fiscal policy to enable combined fiscal–monetary policy experiments.
  - Includes non-Ricardian features amplifying domestic demand responses.
  - Separately models and shocks a commodity sector to assess terms of trade shocks.
  - Endogenous capital formation to track investment dynamics.
  - Model is not log linearized around a constant steady state, allowing policy exercises with different steady states and transition paths.
- High-level result:
  - Without an active monetary policy, fiscal policy must be highly countercyclical to offset stimulative effects of a strong terms of trade shock and to contain inflation.
  - Combined monetary and fiscal policy substantially reduces output costs of containing inflation.

### II. LITERATURE
- Elosegui and others (2007):
  - Small open economy model extended for intervention; four monetary regimes studied: fixed to dollar, fixed to a basket, pure float inflation targeting, and managed floating.
  - Managed floating dampens real exchange rate appreciation and interest rate responses.
- Escudé (2007, 2008):
  - Small open economy with tradable/non-tradable sectors, nominal and real rigidities, direct foreign exchange intervention, banking sector, and a primary goods sector to capture terms of trade effects.
  - Calibrated for the Argentine economy (calibration left for future analysis in 2007; 2008 work includes calibration).
- Neumeyer and Perri (2004):
  - Dynamic general equilibrium for a small open economy exploring real interest rate contribution to output volatility.
  - Finding: eliminating country risk lowers Argentine output volatility by 27 percent; stabilizing international rates lowers it by less than 3 percent.

### III. THE GIMF MODEL
- Model structure:
  - Two-country dynamic general equilibrium model with multiple nominal and real rigidities; nominal rigidities limited to final goods production and labor markets.
  - Non-Ricardian features: overlapping generations (OLG), life-cycle income profiles, liquidity constrained consumers, distortionary taxes.
- Agents and sectors:
  - Households: (a) OLG with finite horizons and habit persistence; (b) liquidity constrained households.
  - Firms: produce tradable and non-tradable goods; face real investment adjustment costs; domestic sales to distributors; foreign sales via domestically owned import agents located abroad.
  - Distributors: assemble domestic non-tradable with domestic and foreign tradable goods; face adjustment cost on imported inputs; combine private output with publicly owned capital (infrastructure) and foreign output to produce domestic final output; subject to sticky prices.
  - Retailers: monopolistically competitive; flexible prices with adjustment costs on sale volume changes.
- Growth and assets:
  - World economy growth: exogenous constant trend.
  - Asset markets: complete home bias in government debt (nominal, one-period domestic-currency bonds); only internationally traded assets are nominal one-period foreign-currency bonds; firms owned domestically; households receive lump-sum dividends; commodity sector owned by both domestic and foreign households.
- Risk premia specification:
  - Foreign exchange risk premium is a non-linear function of current account to GDP:
    - fxpremy_t = 1_fx_y + 2_fx_y*(ca_t/y_gdp) + 3_fx_y*(ca_t/y_gdp)^2 + 4_fx_y*(ca_t/y_gdp)^3 (formula structure retained as presented).
    - Note: premium curve becomes extremely steep as current account-to-GDP approaches 1_fx_y (some negative number).
  - Government debt risk premium is a non-linear function of government debt to GDP:
    - gbpremy_t = 1_gb_y + 2_gb_y*(B_t/y_gdp) + 3_gb_y*(B_t/y_gdp)^2 + 4_gb_y*(B_t/y_gdp)^3 (formula structure retained as presented).
    - Note: premium becomes prohibitive as debt-to-GDP approaches 4_gb_y (some positive number).

### IV. CALIBRATION
- Aggregate and demographic calibration:
  - Argentina: 0.6 percent of world population and 1 percent of world GDP (PPP adjusted).
  - Long-run world real interest rate: 3 percent per annum.
  - Real world growth rate: 2 percent per annum.
  - Population growth rate: 1 percent per annum.
  - Long-run inflation: 3 percent in Argentina, 2 percent in the rest of the world.
- Risk premium calibration:
  - Calibrated to produce about 390 basis points premium over international interest rates at steady state net foreign liabilities to GDP ratio of 0 percent and government debt-to-GDP ratio of 60 percent.
  - Premium is 250 basis points with steady state debt-to-GDP ratio of 40 percent.
- Household and income parameters:
  - Liquidity constrained agents: 50 percent of the Argentine and world population.
  - Share of these agents in dividend income: half of their share in the population.
- Labor, sectoral, and fiscal shares:
  - Labor shares: 55 percent in Argentina; 66 percent in the rest of the world.
  - Share of non-tradables: 56 percent for Argentina (based on CPI basket); 50 percent for rest of the world.
  - Steady state investment share of GDP: 20 percent for both economies.
  - Steady state government spending share of GDP: 16 percent in Argentina; 18 percent in the rest of the world.
  - Government consumption: 12 percent in Argentina; 15 percent in the rest of the world.
  - Transfers: 9 percent of GDP in Argentina; 10 percent in the rest of the world.
  - Tax revenue composition in Argentina: 55 percent consumption tax revenues, 16 percent capital income tax revenues, 23 percent labor income tax revenues.
  - Tax revenue composition in rest of the world: 30 percent consumption, 10 percent capital income, 30 percent labor income tax revenues.
- Commodity sector calibration:
  - Argentina’s commodity output: about 17 percent of GDP.
  - Commodity exports: 10.2 percent of GDP.
  - Commodity revenues distribution: 70 percent to domestic factors of production; 15 percent of the remainder to foreign private sector; rest to the government.
- Trade flows (shares of GDP):
  - Exports of intermediate goods: 5.44 percent of GDP.
  - Exports of final goods (excluding commodities): 1.36 percent of GDP.
  - Imports of intermediate goods excluding commodities: 8 percent of GDP.

### V. POLICY ANALYSIS — Baseline Scenario
- Policy and institutional assumptions capturing Argentina 2003–2007:
  1. Monetary policy: constrained by relative stability of the peso vis-à-vis the U.S. dollar.
  2. Fiscal policy: targets a constant overall surplus via a variant of a balanced budget rule.
     - Overall surplus policy rule (as presented):
       - gs_t − φ = (tax_t − d_tax) + (com_t − d_com), where notation corresponds to the formula presented in the source (policy targets a constant overall surplus when tax_d and com_d are set to zero).
     - In the baseline, the response of the cyclical surplus to excess tax and commodity revenue (i.e., tax_d, com_d) are set to zero, implying fiscal policy targets a constant overall surplus.
     - Government instruments: uses lump sum transfers; government consumption and investment kept constant as shares of GDP.
  3. Economic context captured by four components:
     - A strong terms of trade shock.
     - Increase in government revenues from the commodity sector through higher export taxes.
     - A consumption boom and positive output gap.
     - A real exchange rate initially below its long-run equilibrium.
- Implementation in simulations:
  - The simulation is started away from long-run equilibrium and includes:
    - A shock to world commodity demand, which drives up commodity prices (simulation description truncated at this point in source).

*Content based solely on text from the supplied IMF PDF chapter/section.*

### 1.5 standard deviations (around 8 percent) and increases consumption, investment and

### _wp09117 - 1.5 standard deviations (around 8 percent) and increases consumption, investment and

### Baseline scenario (debt reduction / change in steady state)
- Shock description:
  - 1.5 standard deviations (around 8 percent) and increases consumption, investment and output.
  - The government’s take from the commodity sector is increased by one percentage point of GDP to simulate the impact of higher export taxes.
  - An exogenous boost to private consumption is included—through a temporary increase in the rate of time preference—to capture strong consumption demand.
  - A reduced mark-up in the non-tradables sector is used to simulate a real exchange rate below its long-run equilibrium.
- Fiscal path and mechanism:
  - Public debt is assumed to decline from 60 to 40 percent of GDP.
  - This implies an initial increase in the overall government surplus of 1.2 percent of GDP, achieved through a reduction in transfers.
  - Short-run: domestic demand contracts and GDP falls due to the transfer reduction.
  - Medium-run: lower debt reduces the risk premium, real interest rates fall, and domestic demand settles at a higher level in the new steady state.
  - Private sector agents offset some of the fiscal tightening; the current account surplus responds less than one-to-one to the higher overall surplus.
- Key dynamics and outcomes:
  - High commodity prices increase private wealth and raise consumption.
  - Increased government take from the commodity sector is distributed via higher transfers to maintain the overall surplus target, further stimulating consumption.
  - Inflation increases, pushing down real interest rates (since nominal rates are linked to world interest rates under the fixed exchange rate regime), adding to both investment and consumption over the short-term.
  - Trade balance and current account move into surplus initially due to the terms of trade shock; over time higher imports reduce the surpluses.
  - The currency appreciates in real terms; suppression of margins in non-tradable sectors helps to slow the appreciation.
  - The baseline captures features in Argentina during 2003–2007: strong economic growth, an appreciating real exchange rate, albeit with some degree of undervaluation.

### A. Quantitative items from the baseline setup
- Debt-to-GDP path: 60 to 40 percent of GDP.
- Initial overall government surplus increase: 1.2 percent of GDP.
- Government take from commodity sector increase simulated by: one percentage point of GDP.
- Shock size described as: 1.5 standard deviations (around 8 percent).

### B. A more active monetary policy
- Monetary policy specification:
  - Policy instrument: interest rate; more independence because exchange rate policy is set in line with a forward-looking policy reaction function.
  - Policy reacts to expected inflation, the output gap, exchange rate depreciation, and smooths interest rates.
- Policy rule parameters (exact values used):
  - μ (degree of interest rate smoothing) set equal to 0.5.
  - πμ (response to deviation of one year ahead year-on-year inflation from inflation target) set equal to 1.1.
  - yμ (response to output gap) weight of 0.1.
  - eμ (response to variations in exchange rate depreciation) varies by regime: in a pure floating exchange rate regime eμ is set to zero; in a managed floating exchange rate regime eμ is set to 1.
- Pure floating exchange rate regime (eμ = 0):
  - Exchange rate flexible, determined through uncovered interest parity.
  - Monetary authority raises nominal interest rates in response to higher inflation and an economy above potential; the currency appreciates in nominal terms.
  - Investment initially declines, stimulus to consumption is reduced.
  - GDP and inflation increase by less than in the baseline; inflationary pressures are virtually halved in comparison to the baseline.
  - Overall: a more activist monetary policy reduces swings in both inflation and real activity by much more than the baseline.
- Managed floating exchange rate regime (eμ = 1):
  - Monetary policy reacts to exchange rate depreciation: nominal interest rates initially reduced in response to exchange rate appreciation pressures, then raised in response to higher inflation and positive output gap.
  - Stimulus to consumption and investment reduced compared to baseline, but demand pressures still higher than in flexible ER regime.
  - Inflationary pressures lowered, but not as much as in the pure floating case.

### C. Countercyclical fiscal policy
- Scenarios assessed (steady state: public debt at 40 percent of GDP):
  1. Structural Surplus Rule and Fixed Exchange Rate: fiscal surplus raised above potential and lowered in downturns. In the fiscal policy reaction function, taxd and comd are both set to 1.
  2. Activist Countercyclical Fiscal Policy and Fixed Exchange Rate: stronger countercyclical response; taxd and comd are both set to 2.
- Effects:
  - Under the structural surplus rule, overall and primary surpluses increase in response to positive shocks, moderating the consumption boom somewhat.
  - Fiscal reaction increases investment in the short-run relative to baseline; output boom only modestly contained; inflationary pressures slightly lower than under the overall balance rule.
  - Even with considerably more countercyclical fiscal policy, the impact on volatility of inflation and output is muted.
  - Asymmetry note: response to negative shocks would not be symmetric, particularly with high debt-to-GDP ratios—countercyclical policy could reduce overall surplus, increase debt accumulation and risk premium, reduce investment and consumption. The degree of countercyclicality and impact depend on initial conditions regarding debt and current account.

### D. Combination of fiscal and monetary policies (coordinated)
- Setup:
  - Baseline scenario repeated with both the structural surplus rule (Section C) and activist monetary policies (Section B) operating together (both pure and managed floating exchange rate regimes).
- Mechanisms and outcomes:
  - Monetary policy reacts quickly to inflationary pressures and is supported by countercyclical fiscal policy.
  - Nominal exchange rate allowed to appreciate over the short-term (less so for managed floating regime), quickly lowering tradable goods prices.
  - Higher real interest rates contain consumption and investment.
  - Tighter fiscal policy ensures a greater portion of the commodity windfall is saved.
  - Inflationary pressures decrease quickly and substantially.
  - Economy converges to new equilibrium with significant reduction in both output and inflation variability.
  - When monetary and fiscal policy work together, the amount of interest rate increases needed is much less than with active monetary policy alone.

### E. Volatilities of main variables under alternative policy scenarios (table excerpts as presented)
- Baseline (debt = 40):
  - Standard deviation: Real GDP 0.24, Inflation 0.33, Nominal Interest Rate 0.04
  - Maximum: Real GDP 1.72, Inflation 3.77, Nominal Interest Rate 0.05
  - Minimum: Real GDP -0.18, Inflation -0.70, Nominal Interest Rate -0.21
- Flexible ER (debt = 40):
  - Standard deviation: Real GDP 0.22, Inflation 0.27, Nominal Interest Rate 0.26
  - Maximum: Real GDP 1.50, Inflation 2.72, Nominal Interest Rate 1.81
  - Minimum: Real GDP -0.12, Inflation 0.00, Nominal Interest Rate -0.01
- Managed ER (debt = 40):
  - Standard deviation: Real GDP 0.23, Inflation 0.25, Nominal Interest Rate 0.10
  - Maximum: Real GDP 1.63, Inflation 3.04, Nominal Interest Rate 0.64
  - Minimum: Real GDP -0.15, Inflation -0.12, Nominal Interest Rate -0.09
- Structural Surplus Rule (SSR) (debt = 40):
  - Standard deviation: Real GDP 0.25, Inflation 0.28, Nominal Interest Rate 0.05
  - Maximum: Real GDP 1.63, Inflation 2.99, Nominal Interest Rate 0.06
  - Minimum: Real GDP -0.21, Inflation -0.48, Nominal Interest Rate -0.26
- Structural Surplus Rule (SSR, d=2) (debt = 40):
  - Standard deviation: Real GDP 0.26, Inflation 0.23, Nominal Interest Rate 0.06
  - Maximum: Real GDP 1.57, Inflation 2.37, Nominal Interest Rate 0.07
  - Minimum: Real GDP -0.23, Inflation -0.39, Nominal Interest Rate -0.30
- Combination of policies (SSR and Managed ER) (debt = 40):
  - Standard deviation: Real GDP 0.23, Inflation 0.18, Nominal Interest Rate 0.09
  - Maximum: Real GDP 1.60, Inflation 2.05, Nominal Interest Rate 0.49
  - Minimum: Real GDP -0.18, Inflation -0.01, Nominal Interest Rate -0.58
- Combination of policies (SSR and Flexible ER) (debt = 40):
  - Standard deviation: Real GDP 0.20, Inflation 0.15, Nominal Interest Rate 0.21
  - Maximum: Real GDP 1.36, Inflation 0.99, Nominal Interest Rate 1.23
  - Minimum: Real GDP -0.17, Inflation 0.00, Nominal Interest Rate -0.01

### Overall conclusions and policy implications
- Using either an activist monetary policy or countercyclical fiscal policy alone to respond to strong growth in domestic demand would have only a partial effect on inflationary pressures.
- Relying on monetary policy alone to contain inflation would require a dramatic increase in nominal interest rates; relying on fiscal policy alone would require a highly countercyclical fiscal stance—both imply larger output costs.
- Coordinated use of both fiscal and monetary policy tools can help contain domestic demand growth and reduce inflation with a relatively small output cost.
- Policy effectiveness and costs depend on initial conditions such as debt and current account positions; responses to negative shocks would be asymmetric, particularly at high debt-to-GDP ratios.

*Source: IMF working paper content (as provided in the supplied content).*

### APPENDIX 1. CALIBRATION

### APPENDIX 1. CALIBRATION

### Parameters
- Size of GDP (PPP adjusted) in world GDP 0.6
- Size of population in world population 1
- World real interest rate 3
- Risk premium at 60 percent debt to GDP 390 basis points
- Risk premium at 40 percent debt to GDP 250 basis points
- Real world growth rate 2
- Population growth rate 1
- Steady state world inflation  2
- Steady state inflation  3
- Share of liquidity constrained agents in world population 50
- Share of liquidity constrained agents in Argentine population 50
- Labor share (world) 66
- Labor share (Argentina) 55
- The share of non-tradables (world) 50
- The share of non-tradables (Argentina) 56
- Share of investment spending in GDP (world and Argentina) 20
- Share of government spending in GDP (world) 18
- Share of government spending (Argentina) 16
- Share of government consumption (world) 15
- Share of government consumption (Argentina) 12
- Share of transfers in GDP(world) 9
- Share of transfers in GDP(Argentina) 10
- Share of consumption tax revenues in total (world) 30
- Share of consumption tax revenues in total (Argentina) 55
- Share of capital income tax revenues in total (world) 16
- Share of capital income tax revenues in total (Argentina) 10
- Share of labor income tax revenues in total (world) 23
- Share of labor income tax revenues in total (Argentina) 30
- Share of commodity output in total GDP 17
- Share of commodity exports in total GDP 10.2
- Share of domestic factors of prod. in total commodity revenue 70
- Share of exports of intermediate goods in GDP 5.44
- Share of exports of final goods excluding commodities in GDP 1.36
- Share of imports of intermediate goods excl. commod. in GDP 8

### Scenario: Changing Steady State — 20 percentage point decline in debt-to-GDP ratio
Summary: Argentina: 20 percentage point decline in debt-to GDP ratio
Tracked macro variables (shown):
- GDP Chain-Weighted; GDP Current
- Consumption
- Nominal Interest Rate
- Investment
- Inflation
- Real interest Rate

Fiscal variables (shown):
- Tax Revenue/GDP
- Gov. Spending/GDP; Transfers/GDP
- Commodity Revenue/GDP
- Interest Expenditure/GDP
- Primary Deficit/GDP
- Government Deficit/GDP
- Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate
- Government Debt/GDP

Trade variables (shown):
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER
- Exports; Imports; Oil Exports
- Trade Balance (Chain Weighted)/GDP
- Foreign Interest Earnings/GDP
- Current Account Balance/GDP
- NFA/GDP

### Scenario: Commodity price shock — One and half standard deviation commodity price shock
Summary: Argentina: One and half standard deviation commodity price shock
Tracked macro variables (shown):
- GDP Current
- Consumption
- Nominal Interest Rate
- Investment
- Inflation
- Real interest Rate
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation
- Exports; Imports; Oil Exports

Fiscal variables (shown):
- Tax Revenue/GDP
- Gov. Spending/GDP; Transfers/GDP
- Commodity Revenue/GDP
- Interest Expenditure/GDP
- Primary Deficit/GDP
- Government Deficit/GDP
- Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate
- Government Debt/GDP

Trade variables (shown):
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER
- Exports; Imports; Oil Exports
- Trade Balance (Chain Weighted)/GDP
- Foreign Interest Earnings/GDP
- Current Account Balance/GDP
- NFA/GDP

### Scenario: Increase in government's commodity revenues by one percentage point of GDP
Summary: Argentina: Increase in government's commodity revenues by one percentage point of GDP
Tracked macro variables (shown):
- GDP Current
- Consumption
- Nominal Interest Rate
- Investment
- Inflation
- Real interest Rate
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation
- Exports; Imports; Oil Exports

Fiscal variables (shown):
- Tax Revenue/GDP
- Gov. Spending/GDP; Transfers/GDP
- Commodity Revenue/GDP
- Interest Expenditure/GDP
- Primary Deficit/GDP
- Government Deficit/GDP
- Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate
- Government Debt/GDP

Trade variables (shown):
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER
- Exports; Imports; Oil Exports
- Trade Balance (Chain Weighted)/GDP
- Foreign Interest Earnings/GDP
- Current Account Balance/GDP
- NFA/GDP

### Scenario: Consumption boom — One percent increase in time preference
Summary: Argentina: One percent increase in time preference
Tracked macro variables (shown):
- GDP Current
- Consumption
- Nominal Interest Rate
- Investment
- Inflation
- Real interest Rate
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation
- Exports; Imports; Oil Exports

Fiscal variables (shown):
- Tax Revenue/GDP
- Gov. Spending/GDP; Transfers/GDP
- Commodity Revenue/GDP
- Interest Expenditure/GDP
- Primary Deficit/GDP
- Government Deficit/GDP
- Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate
- Government Debt/GDP

Trade variables (shown):
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER
- Exports; Imports; Oil Exports
- Trade Balance (Chain Weighted)/GDP
- Foreign Interest Earnings/GDP
- Current Account Balance/GDP
- NFA/GDP

### Scenario: Decline in mark-up in the non-tradable goods sector — One percentage point decline in mark-up in NTG sector
Summary: Argentina: One percentage point decline in mark-up in NTG sector
Tracked macro variables (shown):
- GDP Current
- Consumption
- Nominal Interest Rate
- Investment
- Inflation
- Real interest Rate
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation
- Exports; Imports; Oil Exports

Fiscal variables (shown):
- Tax Revenue/GDP
- Gov. Spending/GDP; Transfers/GDP
- Commodity Revenue/GDP
- Interest Expenditure/GDP
- Primary Deficit/GDP
- Government Deficit/GDP
- Labor Tax Rate; Consumption Tax Rate; Capital Tax Rate
- Government Debt/GDP

Trade variables (shown):
- Final Goods RER (+=Depreciation); Exchange Rate Depreciation; Intermediate RER
- Exports; Imports; Oil Exports
- Trade Balance (Chain Weighted)/GDP
- Foreign Interest Earnings/GDP
- Current Account Balance/GDP
- NFA/GDP

*Source: APPENDIX 1. CALIBRATION (content unit)._wp09117 - APPENDIX 1. CALIBRATION*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2009/_wp09117.pdf_