Plans And Disequilibria In Centrally Planned Economies (Empirical Investigation For Poland) 0444701001, 072043100X, 9780444701008

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PLANS AND DISEQUILIBRIA IN CENTRALLY PLANNED ECONOMIES (Empirical Investigation for Poland)

CONTRIBUTIONS TO ECONOMIC ANALYSIS 159

Honorary Editor: J. TINBERGEN Editors: D. W. JORGENSON J. WAELBROECK

AMSTERDAM

NORTH-HOLLAND NEW YORK · OXFORD · TOKYO

PLANS AND DISEQUILIBRIA IN CENTRALLY PLANNED ECONOMIES (Empirical Investigation for Poland) WOJCIECH CHAREMZA, MIROSLAW GRONICKI University of Gdansk, Poland

NH

1988 NORTH-HOLLAND AMSTERDAM · NEW YORK · OXFORD

TOKYO

PWN—POLISH SCIENTIFIC PUBLISHERS · WARSAW

(ς) PWN—POLISH SCIENTIFIC PUBLISHERS—WARSZ AW A—1988 AU rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the copyright owner.

ISBN for this series: 0 7204 3100 X ISBN for this volume: 0 444 70100 1

Publishers : ELSEVIER SCIENCE PUBLISHERS B. V. P. O. Box 1991 1000 BZ Amsterdam The Netherlands PWN—POLISH SCIENTIFIC PUBLISHERS Warszawa Sole distributors for the U. S. A. and Canada ELSEVIER SCIENCE PUBLISHING COMPANY, INC. 52 Vanderbilt Avenue New York, N. Y. 10017 U. S. A.

Library of Congress Cataloging-in-Publication Data Charemza, Wojciech. Plans and disequilibria in centrally planned economies: empirical investigation for Poland/Wojciech Charemza, Mirostaw Gronicki. p. cm.—(Contributions to economic analysis: 159) Bibliography: p. ISBN 0-444-70100-1 (U.S.) 1. Equilibrium (Economics) 2. Economic policy. 3. Central planning—Poland. 4. Poland—Economic policy. I. Gronicki. Miroslaw. II. Title. III. Series. HB145.C47 1987 339.5—dc 19 87-22891 C1P PRINTED IN POLAND

INTRODUCTION TO THE SERIES

This series consists of a number of hitherto unpublished studies, which are introduced by the editors in the belief that they represent fresh contributions to economic science. The term 'economic analysis' as used in the title of the series has been adopted because it covers both the activities of the theoretical economist and the research worker. Although the analytical methods used by the various contributors are not the same, they are nevertheless conditioned by the common origin of their studies, namely theoretical problems encountered in practical research. Since for this reason, business cycle research and national accounting, research work on behalf of economic policy, and problems of planning are the main sources of the subjects dealt with, they necessarily determine the manner of approach adopted by the authors. Their methods tend to be 'practical' in the sense of not being too far remote from application to actual economic conditions. In addition they are quantitative. It is the hope of the editors that the publication of these studies will help to stimulate the exchange of scientific information and to reinforce international cooperation in the field of economics. The Editors

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CONTENTS

Introduction to the Series Contents Preface

Part 1:

Foundations

Chapter

L Background:

V VII IX

Facts and figures from 3

Polish economic history Chapter 2. The theoretical

model

2.1. Households' behaviour and expectations 2.2. State sector behaviour 2.3. Disequilibrium indicators

Part 2: Consumption-Labour-Money Chapter 3. Econometric 3.1. 3.2. 3.3. 3.4.

9 19 26

Analysis

model and its

estimation

Structural form and statistical data Respecification and preliminary estimation Final estimation Linearization

Chapter 4. Estimates

of disequilibria

and their

37 43 49 55 effects

4.1. Estimates of unconditional disequilibria 4.2. Measures of repressed inflation 4.3. Excess demand decomposition and estimates of conditional disequilibria

63 70 74

VIII

Contents

Chapter 5. Internal monetary 5.1. 5.2. 5.3. 5.4. 5.5.

policies

Policy simulations: Some theoretical and technical questions A simple PW policy Planning distance and expectations errors PWC#) policy and labour hoardings Change of currency: Was it a solution?

Chapter 6. Searching for an optimal monetary

Extensions

Chapter

7. Disequilibria

and investments:

83 87 90 96 99

. . .

105 107 113

policy

6.1. Disequilibrium neutralization as an optimal control problem 6.2. Households' optimal income and money policies 6.3. Optimal policies and plans

Part 3:

. . .

Some

inward

policies

7.1. Production and investments: First extension of the model . . . . 7.2. Inward effects of the PWH(5) policy: Consumption volume and planners' tensions 7.3. Direct interventions in investment: Smoothing and private economy problem 7.4. Under- and overinvestment in a long-run Chapter 8. Disequilibria

and foreign

trade : Some external

and conclusions:

130 135 140

policies

8.1. Foreign trade: A further extension of the model 8.2. Constant foreign debt isolated policy 8.3. Constant foreign debt and CMEA acitve policy Chapter 9. Summary Appendix References List of Tables Author Index Subject Index

123

The best ex-post scenario?

145 150 154 161 165 171 180 182 185

PREFACE

The purpose of this study is to investigate interrelations between planning mechanisms and disequilibria in a case where the planning decisions are centralized and are exogenously given to enterprises. A particularly important question in this context is whether disequilibrium (or more precisely: positive excess demand on consumption and labour markets) is a necessary fate of centrally planned economies, or whether it could be replaced by another disequilibrium regime at a certain stage of their development. An answer to this can be given by discussing some auxiliary problems: in particular—can a planning mechanism be used as an efficient tool in reducing disequilibrium, what is the role of money, prices and wages in excess demand formation, and is foreign trade an accelerator or a brake with respect to equilibrium? Perhaps the most controversial question is : 'Is it possible to equilibrate markets (to go sufficiently close to equilibrium) over a certain period with the use of some policy instruments and, if so, what should the desired levels of these instruments be?' Our intention has been to build a model which could be used generally to answer these questions. It is exemplified by the case of the Polish economy. Apart from our national preferences, Polish economy in the sixties and seventies seems to be a promising field for the application of a disequilibrium theory. Phenomena such as full employment and growth, full employment and economic collapse, changes in foreign trade and investment policies, overnight changes in the degree of repressed inflation, 'price revolutions', panic buying and shortages were more evident in Poland than in the other CMEA countries. Last but not least, the statistical data which have been available to us are in relatively good supply. We have not tried to go beyond 1980. Since 1980 so many drastic changes have been made in the economic structure of Poland that the

X

Preface

extension of the model into the future would be highly questionable. Nevertheless, after 1980 some old habits survived. It would be worthwhile to look into the figures which show mistakes made in the sixties and seventies and to derive a vision of the future from them. The work presented here is essentially an empirical econometric study. Consequently, we faced a question which is typical of almost all empirical econometric research: 'What were we to do if we found a problem which had been unsolved (theoretically or numerically)?' The straightforward answer would have been to solve it. That is all very well in theory, but in practice the number of unsolved problems which appeared on the merge between theory and practice was so great that the time taken to solve them would have exceeded ad calendas Graecas the time in which they were to be implemented, or at least to the time when the results would be only of historical value. Basically, instead of spending several years on the programming and computation of mathematically elegant relations, we decided to add some stronger assumptions which enabled us to use relatively simple econometric software. This in turn hastened the date of the first results. Bearing in mind the desire to present the results clearly, we have not introduced the entire model all at once. The first introductory chapter is intended to shed some light on Poland's economic situation during the period under research, 1960-1980. In the next five chapters the basic model, describing the households-planners relations in terms of consumption, labour, money and plans are derived (Chapter 2), estimated (Chapter 3), used for calculation of excess demands (Chapter 4), for simulation of some monetary policies (Chapter 5), and finally for providing optimal control experiments in which consumption excess demand is minimized on a reasonable level of the consumption volume (Chapter 6). In the next two chapters the basic model is gradually extended. In Chapter 7 the production-investment sector is added and considered in simulations of disequilibrium reduction policies, and in Chapter 8 foreign trade is considered in a similar manner. Finally, in Chapter 9 an attempt is made at summarising the results by fomulating a better (e.g. less costly and more effective) ex-post scenario. The work is, to a large extent, based on our draft papers, seminars

Preface

XI

and lectures presented at various conferences during the last few years. Therefore, we are grateful to many scholars whose useful comments on particular papers stimulated us in our progress. Among those who helped us we would like to mention Janusz Beksiak, Phillip Hanson, Zdzislaw Hellwig, Miroslaw Krzysztofiak, Mario Nuti, Richard Portes, David Winter, and especially Richard E. Quandt. We wish to express our thanks to Wladyslaw Welfe, not only for encouraging us to tackle this problem, but also for his permission to use the W-3 data bank at the University of Lodz. We also gratefully acknowledge the financial support of ESRC Research Grant No. B00230025 which, among other things, enabled us to make part of the calculations in the Birmingham University Computer Centre, and the permission of Andries Brandsma and Andrew Hughes Hallett for the use of their optimal control computer package. Last but not least, we wish to mention our great debt to Jola Murjas, not only for her excellent typing of various versions of the manuscript, but also for her continuous patience in converting our Anglo-Polish into English. Obviously, we are solely responsible for all the remaining déficiences. University of Birmingham and University of Gdansk March 1985

Wojciech Charemza Miroslaw Gronicki

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PART I

FOUNDATIONS

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Chapter 1

BACKGROUND: FACTS AND FIGURES FROM POLISH ECONOMIC HISTORY

Before the Second World War Poland was one of the poorest countries in Europe. According to estimates by Michal Kalecki, the per capita national income in 1930 was one-sixth of that of the United Kingdom and one-seventh of that of the United States. The damages and losses suffered by Poland in the Second World War were extremely severe. For example, before the war 32.5 mln inhabitants lived within the current borders, whereas at the end of the war the population was reduced to only 24 mln (this reduction was also due to changes in the borders and to the migration of Poles and Germans in 1944 and 1945). The per capita national income dropped by half between 1938 and 1946 and only 62% of pre-war fixed assets remained. The main target of the first post-war economic policy had to be the reconstruction of the economy. This, however, was not an easy task, not least because the great number of engineers, scientists and skilled workers died during the war and the substantial number of those who emigrated to the West. During the first years of reconstruction the foundations of a new economic system were introduced: — on 6 September 1944 a new agricultural policy was announced; as a result (and unlike in other Eastern countries where collectivization was later maintained) 76.2% (in 1983) of agricultural land in Poland is in private hands, but only 5.7% (in 1981) of private farms are bigger than 15 hectares;

4

W. Charemza, M. Gronicki

— on 3 January 1946 large and medium production enterprises (the units employing more than 50 workers) were nationalized; — from 1947-1948 private retail and wholesale trade was practically liquidated (but it gradually recovered in later periods); — on 10 January 1945 the Central Planning Office (CUP) was established and a first system of planning was introduced (three-year plan 1947-1949). The system of decentralized planning in the economy—managed by CUP—resulted in the rapid growth rate of both consumption and investment. The reconstruction period officially ended in 1950 when the national income reached its pre-war level. However, while manufacturing output was greater than in the pre-war period, this was not the case for agriculture. The reconstruction period was followed by the first attempt to 'industrialize' Poland (six-year plan 1950-1955). The previous decentralized planning schemes were replaced by a highly centralized one. Priority was given to the rapid development of industry; heavy industry, in particular, was substantially developed. The aims fixed by planners were, however, too optimistic and plans were not fulfiled in almost all sectors (for instance, for investment the proportion of the target achieved was 98%, for consumption—87-90% and for real wages— 75-81%). In 1949 the six Soviet-type centrally planned economies (USSR, Bulgaria, Czechoslovakia, Hungary, Poland and Romania) formed the Council for Mutual Economic Assistance (CMEA). This created a base for further, more or less successful, economic cooperation among the socialist countries. In 1956 both the political and economic systems were slightly changed away from the strict, highly centralized rules. The principles in planning were revised and during the first half of the five-year plan (1956-1960) the growth rate of consumption usually exceeded that of investment. The huge investment backlog was reduced and the whole economy was nearly stable. The new industries emerged then and especially the branches of consumer durables like household electronic equipment, cars etc.

Background

5

During the next two five-year plans (1961-1965 and 1966-1970), the Polish economy developed smoothly. Due to successful geological investigations made in the fifties and investment in heavy industry the huge (even by the world standards) sulphur, copper and brown and coke coal mines were built. It enabled the rapid development of non-ferrous metals, certain branches of machinery and equipment and chemical industries. The other industries were developing not as quickly but even without the broad access to new technologies the results achieved were undiscussive. However, the rate of growth of the whole economy gradually slowed down, and the cost of continued development along existing lines appeared increasingly prohibitive. Personal consumption was growing more slowly than the net material product, the growth rate of real wages was not considerable, and the economic policy, less highly centralized than at the beginning of the fifties, reflected deflatory aspects. Priorities given to the manufacturing and state agriculture sector led to two slowdowns of the economy. In 1962-1963 there were bad harvests, and to avoid substantial disruptions on the consumption market the growth rate was reduced and the expansion of the investment sector was limited (about 20% of investment projects were cancelled). When a similar thing happened in 1969-1970 the government tried to freeze real wages for the next two years and announced overnight price rises of foodstuffs by up to 40%. The impact of these decisions was severe and eventually led to unrest in December 1970. Changes in the government were then made and the new economic policy was introduced. In the new period, the economic policy represented a reversal of some of the decisions of the previous year. One of the principal objectives became an increase in real personal income and consumption, and the stabilization of food prices. In March 1971 food prices were restored to the pre-December 1970 level and the government simultaneously decided to increase the subsidies to agriculture and to the food industry. To cover the higher demand for manufactured consumer goods a slight acceleration of the growth rate of manufacturing was planned. This new economic policy was embodied within a five-year plan which aimed to improve the standard of living of Poles and eliminate the imbalances of supply and demand in both production and consumption. Indeed,

6

W. Charemza, M. Gronicki

the planned growth of consumption showed the greatest increase over previously achieved levels. These planned rates of growth were not, however, considered to be rigid. As was pointed out at the time, the five-year plan was a so-called 'open-ended' plan which made possible future corrections justified by social and economic needs. So the expansionary policy replaced the old deflatory one and the positive achievements were clear in the first years of its implementation. Net material product and manufacturing and agricultural output increased very rapidly and usually surpassed targets envisaged in the annual national plans. The expansion of consumption and investment provided incentives for productivity growth and for the introduction of modern technology. The new industries producing both the intermediate and consumer goods were created and the quality of goods was improved. On the consumer durables market, such products as 'Fiat 126P' and electronic equipment were the best examples. The same happened to machinery and equipment industries. It was possible mainly because of substantial increase in foreign borrowing. During the five-year plan 1971-1975 the Polish debt in convertible currencies rose by about 700%. The open-ended plans led to the relaxation of strict rules in planning and allowed the introduction of minor economic reform in 1973. This reform was designated to give large industrial units more autonomy. However, it was soon restricted because other decisions towards centralization were caused by the side-effects of expansionary policy and the world economic crisis in 1974. Several bad harvests and long periods of food subsidising encouraged the authorities to increase prices for consumer goods in June 1976. This again provoked strikes and riots and price increases were quickly withdrawn. The rush in the first half of the seventies and keeping the rate of accumulation on the relatively high level till the end of the seventies resulted in building a number of modern factories in the heavy and light industry, like e.g. iron foundry in Katowice, computer equipment and textile factories. The investment'boom' occurred also in other branches of the economy. Especially, the country infrastructure was modernized and an inflow of modern technology enabled the building of new transport facilities. However, the investment 'boom' also caused 'bottlenecks' in construction

Background

7

processes and a gradual increase in the number of unfinished investment projects. The industries selected for specialization (i.e. privileged in the rationing of investment goods) were mainly material-intensive (mostly in imported materials). Simultaneously, the expansion of heavy industry (which was not competitive on the depressed world market) caused problems with repayment of foreign credits. Hence, together with the increase of locked-up investments, further rapid growth of the hard-currency debt was observed (e.g. in 1976 one-quarter of the total export revenue in hard currency was spent to cover the servicing of foreign debts, and thus the safety margin was surpassed). Since no effective economic decisions were undertaken (although an attempt was made at freezing labour demand and stopping overinvestment), the growth rate of the main economic indicators slowed rapidly and in 1979 the net material product was lower than in previous years for thefirsttime in the post-war period. To cover ever-growing consumer demand the government decided to spend a large portion of credits to import consumption goods and semi-products used in consumer goods industries. However, the disruptions in the economy became too severe: in 1980 the government tried to introduce the deflatory policy once more. This led to strikes in the summer of 1980 and to the economic chaos of 1981. The open economic crisis began.

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Chapter 2

THE THEORETICAL MODEL

2.7. Households9 behaviour and expectations One of the important starting points in the modelling of economic behaviour is to distinguish economic sectors and, consequently, particular units within these sectors. In the case of a CPE (centrally planned economy) three sectors are usually considered: households, state enterprises and central planners. Despite details in 'sector' definitions (in Marxian economics sectors are distinguished according to the form of ownership of the means of production, while in neoKeynesian economics attention is paid to different types of targets and objective functions), an enterprise is treated as an economic unit. Nevertheless, it seems that in the contemporary stage of the socialist economy enterprises are allowed neither to fully manage their production means nor to optimize a well-defined objective function (see detailed discussion of this subject in Section 2.2). In general, targets, and consequently the behaviour of central planners and state enterprises, are similar while meeting households' offers (consumption and money demand and labour supply). Therefore in a consumption-labour-money (CLM) analysis, where the investment side is not explicitly considered, it seems to be sufficient to distinguish two main economic sectors in a CPE: private (households) and state (enterprises and central planners). In general, the private sector is not homogeneous. In a model of a 'pure' socialist economy, the private sector is represented by workers' households, which sell their labour and buy goods and services offered

W. Charemza, M. Gronicki

10

by the state sector. As is evident, in many socialist countries some households are also small producers (mainly in agriculture and craft). Consequently, on a micro level two types of households should be distinguished: 'pure'—selling labour and buying consumption goods and services, and 'productive', which sell their products and buy investment goods. For simplicity's sake, we shall not consider here 'mixed' households, partly engaged in the production of goods and partly in selling labour. (It should be stressed that the above distinctions are provided only on a micro level; aggregate CLM functions covered all types of households—see the end of this section.) Let us first consider 'pure' households, trading only with the state side. We assume a static utility function of the /^-th household, denoted by ukl, to be concave and at least twice differentiable. It is given in the form (2.1)

where cki—consumption of the A^-th household, Tki—time endowment, lki—labour time, mki—money holdings at the end of the period, p—aggregate price of consumption goods and services. If the only restriction for a household is the budget constraint wfcl + /f/fcl+e>iftl * lkl = ckl + mkl,

(2.2)

where mki—money holdings at the beginning of the period, nfky—non-labour income (social benefits, interests, etc.); coki—wages, then maximization of the utility function (2.1) with the budget constraint (2.2) leads to Walrasian (notional) consumption demand (cdk), labour supply (lk) and money demand function (m{) cdki = cdki(mki,nfki,

coki9Tki),

The theoretical model

11

- —it, = — - liSrnk^ nfk, cok , Tk), p p

Tki for consumption), the appropriate Clower (1965) functions are derived. In Ito (1980) functions, which are similar to the effective Clower demand and supply functions, consumption is constrained on labour, despite the presence of the labour shortage restriction and vice versa (for the comparison of these concepts see Portes (1977), Ito (1980) and Quandt (1982a)). In this study the effective demand and supply functions in the Ito sense are considered. There are several reasons for this approach. Firstly, Drèze demand and supply seems to be inexplicable in empirical disequilibrium analysis since effective demand (supply) always satisfies restrictions and consequently the estimation of a disequilibrium gap is not feasible. Secondly, Clower functions are in fact special cases of the Ito ones, with certain nonlinear restrictions. Thirdly, in the case of the full employment policy provided in CPE's, households are restricted on labour even if a state demand exceeds supply (the 'upper' restriction). Consequently, the Ito effective consumption function can be obtained through the maximization of the utility function (2.1) under the restrictions (2.2) and '*, = '*,·

(2.3a)

W. Charemza, M. Gronicki

12

Labour supply and money demand functions are in turn the results of the maximization of (2.1) under (2.2) and (2.3b)

cki = cki. The results are 4, = cdki(mki, nfkl, œki, Tkl, Tkl), —'ίι = ° γ

1

(2.4a) (2.4b)

^ ^ nfi^kj

%+ßkj+Ykj

ßkj Ot+ßkj+Ykj

J_ . Ύ

kj

p

+nf II mkjm kj-d-v kj kj+nf kj-d-v k. \

I

P

/*

(2.10b)

The theoretical model

mi _Λ P

vk Çl %+ßkj+ykj

=

17

Γm k + nfk +cok k · Tk — d- vk 1 _L·^ j_hl h. I L p J

(2.10c)

where 7 = 1,2 and d = 0 if j = \, d = 1 if j = 2. As the result of maximization of the overall (2.9) utility function given u2kj9 u3kj, u4kj > 1 (u2kj, u3Kj, u4kj < 1) with a budget constraint, appropriate FC-functions are derived. It is additionally assumed that the expectations are of linear form 3 cî. = Hj+àlkfcÎrck)%X9

"»■Λ Ώ

_A

=

=

ôlkj > 0,y = 1 , 2 ,

- Jr - ^ + S ^ " " p

..A

J

+

δ

(2.11a)

», > , y = 1,2,

J

^ 1 ^ _ V 1 1 ,

(2.11b)

J

^ > 0 , y =

1,2,

(2.11c)

where ?£., /£. and ra£. are respectively FC-demand for consumption, FC-labour supply and FC-money demand. The differences: ck —ck., 4s -IL a n d rht.—rnk express expectations effects (FC-effects) in particular functions. Finally, EC-demand and supply functions are derived as a result of maximizing the overall utility function (2.9) with w2k , u3hm, u4k > 1 (w2fc., w3k, w4k. < 1) and with a budget constraint from the corresponding market, i.e. with (2.3a) for consumption and (2.3b) for labour and money. With the use of (2.11) the results are otk T-QXD%„

(2.24)

then the disequilibrium labour adjustment equation can be expressed as W

(Z/--L0 (2.25) P In this work the ρ coefficient is called the normal shortage coefficient. The normal labour shortage, denoted by L", can be calculated as Z = JM-

L" = (l-Q)t N

■'(τΉ-

p

where XD = XD +r = XD% and χ~1(') stand for the inverse χ function. The above equation indicates the role of the ρ parameter: the closer ρ is to unity, the smaller the normal labour shortage, and simultaneously—the larger the reaction of plans subject to disequilibrium. Turning back to the terminology introduced, plans are more active if the ρ is large. It should be pointed out that the rational expectations equilibrium seems to be a special case of (2.24)-(2.25), in which ρ = 1.

PART 2

CONSUMPTION-LABOUR-MONEY ANALYSIS

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Chapter 3

ECONOMETRIC MODEL AND ITS ESTIMATION

3.1. Structural form and statistical data The equations described in Chapter 2 create a basis for formulating an econometric model evaluating disequilibria on the consumption and labour markets. Nevertheless, it is necessary to specify functional forms and the stochastic structure of particular relations in order to identify any problem of unobservability of particular variables and to find admissible statistical data. As can be seen from the main assumptions given in Chapter 2, an appropriate econometric model would not be a trivial one. The number of simultaneous and lagged feedbacks, nonlinear transformations, leads and lags in dynamic structure and, above all, the unobservability of numerous variables lead to the conclusion that a joint (full-information) estimation of the model is not feasible in practice. Some additional assumptions have to be added to enable extensive estimation through limited information techniques. They are the following: — behavioural equations are linear subject to estimated parameters (which in turn can be nonlinear, but identified, functions of structural parameters of the model), — disequilibrium indicators are of a deterministic nature (without error terms explicitly given), — the number and distribution of time lags are known a priori, — leads are expressed as weighted averages of the current and one-year lead variables,

W. Charemza, M. Gronicki

38

— error terms are normally distributed with zero expectations and homoscedastic variances, and are independent of exogenous variables, — endogenous variables do not Granger cause exogenous variables, — rational expectations are generated by the AR(1) process of prediction of exogenous variables, — in the labour bargaining equation (2.18) ocL = 1 and Lp < Ld (consequently Ld = Lei), — discrete structural changes of economic policy are expressed by dummy variables which are treated as exogenous. Starting from these assumptions the following econometric model is postulated

Cd = (JcD(M_ 1 +NF+w· T- V), Cd = Cd + ~CD( C"- CS)~ 1 ,

(3.2)

Cd = aCD+Cd+YCDW' (L-iS)+eCD'

(3.3)

(3.1)

(3.4) (3.5)

w w ,., 1 A -LS = (XLs+--Ls+Yls-(C-Cd)+B LsZl+eLs, p p 4 P

(3.6)

1 1\ 1 -Md = {3MD-' (M_1+NF+w· T-V), p p

(3.7)

1,., 1 A pMd = p-Md+~MDp'

1

[rcCI)' (C d-CsY+r c {2) ' (Cd_CS)'~.l],

(3.8) 1

-M p

d

1 -d 1 (Ad ) = or are more complicated, as restrictions resulted from deriving supply and demand functions from a utility function. As is explicitly shown, a structural parameters restriction appears in (3.4). Moreover, as is shown by (2.10) and (2.12), the following restrictions for parameters which appear in various equations should be considered: YMD+ÏLS = 1 and/?cp+/?MD = ßLsThe different problems appear while collecting the appropriate data for the observable variables. To estimate the model, statistical data covering the period 1960-1980 are needed, with additional information about the lagged variables for the pre-1960 years. It is often argued that the official statistical data as published by CPE statistical offices are of a low quality, often incomparable in time, and deliberately or not deliberately biased. Criticism is raised by socialist (Jakubowicz (1982), Kordos and Kowalski (1983), Peuker (1981), as well as by Western economists (e.g. Alton (1977), Wiles (1982), Pitzer (1982)). As a result, some alternative data for leading economic indicators for socialist countries have been published (i.e. for households' income and personal

42

W. Charemza, M. Gronicki

consumption data see Alton et al. (1984a), Rudcenko (1979), Schroeder and Denton (1982), for GDP or GNP data see Alton (1984b), Krejci (1982), NFAC (1982), and for foreign trade see Green and Higgins (1977, pp. 257-259), NFAC (1982), and Fink et al. (1980)). Nevertheless, these alternative data and methodology also suffer from shortcomings and incompleteness (see e.g. Hanson (1984) and Nove (1982)). In this work we have decided to use the official data (with the one exception of the foreign trade sector—see Section 8.1). The official data for Poland are in reasonably good supply and—what is important—with a realistic possibility of systematic updating in the future, which could enable us to extend the analysis in time. However, we have not used the data in their raw form; we have recalculated most of the series, trying to achieve aggregates relatively close to the variables used in the model. A detailed description of the construction of the time series is given in the Appendix. Herewith we will outline the most important principles as applied for the data creation. Since in (3.1) consumption demand depends on the households' income components, the dependent variable should consist not only of the consumption of material goods and services (as is usually adopted in CPE statistics) but should also include non-material services. Consequently, we have calculated the consumption variable by summing up all the components of households' disposable money income and subtracting from it changes in money stock and households' investment expenditures. The data for the corresponding average wage is not taken directly from the Statistical Yearbook. Since it appears in the budget constraint and should, therefore, match households' labour, it is defined as total labour earnings (obtained by summing up the components of labour income) per employee, and should also include self-employment incomes. The structure of the model suggests that the XD variable (and consequently XDP) should express the results of total production efforts (including again non-material services). The published data for the material product seems, therefore, to be its biased approximation (for a critique of this measure see Jakubowicz (1982), Krejci (1982, pp. 12-15). As a result, we have decided to calculate total final domestic expenditures (TFDE). Firstly, total final expenditures (TFE) are cal-

Econometric model

43

culated by summing up material and non-material consumption, investments, changes in stocks and government expenditures. The TFDE figures are then calculated by subtracting from TFE a proxy for the balance of trade, expressed as the difference between the national and domestic gross material product.3 The planned values of particular variables are calculated in a similar way, using the planned percentage changes of particular indicators officially announced at the beginning of each year. 5.2. Respecificatiort and preliminary estimation The econometric model described in Section 3.1 was estimated for Poland with the use of yearly data 1960-1980 (for lagged variables earlier data were regarded). The basic method of estimation, whose results are used in simulation and optimization experiments, is a Bayesian limited-information method, described in Section 3.3. Nevertheless, its application is preceded by the presentation of results of estimation with the use of non-Bayesian (traditional) limited-information methods (these traditional results were in turn partly used as starting points for the Bayesian estimation). The necessary conditions for a limited-information estimation of a disequilibrium-type model are essential to derive respecified equations with (possibly) nonlinear estimated parameters and with a relatively small number of explanatory variables. After this, the respecified equations can be estimated with the use of instrumental variables two-stage methods and—in the case of rational expectations variables—by using 3 It would be interesting to compare the TFDE figures with the estimates of GDP, as derived for Poland by Krejëi (1982, pp. 91-97). Our figures are systematically smaller (up to 5%), although for 1972 the results are practically identical. Detailed discussion, however, seems to be beyond the scope of this study. Moreover, it should be stressed that the terminology used in national income accounts is often misleading. In Marxist terminology national and domestic material products are named respectively as national income for distribution and national income produced. For a criticism of the concept of gross material product see Krejöi (1982, p. 15) and Strumilin (1979, pp. 96-118). For a detailed comparison of Marxist and Western ideas for measuring national income, see Ryabushkin and Simchera (1981, pp. 290-340) and Pitzer (1982, pp. 11-13).

W. Charemza, M. Gronicki

44

the Sargan method.4 These estimators are numerically feasible and are, in general, also consistent (but inefficient) in the case of a nonlinearin-variables model (see Kelejian (1971)). The complicated structure of the model presented requires the application of several variants of this general procedure. There are two main reasons for this : — some of the jointly dependent variables are expressed in constant prices, and some in current prices; it seems logical to apply constant-price instruments for the former, and current-price instruments for the latter, — in the case of RE variables, a priori causal selection of lagged exogenous variables is provided to reduce their number. The subset of equations (3.1)—(3.9), describing private-sector behaviour, can be respecified to three stochastic equations with identified parameters. By substituting (3.1) and (3.2) into (3.3), and exploiting the repressed inflation assumption, it can be shown that (see Charemza and Gronicki (1983)) Cd= · (L-L ) + eCD, (3.24c) — Is = 0.8369 - · Γ-0.1631 — · (M^ + NF-V), P P P

(3.25a)

— U = ^b+m9.0l0.3(p-p^Y+0.7(p-p_1y+1], P P

(3.25b)

— U = -51.673+ —L s +0.3523 — (C-Cd) + 30.194Zl + eLS, P P P (3.25c) — = 0.2631 — · (M_! +NF+w■ T- V), (3.26a) P P Md Md 1 (3.26b) — = i l - +0.9170— [0.75(Cd-CsY+0.25(Cd-C%1], P P P M " -78.326+ — +0.6477— (C-C)-38.448Z2+e M I ) , P P P (3.26c) s (3.27) w = w_ 2 +0.1688(C-C ). Equation (3.17) is used as a disequilibrium indicator for estimating (3.13). The respecified form of (3.13) is ßLD[Tx(l)-XDp+Tx(2)XDl1]-YLDZ3 L = ocLD + --t-lXDlt-çXDXJ

+ eLD.

Econometric model

49

The above equation was estimated by the instrumental variables Sargan method with a priori fixed weights τχ{\) = 0.6 and τχ(2) = O.4.5 The parameter ρ was found by iterative searching in the interval (0; 1), where the criterion was maximizing the /-ratios of the remaining parameters. This gives L = 10.198 + 0.00340 [0.6XZ)P + 0 . 4 1 7 ) ^ ] (15.89) -0.00284[Xi) p 1 -0.88XZ)* 1 ]-1.0491Z3, (3.59) R2 = 0.9588,

a2 = 0.0937,

d = 1.20.

(3.28)

Finally, the estimated equations (3.13) and (3.17) are Ld = 10.198 + 0.00340[0.6Zi)p + 0.4^/)î 1 ]-1.0491Z3 + ^ D , P

XD

+1

=

0MXDe+1

d

s

+ 351.746(L -L ).

(3.29) (3.30)

It seems that the estimates of the model are admissible for empirical analysis. High /-ratios as well as high R2 coefficients confirm the initial specification of the model. Durbin-Watson statistics suggest positive autocorrelation in (3.22), (3.23) and (3.28), which caused over-estimation of the /-statistics, although the /-values are high enough to be significant even with a reasonable reduction. As is mentioned above, it is not possible in practice to provide a full analysis of residuals in a model of the type considered. Simulation and optimal control properties can be evaluated by sensitivity analysis of preliminary simulation and control experiments.

5.5. Final estimation For final estimation (e.g. for deriving the results which are in turn used in policy simulation experiments) we modified the limited-information Bayesian method of estimation for linear models (the original method 5

The aggregation for the planned variables has a special interpretation. The planned data we use are for initial production plans, which in fact were often corrected and adjusted within the year. Therefore the aggregated variable [0.6XDp+0AXD+i] is an approximation of a final plan for the year / + 1 .

50

W. Charemza, M. Gronicki

is described by Drèze (1976) and by Drèze and Richard (1983), and its modification for disequilibrium models is given by Gronicki (1981)). According to this method, the respecified equations of Cd, Ls, Md and Ld are regarded as linear, and a priori information is given to the parameters of the respecified form rather than the original one. Following Drèze (1976) it is assumed that prior distributions are fully specified only for an estimated equation, while for all the other parameters the distributions are non-informative ones. The modification of the original Drèze and Richard method applied here allows the estimation of an equation without explicit information about a reduced form of the system. Moreover, it is consistent with the non-Bayesian estimation as described in Section 3.2, since a Bayesian counterpart of the Sargan method for RE variables is envisaged, and the sets of first-step instrumental variables are identical to those used in Section 3.2 for particular equations. A commonly used formula is adopted, according to which prior distributions for parameters appearing with exogenous and dummy variables are non-informative, while priors for endogenous and RE variables parameters are beta-distributed on an interval [a, b]. In the respecified consumption demand equation (see (3.21)) there are two jointly dependent variables on the right-hand side, denoted previously as Q\ and Q2, as well as an RE variable Q2e+1. A joint prior distribution for this equation can be expressed as P( ÏCD,

aCD,

bCD,

fb(yCD\Ρι.,4ι,αι,^)'

Σ)

oc

fb(acd\p29q2,a29

xfb(bcD\P3, q3,a39b3) · |27|-(»+»+D/2,

b2) (3.31)

where Σ is a covariance matrix of the structural form random terms; Pi, qx are parameters of the beta distribution for yCD in an interval l>i > £i] ; Pi 9 Qi—for aCD and p3, q3 for bCD, in intervals [a2, b2], [a3, b3] respectively. The symbol of the type/fc( · ) denotes a beta density function, oc is a proportionality sign, m is a number of jointly dependent variables in a system, and n stands for a number of extraneous variables. The estimation procedure requires a priori knowledge of intervals and parameters of the particular beta distributions. It is relatively easy

Econometric model

51

for the spillover coefficient yCD> which expresses an influence of labour market disequilibrium (strictly: its effect on the labour supply side) on consumption demand. Since changes in labour supply are an important factor in money accumulation, which in turn substantially affects consumption demand, an interval of prior beta distribution should be closer to unity than to zero, with an asymmetric tendency towards unity. Obviously, it should not be very close to one, since intuitively the spillover effect seems to be a less important factor in creating EC-consumption demand than FC-demand. Consequently, for yCD we admit an a priori interval [0.6,0.8] and parameters/?! = 0.3 and q1 = 3.5 for the beta distribution. This gives an expectation value equal to 0.755, standard deviation = 0.032 and mode = 0.784 (note that the prior standard deviation is about four times greater than that which is estimated traditionally—see (3.21); it reflects our uncertainty about prior information). Prior information for the aCD parameter is even more uncertain, since it is a nonlinear function of the parameters ÔCD a n d OLW. In the absence of more detailed data, we assume that the parameter dCD should not be more than ten times greater than aw (i.e. that expected disequilibrium can affect consumption demand up to ten times more strongly than the current disequilibrium). We admit a symmetric beta distribution which is characterized by p2 = q2 = 0.5, a2 = 0, b2 = 10. Since the existence of a multiplicative tendency can be considered in generating disequilibrium by an increase in wages, we assume an asymmetric beta distribution for the parameter bCD = 1 /a w (the parameter is estimated together with its sign, so in fact we consider the parameter (~-bCD) rather than bCD)· The lowest possible value seems to be between 0.05 and 0.08, which suggests a lower limit of the beta distribution equal to —15. We obtained p3 = 5, q3 = 1, a3 = —15, b3 = 0 for the beta distribution, which gives an expected value equal to —11.25, mode = —12.5 and standard deviation = 2.17. The estimation of a joint posterior distribution with the prior information indicated above and with a quadratic loss function requires the calculation of a three-dimensional integral. This was done with the use of the iterative Simpson formula. If the Bayesian estimates are

W. Charemza, M. Gronicki

52

equal to the expected values of posterior distributions, the estimated respecified consumption demand equation can be presented as C = 66.926 + 0 . 6 9 6 4 ( M _ 1 + J V / f + w i - K ) (67.48) + 3.881(w-w_ 2 ); 1 -8.0067(vv--w_ 2 ), (3.29) (6.07)

(3.32)

for informative priors, and C = 67.609 + 0 . 6 8 9 7 ( M _ 1 + J V F + w L - K ) + 3.7224(w-w_ 2 )* JL (71.86) (3.19) -6.9340(w-w_ 2 ), (5.80) for diffuse (non-informative) priors, i.e. for px = q± = 0, i = 1, 2, 3. In the brackets below, the estimates of the Bayesian counterparts of /-ratios are given (ratios of the posterior distribution expected values to their standard deviations). In the labour supply equation, estimated in the form (3.22), a parameter yLS stands with a jointly dependent variable, and a parameter dLS with an RE variable. Therefore, two prior distributions should be specified. As for consumption, the prior beta distribution for labour is specified as asymmetrical; moreover, due to the suspected relatively low impact of consumption disequilibrium on the labour supply in the short-run, its mass is to be concentrated in the first half of the 0-1 interval. Consequently, for yLS: p1 = 7, qt = 0.2, ax = 0.1, b1 = 0.5, which gives an expected value equal to 0.152, mode = 0.111 and standard deviation = 0.042. The prior distribution for dLS which stands with the RE variable is also asymmetrical; the impact of expected price changes on the labour supply seems to be more important for relatively large values of dLS—consequently the distribution is negatively skewed. Finally, p2 = 0.3, q2 = 1.2, a2 = 0, b2 = 2,000, for which the expected value is equal to 1,257, mode = 1,600 and standard deviation = 456. The estimates equal to expected values of posterior distributions are Y=

-61.432 + 0 . 3 3 5 2 - 1 - ( C - M _ 1 - ^ F - v v T+V) (14.4) P + 795.2[0.3(^- J p_ 1 ) e + 0.7(/7-J?7_1)^1] + 26.463Zl. (2.31) (4.83)

(3.33)

Econometric model

Prior fixed in Pi = ?i # 2 = 0, — P

53

distributions for the parameters γΜΟ and aMD = dMD/ocw were a similar way. The appropriate characteristics for yMD are: = 0.2, at = 0.6, è x = 0.7; for aMD: p2 = 0.4, q2 = 0.2, 6 2 = 10· The estimates are given below = -78.370+0.6636 — · (M-x+NF+w (32.21) P

T-V-C)

+ 6.2645[0.75(νν-νν_ 2 ) β +0.25(νν-νν_ 2 )^]-36.187Ζ2. (5.39) (6.36)

(3.34)

For estimating (3.33) and (3.34) two-dimensional integrals of prior parameters distributions were calculated. Prior distributions for ßLD and aLD = —l/a X P of (3.28) parameters are given. For ßLD it is assumed that the parameter should be positive, with the highest admissible marginal labour/planned TFDE ratio as the upper limit of the interval. According to the statistical data, it is fixed at the level 0.006. Moreover, it is stated that the prior distribution is slightly skewed towards the upper limit of the interval, since a rising tendency of the marginal labour/planned TFDE ratio seems to be more relevant in labour demand formation. The appropriate parameters of a priori beta distribution for ßLD are: px = 0.2, q± = 0 . 3 , ax = 0, bx = 0.006, which gives expected value equal to 0.00312, mode = 0.0036 and standard deviation = 0.0016. The a priori distribution for aLD is obviously negative, skewed towards the lower limit (which gives importance to relatively high values of ocXP; a 'large' disequilibrium is more important than a 'small' one). Considering the scales of the L and (ZD+!—0.88 XDe+l) variables, the upper limit of interval for parameter ocXP is to be equal to 100. Consequently, a priori beta distribution for aLD has the following characteristics: p2 = 0.9, q2 = 0.3, a2 = — 0.01, b2 = 0 and the expected value is equal to —0.0059, mode = —0.0075, standard deviation = 0.0024. The appropriate estimates are L = 10.162+0.00347(0.6ZZ)p + 0.41rZ)i1) (13.37) -0.00323(^2)^-0.88ZZ)^ 1 )-1.0004Z3. (3.67) (5.00)

(3.35)

It is worth comparing traditional and Bayesian estimates of particular

W. Charemza, M. Gronicki

54

parameters. Relatively small differences between corresponding estimates are derived for money demand and labour demand equations. The percentage average difference of Bayesian and non-Bayesian estimates is equal to 6% for money demand and 5% for labour demand. For the two remaining equations these differences are somewhat greater: 14% for consumption demand and 21% for labour supply. This indicates that prior information affects the estimates of the two latter equations much more than the two former ones. Generally, the Bayesian structural parameters estimates in the respecified Cd equation are higher than the traditional ones (with the constant term as a correction factor). In the Ls equation the relation is inverted; a consideration of prior information caused a decrease in the estimates for yLS, 5LS and eLs. With the use of the algebra manipulation described in 3.2, it is possible to derive Bayesian estimates of the model parameters from (3.32)—(3.35). Since these results are further used for empirical investigations, the model is therefore given below in its full notation, together with identities Cd = 0.6037(Μ_! +NF+ w · T- K), d

d

d

(3.36a)

s e

C = C +0.4847(C - C ) +1, d

d

(3.36b) s

C = 66.926 + C +0.6964w · (L-L )

+ eCD,

— U = 0.8669— · Γ-0.1331 — · (Μ.,+NF-V), P P P y V

= y ί*+795.2[0.3(ρ-ρ„ιγ+0.7(ρ-ρ_ιγ+ι],

— U = -61.432+ — I s +0.3358 — P P P +26.463 Zl + eLS, — - = 0.2632— · (M-t+NF+w Md

(3.36c) (3.37a) (3.37b)

(C-C")

■ T-V),

(3.37c) (3.38a)

1 Λ _ +0.7824— [0.75(Cd-Csy+0.25(Cd-Oy+1], (3.38b) P P P Md „n„n Md 1 Λ „ _ = -78.269+ - ^ - +0.6642 — ( C - Ç ) -36.187Z2+e M D , P P P (3.38c)

M"

Econometric model

55

MC = Md+HD,

(3.39)

HD = HD-L + HC-HR,

(3.40)

— =XD + BT-I-G-S, P Ld= 10.162 + 0.00347[0.6XDp + 0.4ArZ)i1]

(3.41)

-1.0004 Z3 + eLD, d

(3.42)

s

C = min {C ,C }, d

(3.43)

s

L = mm {L ,L },

(3.44) d

s

iv = w_ 2 +0.1249(C -C ), XD

P

+1

=

0MXDe+1

(3.45) d

s

-f 309.767(L -L ).

(3.46)

3.4. Linearization In the above system the equations (3.36a), (3.36c), (3.37a), (3.37b), (3.37c), (3.38a), (3.38c), as well as the identity (3.41), are nonlinear in variables. (Also seemingly nonlinear is (3.38b), but it can be transformed into a linear equation by multiplying both sides by /?.) In some applications, and especially in reduced-form analysis and in optimal control experiments, a linear model is usually required. A model in its linear form simplifies numerical problems in an acceptable way and moreover, gives some additional information about the strength o, influence of particular explanatory variables on a dependent variablef since first derivatives are given explicitly. If the minimum conditions are replaced by their linear equivalents (i.e. C = Cs, L = 27), nonlinearities in the system (3.36a)-(3.46), are of a straightforward nature: some variables are simply multiplied by w and (or) derived by p. In this case we use a method of linearization .which consists in expanding nonlinearities in a Taylor series and considering its first component. Since the method was described in detail by Friedman (1975, pp. 37-39), and Theil (1971, pp. 479-480) we decided to present only the results of calculations. Particular equations are given in the form y = λ0 + λ1χ1 + λ2χ2+

... +λ„χη>

56

W. Charemza, M. Gronicki

where y is a dependent variable, x x , x 2 ,..., xn are explanatory variables, λΐ9 λ2, ..., λ„ are derivatives of the original (nonlinear) function subject to particular variables, and λ0 is an ex post calculated correction factor. The derivatives λί9 λ2,..., λη in general vary over time; their time paths are not reported here. Nevertheless, for practical purposes their time trends should be known, as well as their averages for the entire period 1960-1980, and for particular sub-intervals, which are of special interest. We have divided the two decades 1961-1980 into four time sub-intervals, according to five-year plans: 1961-1965, 1966-1970, 1971-1975, 1976-1980. For each sub-interval, as well as for the entire period, averages A; of particular Af, / = 1, ... , n coefficients were calculated together with a percentage of standard error divided by corresponding averages of A,·. Furthermore, in order to detect possible errors made by approximating a nonlinear function by a Taylor expansion, mean-square errors of linearization (MSEL) and relative mean-square errors of linearization (RML) were calculated, according to the expressions

where ^rnin, Tmax—lower and upper limits of a time sub-interval, respectively, y^—predicted values of a dependent variable yt as calculated from an original nonlinear equation, y\2)—predicted values of yt as calculated from a linearized equation with the λι coefficients averaged in the interval |T min , Tm&x], In Tables 3.1-3.8, the characteristics of linearization of particular equations (as estimated by the Bayesian method) are given. Standard deviations expressed in percentages are presented in brackets.

Econometric model

57

The results in Tables 3.1-3.8 indicate the existence of significant differences among corresponding marginal propensities of dependent variables subject to explanatory variables in particular sub-intervals. Simultaneously, mean-square errors of linearization are relatively low, usually lower than 0.1% for five year sub-intervals, and lower than 5% for the entire sample. There are, however, two exceptions, for which goodness of approximation is worse: the identity for Cs (7.7%) and the U equations (11.1%). Despite large differences, the first derivatives of particular variables have, in most cases, identical signs in particular sub-intervals. Nevertheless, there are four exceptions. For Cd, the estimated marginal proTABLE 3.1

Linearization of equation for Cd d C = λ0+0.604 (M-i+WF-KH/l! Τ+λ2\ν

λο λι λ2 MSEL RML

1960-1980

1961-1965

1966-1970

1971-1975

1975-1980

-474.158 22.735 (49.2%) 11.195 (8.9%) 17.69 2.9%

-212.729 12.746 (6.4%) 10.043 (1.7%) 0.180 0.07%

-289.564 16.129 (5.5%) 10.801 (2.1%) 0.271 0.07%

-471.088 24.140 (16.3%) 11.643 (2.4%) 1.50 0.2%

-843.250 40.285 (13.0%) 12.566 (1.5%) 1.43

ο.ι%

TABLE 3.2

Linearization of equation for Cd Cd = Ao + C'+A^L-Z/'H^vv

Ao Ai

A2 MSEL RML

1960-1980

1961-1965

1966-1970

1971-1975

1975-1980

65.702 26.225 (49.2%) -0.211 (175.8%) 4.80 0.7%

80.436 14.702 (6.4%) -0.657 (16.2%) 0.146 0.05%

70.030 18.605 (5.5%) -0.144 (120.9%) 0.243 0.05%

56.706 27.846 (16.3%) 0.218 (41.0%) 0.468 0.05%

78.643 46.469 (13.0%) -0.114 (139.0%) 1.154 0.06%

W. Charemza, M. Gronicki

58

TABLE 3.3

A

Linearization of equation for V V =

λο Ai A2 MSEL RML

λο+0Μ7Τ+λι(Μ..ί+ΝΓ-ν)+λ2)ν

1960-1980

1961-1965

1966-1970

1971-1975

1975-1980

-1.184 -0.0043 (40.5%) 0.022 (11.3%) 0.326 2.1%

-0.458 -0.0063 (6.3%) 0.021 (4.7%) 0.0029 0.02%

-0.679 -0.0050 (5.6%) 0.025 (8.5%) 0.0041 0.03%

-0.976 -0.0034 (16.3%) 0.024 (4.8%) 0.021 0.13%

-1.326 -0.0020 (12.8%) 0.020 (7.8%) 0.0090 0.05%

TABLE 3.4

Linearization of equation for U V = λ0 + Ls+ λΛΟ.Ιίρ-ρ-ιΥ+Ο.Κρ-ρ.^Η 1960-1980 λο Ai

λ2 λ3 MSEL RML

-9.084 0.449 (54.4%) 16.085 (28.1%) -0.0079 (81.7%) 4.723 11.1%

λ2ρ+ λ3\ν

1961-1965

1966-1970

1971-1975

-11.608

-10.394 0.354 (17.8%) 17.969 (3.4%) -0.0080 (21.2%) 0.255 1.7%

-7.884 0.663 (23.4%) 13.381 (11.7%) -0.011 (21.2%) 0.340 2.1%

0.235 (56.2%) 21.197 (4.2%) -0.0061 (52.3%) 0.181 1.3%

1976-1980 -7.747 0.648 (15.2%) 10.287 (2.8%) -0.0084 (17.2%) 0.864 5.0%

pensity to consume with respect to wages is negative for 1960-1969, 1978-1980, and positive otherwise. This paradox is not easy to interpret. It seems that in the sixties, when the consumption disequilibrium level was relatively low (see Chapter 4), unanticipated demand (often never realized) played an important role in moving part of the consumption demand for future times. For 1978-1980 the source of this phenomenon was quite different; it was connected with a large consumption disequilibrium and consequently with growing 'secondary' transactions which,

59

Econometric model TABLE 3.5

Linearization of equation for V V = λ0 + ί°+λί(€-Ο1)+λ2ΖΙ

λο λι λ2 λ2 λ* MSEL RML

+ λ3ρ+λ4\ν

1960-1980

1961-1965

1966-1970

1971-1975

1976-1980

-0.267 0.011 (40.5%) 0.535 (28.1%) -1.825 (57.7%) 0.023 (96.7%) 0.303 2.0%

-0.093 0.016 (6.3%)

-0.164 0.013 (5.4%)

-0.161 0.0086 (16.3%)

—

—

—

-3.176 (6.9%) 0.052 (14.1%) 0.070 0.5%

-1.922 (24.3%) 0.017 (70.9%) 0.215 1.5%

-0.901 (43.6%) 0.0036 (51.0%) 0.173 1.1%

-0.590 0.0051 (12.8%) 0.342 (2.8%) -0.921 (10.6%) 0.011 (19.1%) 0.066 0.4%

TABLE 3.6

Λ

Linearization of equation for Md M = A0 + 0.263(M_ 1 +iVF-K)+A 1 r+A 2 w d

1960-1980 λο λι

h MSEL RML

-206.73 9.912 (49.2%) 4.881 (8.9%) 7.715 2.9%

1961-1965 -92.75 5.557 (6.4%) 4.379 (1.7%) 0.078 0.07%

1966-1970 -126.25 7.032 (5.5%) 4.709 (2.1%) 0.118 0.07%

1971-1975 -205.39 10.525 (16.3%) 5.076 (2.4%) 0.654 0.2%

1976-1980 -367.64 17.564 (13.0%) 5.479 (1.5%) 0.623 0.1%

in some cases, started to dominate official transactions. In this case some parts of money earnings were diverted towards much easier parallel markets. The second and third exceptions are marginal propensities to work, subject to expected price inflation and wages in the FC-labour supply equation; they are negative for the first two years, which is probably connected with a stable price-wage policy provided in thefiftiesand at the

60

W. Charemza, M. Gronicki TABLE 3.7

Linearization of equation for Md Md = λ0 + 0.664 {£ά-0+λγΖ2+ λ 2ρ 1960-1980 λο λί λ2 MSEL RML

7.355 -24.054 (18.8%) -5.169 (29.0%) 2.873 1.3%

1961-1965

1966-1970

1971-1975

1.641

-4.142

-1.942

6.687 (51.8%) 0.048 0.05%

1.616 (673.6%) 0.309 0.1%

—

—

-3.211 (160.4%) 0.058

ο.ι%

—

1976-1980 24.850 31.126 (10.3%) -25.208 (55.3%) 0.859 0.2%

TABLE 3.8

σ 1960-1980 λο λ, λ2 MSEL RML

-732.01 0.665 (18.8%) 910.10 (40.0%) 50.155 7.7%

Linearization of equation for Cs = λο + λ^ΧΌΛ BT-G-S- -Ι)+λ2ρ 1961-1965

1966-1970

1971-1975

1976-1980

-300.74 0.561 (2.2%) 533.46 (6.9%) 0.419 0.1%

-430.10 0.603 (2.2%) 710.09 (7.9%) 0.615 0.1%

-699.20 0.660 (5.1%) 1039.63 (12.9%) 3.44 0.5%

-1260.32 0.860 (10.3%) 1448.87 (3.9%) 4.64 0.4%

beginning of the sixties. More important is the fourth exception: the first derivative of money demand, subject to consumer prices in the Md equation. The sign of this derivative is negative for 1960-1962, 1964, 1972-1973 and 1976-1980, and its dispersion is relatively high. Since the p variable is used in the Md equation as a deflator, it is difficult to give a causal interpretation of this phenomenon. It is interesting to follow time paths of some derivatives, namely those which indicate an impact of disequilibrium and expected inflation phenomena on explanatory variables. In the Cd equation λχ reflects the impact of labour disequilibrium on the EC consumption demand. Relatively stable in the ftret decade, it started to grow exponentially

Econometric model

61

from 1970 and reached its peak in the last year investigated. Simultaneously λχ in the EC-labour supply equation is characterized by a systematic negative tendency; the impact of consumption disequilibrium on labour supply decreased over time. The derivative λχ in the FC-labour supply equation is a marginal propensity to work with respect to expected inflation. With the exception of thefirsttwo years, this propensity is positive with a tendency to increase after 1973. After a stable period in 1973-1977, it fell substantially for the next two years. It seems that this phenomenon can be clearly interpreted as a measure of 'faith' in the planning of the consumer market; households are willing to increase their work in the case of expected price increases if they believe that additional work can diminish the negative effects of price increases. If they simultaneously expected 'worse times', e.g. greater market shortages, their propensity to work could have been lowered.

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Chapter 4

ESTIMATES OF DISEQUILIBRIA AND THEIR EFFECTS

4.1. Estimates of unconditional disequilibria The estimation of excess demand is one of the major aims of this study. Formally, excess demand estimation is straightforward: simply the calculation of demand and supply and their difference. It is worth remembering, however, that the notion 'excess demand' is of a highly subjective nature. It depends strictly on an a priori assumption about demand, supply and their interrelations, since definitions of demand and supply are ambiguous, although their meanings are intuitively understandable. Therefore, in order to approach an intuitive meaning of 'excess demand' it seems necessary to compare excess demand estimates as obtained from various positions with the use of different assumptions. Moreover, it appears that the simulation of disequilibrium estimates might be useful, subject to changes in particular restrictions. Throughout this study these kinds of disequilibrium estimates are called the conditional disequilibrium estimates. They supply the answer to the question : 'What would be the excess demand if particular restrictions originally admitted were relaxed?' In the literature various ways of calculating excess demand are proposed (see Portes et al. (1983), Charemza (1983b)). Here we have decided simply to estimate it by calculating demand predictions from the structural form of the model by deterministic, static simulation. It is possible to include regression residuals and to consider them as known, since error terms of the original equations can be directly identified from the respecified-form error terms (see 3.2). The corre-

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sponding transacted quantities are then subtracted from the estimated demand. Alternatively, we have calculated excess demand estimates by providing dynamic simulation on the entire (3.36a)-(3.46) system of equations with the five-year loop, starting from the beginning of each five-year plan (e.g. returning to the initial values as taken from statistical data for 1966, 1971 and 1976). Since this method is further used for policy simulation experiments, it is described in detail in Section 5.1. In Table 4.1 estimates of unconditional consumption and labour excess demands, as derived through static simulation, are presented. They are given respectively in absolute values and in the percentage of a quantity transacted. The Bayesian estimates of the model were used in the calculations. For a comparison, the percentage estimates of excess demand as calculated by dynamic simulation are given. The differences between the static and dynamic estimates are generally meaningless. The only reasonable difference is for the labour excess demand estimates for 1971, where the figure derived by the dynamic experiment exceeds the static one by about 23%. However, for this particular year the labour excess demand is the smallest and the absolute difference is small. For all the other years the difference ratio to appropriate static estimates is well below 10%. The comparison indicates a consistency of the directly interprétable static estimates of excess demands with the dynamic abilities of the model (more information about simulation properties of the model is given in Chapter 5). We have, therefore, decided to use the static estimates of consumption and labour excess demand in further analysis. These estimates are subsequently referred to as 'historical'.1 1 In this work we faced the problem of introducing new terminology for the particular existing (in reality) and nonexisting (simulated) values of the variables. In our case the normal notions of 'observed' and 'actual' values as referred to the results derived directly from statistical samples are often misleading. Certain unobservable variables can be lagged or leaded and calculated from statistical or imaginatory (simulated) data. To avoid confusion, we have used the adjective 'historical' for the observed and unobserved (i.e. expected) variables, if they are calculated univocally from the estimated model and with the use of the same data as for estimation. The simulated values are the opposite to 'historical' ones; therefore a variable value can be 'historical' but 'unobserved', 'simulated' but 'observed', etc.

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TABLE 4.1

Consumption and labour unconditional excess demand estimates Static estimates in percentage of quantity transacted

absolute Year consumption in bil. zl. 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

15.6 16.5 16.1 13.2 15.2 17.2 20.3 20.2 19.6 16.2 13.9 30.8 48.4 62.8 79.7 81.4 86.0 87.6 80.4 92.1 117.7

labour in consumption mil. of employees 0.373 0.351 0.532 0.234 0.309 0.140 0.089 0.365 0.265 0.428 0.269 0.039 0.261 0.971 0.919 1.273 1.313 0.826 1.169 1.985 2.133

6.42 6.25 5.74 4.43 4.82 5.04 5.53 5.07 4.51 3.54 2.84 5.81 8.08 9.30 10.34 9.27 8.48 7.72 6.51 6.81 7.74

labour

3.01 2.79 4.15 1.79 2.35 1.03 0.64 2.54 1.80 2.84 1.77 0.25 1.65 6.01 5.58 7.68 7.93 5.00 7.03 12.00 12.93

Dynamic est imates in percenta geof quantity trarisacted consumption labour

_ 6.29 5.76 4.62 4.91 5.21 5.54 5.25 4.74 3.72 2.97 6.00 8.28 9.55 10.52 9.46 8.57 7.84 6.59 6.88 7.78

2.80 4.16 1.85 2.40 1.12 0.65 2.59 1.89 2.96 1.87 0.31 1.73 6.13 5.70 7.79 7.96 5.02 7.08 12.05 12.97

Increasing trends in consumption and labour excess demands are observed. This can be noticed for both the absolute estimates and for the estimates as expressed in percentages. For the latter, correlation coefficients with time are equal to 0.54 (consumption) and 0.73 (labour). Obviously, changes in the estimated excess demands are not linear in time. For the percentage series a U-shaped tendency can be observed, with the minimum in the middle of the period investigated (1970 for

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consumption and 1971 for labour), while the U-shape is wider for labour (the maximum is for the last, 1980, year) than for consumption (where the maximum is for 1974). In the case of consumption, 1970 seems to have been a turning point; for the earlier years disequilibrium was substantially lower than for the later years. In particular, a great jump was estimated for the years 1971 and 1972; after 1972 the disequilibrium remained on a relatively high level. The general tendency is intuitively understandable, although it is difficult to explain the jump in excess demand in 1972-1974 (see Section 4.3 for expected and spillover effects in disequilibrium estimates). A small decrease in consumption excess demand is indicated for 1978-1979, which seems to be the result of Gierek's policy of importing consumption goods which reached its peak in these years. For labour, the general tendency for increasing excess demand was restrained in 1977-1978 (both in absolute values and in percentages). This seems to have been the effect of a policy of reducing labour demand by various restrictions on enterprises wage bills (the so-called 'job-freezing' policy). The estimates show that this policy was not effective in 1979-1980. The disequilibrium estimates were derived from the model estimated by Bayesian techniques. While these estimates are compared with those obtained by traditional techniques, it is possible to evaluate the impact of out-of-sample information on excess demand. The ratio of Bayesian to traditional excess demand estimates is equal to 1.35 for consumption and 1.14 for labour. This result can be interpreted in two ways; firstly, that subjective information caused an increase in consumption disequilibrium which was much stronger than labour disequilibrium, and secondly, that 'weight' (a measure of hardness), 1 per cent of consumption disequilibrium is over two times greater than 1 per cent of labour disequilibrium. In other words, there is a tendency to increase the investigated disequilibria, if out-of-sample information is used (especially for consumption). In Table 4.2, our consumption disequilibrium estimates (denoted below as CG) are compared with those previously obtained by Portes and Winter (1980), Podkaminer (1982) and Portes et al. (1983). (A similar comparison for labour is not possible as we could not find published disequilibrium estimates for this market.) Assumptions about generating

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TABLE 4.2

Comparison of estimates of consumption excess demand (in percentages of quantity transacted) Year

CG

PW

Ρ 'Ireland'

1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

— — — — — 6.42 6.25 5.74 4.43 4.82 5.04 5.53 5.07 4.51 3.54 2.84 5.81 8.08 9.30 10.34 9.27 8.48 7.72 6.51 6.81 7.74

-1.57 -1.18 0.53 -6.89 -4.07 0.15 -4.12 -5.51 -7.05 -9.05 -4.16 -9.10 -3.73 -5.85 -5.46 -5.02 -6.47 2.52 2.74 1.26 -6.77 -8.30 — — — —

—

PQWY 'Italy'

— — — — — — — — — —

— — — —

—

1.26 0.92 2.03 2.41 4.12 4.62 7.96 9.99 11.93 14.99 14.41 12.97 11.98 12.45

-3.76 -0.30 -3.13 -2.54 -1.37 -0.90 2.07 3.88 5.70 8.38 7.91 6.51 5.64 5.84

— — —

— —

—

—

—

—

— —

1.0 -3.1 0.4 -5.4 2.6 -3.0 -0.8 -2.8 -0.3 -1.9 -1.7 1.3 0.0 -0.1 3.3 3.4 -0.2 0.9 1.4 -1.8 -1.4 -8.4 0.9 0.7

excess demand used in these works are different. In the Portes and Winter article (referred to below as PW), a generalized disequilibrium model was used for generating demand and supply, without any disequilibrium adjustment mechanism. Estimates were made for the years 1954-1975 using the maximum likehhood method. Podkaminer's estimates (P below) were derived from an Extended Linear Expenditure

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System (ELES) and 'disequilibrium' (excess demand?) is defined as the difference between 'equilibrium supply' (equal to notional demand) and observed supply. The P results are presented in two versions: 'Ireland' and 'Italy', since some parameters of the ELES model were taken from appropriate expenditure models for Ireland and Italy. Moreover, the results need to be aggregated since they were given for particular commodity groups. We provided the aggregation with the use of prices as given in Podkaminer's paper. In the Portes et al. (1983) paper (referred to as PQWY), a supply/demand model with a disequilibrium indicator was used. The Charemza and Quandt (1982) planadjustment mechanism with a plan of consumption as a dependent variable (hard target) was applied. Excess demand estimates were derived by stochastic simulation experiments and by averaging the results over a simulation sample. In their paper, PQWY analysed estimates for four variants of the models without selecting among them. Since their comments are generally valid for all these variants and in fact the results are relatively close to each other, we decided simply to average their estimates in order to obtain a synthetic expression of their results.2 It has been shown that differences among particular estimates are reasonable. According to PW and PQWY, the period before 1970 was characterized for most years by excess supply. In the period 1960-1970, excess supply appeared for all the years (according to PW) and for all but 1961, 1968 and 1969 (?) (according to PQWY). Similarly, the P 'Italy' results indicate excess supply for 1965-1970. The P results for the two variants are strongly correlated (correlation coefficient γ is equal to 0.98), and they differ greatly in values and in signs for 1965-1970; they are almost exactly proportional. The PW and PQWY estimates are not correlated; however, the PQWY results are smaller in absolute values than the PW ones. They are also smaller than any other estimates. The CG and P results are correlated, and the correlation is slightly higher for the 'Italy' version (r = 0.88) than for the 'Ireland' one (r = 0.84). 2

In their subsequent paper, Portes et al. (1984) expressed their caution at interpreting the results and described the sign of the estimated excess demand for 19621966, 1969, 1975 and 1978 as 'uncertain'.

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For the period 1965-1970, it is possible to compare time trends for particular estimates. Estimates of linear trends, obtained by the ordinary least squares method, are as follows (/-values are given in brackets, R2 denotes the coefficient of determination) CG estimates excess demand = 2.894+0.568/ + error term, (3.7)

JR2 = 0.554,

PW estimates excess demand = -6.040+0.337/-+-error term, (0.9)

P 'Ireland' estimates excess demand = —2.527 + 1.552/+error term, (13.1) P 'Italy' estimates excess demand = —5.960 +1.235/4-error term, (8.3) PQWY estimates excess demand = -1.174+0.288i+error term, (2.0)

R2 = 0.069,

R2 = 0.940, R2 = 0.862,

R2 = 0.303.

Trend coefficients are positive for all the considered results. However, for PW the /-value is too low to reject the hypothesis of a zero time trend coefficient. The other /-values indicate the existence of a positive time trend at a significance level, equal to at least 0.1. The highest increases in time are estimated for the P models and the closest relation with time is for the P 'Ireland' version. The constant term is positive for only one estimate—CG—which suggests positive excess demand estimates for 1964 and for earlier years. The general conclusion of this comparison is that if we were to begin from slightly different assumptions about excess demand formation, this would lead to completely different results. The meaning of 'excess demand' and 'disequilibrium' is ambiguous and should be carefully defined in particular studies. Nevertheless, all the results compared suggest an evolution of consumption disequilibrium towards positive excess demand.

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4.2. Measures of repressed inflation In Section 4.1, disequilibrium estimates expressed in quantities are presented. In fact, disequilibria on consumption and labour markets can also be described in terms of prices and wages. The relatively simplest price disequilibrium characteristic could be a (supply) balanced price. Throughout this study 'balanced price' denotes a level of consumer prices which would revalue quantity realized to equal that of the level of demand. Obviously, the balanced price cannot be identified with the equilibrium price. Adjusting price towards equilibrium would change demand, and the balanced price is calculated on the assumption that demand remains unchanged. Some other balancing characteristics can also be proposed. In particular, before calculating balanced prices it is useful to evaluate a repressed inflation degree (RID), as a difference between the excess demand chain index evaluated in constant prices and the price chain index for particular years. In Table 4.3, a comparison of appropriate indices is presented. Disequilibrium indices were calculated with the use of data from Table 4.1, and the historical price index is an index used in estimation (see Appendix). The RID figures express annual changes in the repressed inflation policy. For instance, in 1961 consumption excess demand rose by 9.8% in comparison with 1960, and at the same time prices rose by 0.9%. This means that 8.9% of the disequilibrium increase was not recompensated by the increase in prices. Consequently, the degree of repressed inflation is equal to 8.9% in 1961. In 1960-1980 the rate of growth of consumption excess demand (in constant prices) was 7.5%, and the rate of growth of prices was only 3.2%. The degree of repressed inflation increased on average by 4.3%. The development of repressed inflation is not smooth; for 10 of the 21 years investigated, a negative sign of RID was calculated, which means that in these years the level of the repressed inflation policy had diminished in comparison with the previous year. A great jump in the repressed inflation policy took place in 1971-1973. After 1975, some efforts at curbing this phenomenon were observed, but their impact on the overall degree of repressed inflation was not important. After calculating RID, a balancing consumer price index is derived.

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TABLE 4.3

Calculation degree of repressed inflation for consumption Year

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Chain indices excess demand (1) — 109.8 94.6 81.1 112.5 112.8 116.2 97.6 95.6 81.2 84.8 220.7 156.9 125.9 119.3 99.3 99.8 96.7 85.0 107.3 116.2

RID

Pnces (2) — 100.9 102.6 100.8 101.6 101.5 100.9 101.7 101.7 101.5 101.3 101.0 100.2 103.2 106.5 102.9 105.7 105.3 108.0 106.7 110.0

(D-(2) — 8.9 -8.0 -19.7 10.9 11.3 15.3 -4.1 -6.1 -20.3 -16.5 119.7 56.7 22.7 12.8 -3.6 -5.9 -8.6 -23.0

0.6 6.2

It is calculated by dividing the estimated consumption demand expressed in current prices by consumption supply in constant prices.3 The results are given in Table 4.4. The balancing price index is denoted by pB, while p60 stands for the historical price index with a base of 1960 = 100.0 (throughout the study the symbol p denotes a price index with a base 1980 = 100.0). A difference between pB and p60 can be interpreted as follows: how much the prices would have risen to balance supply to a level of consumption demand. Since pB is bal3

Since balanced price pB is defined by CdjC3 = pBjp.

W. Charemza, M. Gronicki

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TABLE 4.4

Observed and balancing price indices (1960 = 100.0) Year

PB

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

106.2 107.6 109.4 108.9 111.1 113.0 114.6 116.0 117.4 118.0 118.8 123.4 126.2 131.7 141.6 144.2 151.3 158.2 169.0 180.8 200,6

p60 100.0 100.9 103.5 104.3 106.0 107.6 108.6 110.4 112.3 114.0 115.5 116.6 116.8 120.5 128.3 132.0 139.5 146.9 158.7 169.3 186.2

pB-p60

6.2 6.7 5.9 4.6 5.1 5.4 6.0 5.6 5.1 4.0 3.3 6.8 9.4 11.2 13.3 12.4 11.8 11.3 10.3 11.5 14.4

ancing, but not equilibrium price, it is calculated under the assumption that demand remains unchanged subject to price. It is worth noting that the difference pB-p60 reached its peak in the last year of the period investigated, and not in 1974, when consumption excess demand expressed in percentage was the greatest. This confirms the existence of a policy of reducing inflation by price increases which took place in the second half of the seventies. This policy could not be effective, since the rate of growth of excess demand was higher than the rates of growth of the balancing and observed prices. It is equal to 7.45% (excess demand), 3.54% (balancing prices) and 3.16% (observed prices). Investigating the effects of repressed inflation on the labour market is slightly more complicated, since both the price and wage effects should

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73

be considered. Firstly, nominal balancing wage (wB) can be calculated in a similar way as applied for prices, i.e. B

W L U > Ls and NL = Ld-U. If, on the other hand, L > L\ the difference L-U is not an excess demand component, since Lr > U = L > ΖΛ The situation is analogous for consumption. A positive difference between C and Cd does not increase excess demand since Cd > Cs = C > Cd. According to the repressed inflation assumption, the signs of unconditional excess demand are a priori known. Nevertheless, it is interesting to investigate disequilibrium regimes without spillover effects. In particular, a difference between Walrasian demand and supply can be interpreted as disequilibrium in the Walras sense (i.e. a situation in which equilibrium in the Walras sense—equality between Walrasian demand and supply—does not exist). Moreover, it is also possible to investigate disequilibrium in the Clower sense (see Gourieroux et al. (1980), Ito (1980)). For evaluating Clower-sense disequilibrium, it is posited that in the repressed inflation case households are not constrained with respect to labour, and consequently the spillover effect in the EC-consumption demand function is equal to zero, and consumption demand is equal to Walrasian demand.4 Appropriate conditional excess demands can be expressed (positing that Walrasian consumption supply is equal to Cs and Walrasian labour demand is equal to Ld) as 4 Similar results can be obtained if FC-demand (supply) is regarded instead of Walrasian demand (supply).

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— disequilibrium in the Walras sense (N(W)C, N(W)L): N(Wf = Cd-Cs,

N(W)L = Ld- Ls,

— disequilibrium in the Clower sense (N(C)C, N(C)L) : N(Cf = Cd-C\ N(C)L = Ld-Ls. The appropriate estimates for N{W)C = N(C)C and N(W)L are given in Table 4.8 (note that N(C)L = NL, as given in Table 4.1). It can be noted that these estimates are equal respectively to JV(1,2)c less the constant and error terms and N(l, 2)L plus constant and error terms and the dummy variable Z\ with its structural parameter. In 1960-1966, Walrasian demand was smaller than Walrasian supply on both markets,. TABLE 4.8

Disequilibrium in the Walras and Clower sense (in %) Year

1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

N(W)C min {Cd,Cs} -17.70 -15.23 -15.34 -15.02 -13.57 -14.37 -13.54 -13.93 -13.64 -13.08 -13.58 -11.84 -10.93 -8.16 -5.23 -2.92 -2.73 -2.86 -1.59 -0.10 1.31

N(W)L min {L\LS} -7.70 -6.56 -3.34 -4.58 ' -4.79 -4.41 -3.95 0.47 0.75 2.61 2.37 0.82 3.42 8.37 8.56 10.37 8.90 5.10 5.91 9.84 9.71

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which corresponds to the Keynesian unemployment regime (see Section 2.3). This type of disequilibrium would appear if there were no interrelations between disequilibria on the markets investigated. Under this condition, for 1967-1979, the underconsumption regime is observed (Cd < Cs9 Ld > U). In some works the existence of an underconsumption regime is doubted (see Malinvaud (1977), Sneessens (1981, pp. 38-39)). They generally posit that households, while constrained neither in consumption nor in labour, can immediately adjust their consumption demand to the level of supply by increasing labour supply. Nevertheless, in a well-developed socialist country some non-economic mechanisms for restraining consumption could exist. These mechanisms could be connected with efficient long-term consumption planning which would, in this case, have become a 'hard' rather than a 'soft' target. Consequently, it might be interesting to regard underconsumption as a disequilibrium regime for a future, more highly organized, socialist economy in which spillover effects would be liquidated. However, this does not seem likely to occur in Poland in the near future. In the seventies, Walrasian consumption excess supply decreased systematically and finally it switched to excess demand in 1980. For 1980 a repressed inflation regime is estimated, while disequilibria in the Walras sense are regarded. Similar results are obtained for the Glower disequilibrium estimates. The difference (in comparison with Walras estimates) was for labour for 1960-1966. For the entire period (with the exception of 1980), Clower consumption demand was smaller than supply, and labour supply was smaller than demand, which gives an underconsumption regime for 1960-1979. It should be stressed that the achievement of an underconsumption regime in 1960-1980 in Poland was not regarded as an economic success. In both the Walras and the Clower analysis, EC-consumption demand was greater than Walrasian demand, and the way out of the repressed inflation regime would have been to reduce EC-demand to the level of quantity transacted. This, in turn, would have led to a reduction in the quantity transacted, which is equal to the minimum of Cd and C s , which, in this case, is equal to Cd.

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Chapter 5

INTERNAL MONETARY POLICIES

5.1. Policy simulations9. Some theoretical and technical questions The evaluated disequilibria, as described in the previous chapter, could be used as straightforward and convenient measures for evaluating various economic policies which would be implemented in the system investigated. More precisely, it seems to be sensible to regard a policy A as superior to a policy B if excess demand corresponding with A is smaller than excess demand corresponding to B. According to this, the examination of some alternative economic policies through simulation experiments is relatively easy, and additional tests to find out whether one policy is better than the other need not be applied. Obviously, the minimizing of excess demand cannot be regarded as the only criterion for choosing an adequate economic policy. For instance, if in a given experiment consumption excess demand is close to zero and the absolute level of consumption is relatively low, such a policy is usually not efficient, since it is connected with a lowering of the standard of living by a decrease in consumption. Nevertheless, if in the examined policy experiments consumption supply can be established at similar levels, simulated excess demand could be the most simple and complex characteristic of the policies' validity. In the present chapter we have analysed some internal policies which could possibly lead to a decrease in consumption and labour excess demand through the manipulation of financial factors, affecting mainly households' consumption demand and labour supply. In all these

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experiments we have stated that the level of output, investments, government spendings, changes in stock and foreign trade remained unchanged, which also caused the consumption supply to be invariant (if expressed in comparable prices—see (3.12)). From the state side, these policies are not 'inward' in the sense that they have not caused changes in the produced (and imported or stocked) and distributed quantities. Such policies are therefore regarded as Outward'. Two main types of these policies are considered in this study: 1. Price-wage policies, which consist in price rises and wage reductions, reaching a point which is relatively close to equilibrium (these policies are denoted below as the PW policies, reforms, or experiments). 2. Money demand policies which, in the case of a CPE, consist in freezing (or annihilating) a substantial part of households' money assets in order to reduce consumption demand and to stimulate labour supply. Among the various possible money demand policies, we have analysed the most drastic ones (which had, however, to be implemented in practice), in which a part of the money assets (especially savings) is discarded by an immediate change of currency, while only a part of the households' money assets can be exchanged. These policies (reforms) are denoted by the abbreviation CC. In practice it is possible to combine the PW and CC policies, i.e. by starting an active PW policy with a change of currency. These combined policies are also considered. It is interesting to look at these policies through the familiar quantity of money equation, which is a base for various financial theories. This is usually formulated as: nominal stock of money = price· real income/velocity of circulation. Particular financial theories differ in defining targets, instruments and neutral (i.e. determined by non-financial factors) variables in the above equation. According to Portes (1983), in its Keynesian interpretation price should be regarded as an instrument affecting money, and in one of the various monetarists' quantity theories of money? price is a target, and money (regarding velocity as invariant) is an instrument. In both cases real income is neutral. Portes (1983) also

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85

distinguishes a CPE planners' policy, in which prices and income are fixed by planners and which is based on Marx's law of circulation; income is thus not neutral any more. In the policies analysed in this chapter, the aim is to reduce income or stock of money (or both) in order to reduce consumption demand and to increase prices so as to increase supply. A price-wage policy should, in this context, be regarded as Keynesian, while a money supply policy with exogenously fixed prices is of a new type, which does not correspond to the above classification. In that case the target is obviously the velocity of circulation; its increase is caused by the exogenously determined decrease in stock of money. In particular, the smaller the stock of money, the greater the velocity of circulation. It must be stressed that a price-wage policy also affects velocity, although in an ambiguous way. In the short-run reduced (through wages) income helps to decrease velocity, while in the long-run the decreased stock of money (which is a positive function of income) makes it increase. We have examined particular policies by providing simulation experiments on the model described in Chapter 3. Technically, it would be a rather simple numerical exercise if the model had admissible control and dynamic properties. Unfortunately, it is clear that the 'wage illusion' equation (3.16) is a source of unstability. Moreover, if this equation is included in the system, the variable w (wage), as a jointly dependent variable, cannot be regarded as a policy instrument in the PW experiments. This leads to the conclusion that the search for a sensible economic policy which would provide a reduction in disequilibrium would mean getting rid of the 'wage illusion' effect. Only in the case, when the policy-makers are able to change the role of wages and convert them from an instability-causing dependent variable into a policy instrument, will the necessary conditions for the existence of a 'better' money policy than the realized in practice appear. All the experiments considered below have to be regarded under this condition. Nevertheless, discarding the wage equation creates some technical problems. Usually, the 'control' solution of a model (e.g. the solution which is a base for comparing the examined policies) is that which is based on the observed (historical) data. Dropping one equation from

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the system would lead to a control solution which is relatively far from that based on a full system and cannot be directly compared with the 'historical' data, which are adequate for the full model. To avoid this, we have provided the simulation experiments in the following way: 1. Simulate the 'control' solution using historical data for the model with dropped wage equation. Both prices and wages are therefore extraneous to the system.The system of equations (3.36)-(3.46), with the omitted (3.45), is nonlinear; nevertheless it can be simply solved as linear due to the fact that the only nonlinearities appear through multiplying and dividing by the extraneous variables p and w. Therefore the system of equations can be expressed as At-yt = xt, where yt is a vector of current endogenous variables, xt consists of residuals and predetermined variables with their estimated parameters, and At is a matrix of partial derivatives of yt subject to particular predetermined variables. The matrix At includes the estimated parameters standing with jointly dependent variables and functions of p and w. Since p and w are known, the solution of the system for each t is (5.1) V =A7l-xt. The only difference to the linear reduced form solution is that the inverse matrix A;1 has to be calculated repeatedly for each t. The simulation is dynamic in the sense that for / = 2, 3, ... the lagged values of endogenous variables are replaced by their simulated values as calculated for /— 1. Note that the above solution is not in general equal to the historical data on dependent variables. If one denotes the historical data on dependent variables (including w) by yf, and the rest of the system (excluding w) by xf9 the solution becomes which is obviously not equal to (5.1) (neither is A'1 a sub-matrix of/,(·)). 2. Calculate 'correction factors', i.e. differences between the historical values of dependent variables and the 'control' ones. In the case of unobservable demand variables their estimates, as calculated in Chapter 4, have been used instead of historical values.

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3. Simulate a policy with the given fixed values of policy instruments and historical values of the rest of exogenous variables using the equation (5.1). Again the dynamic simulation has been provided. 4. Adjust the simulated values of dependent variables using previously calculated correction factors. 5.2. A simple PW policy We have started from a simple PW policy, in which prices and wages are determined on the level of balancing prices (pB), and balancing wages (wB), as derived in Chapter 4. In this study, this particular variant of a PW policy is denoted as PW(i?). I n that case no other intervention has been admitted. Deterministic dynamic simulation has been provided for particular five-year intervals: 1961-1965, 1966-1970, 1971-1975 and 1976-1980, which correspond to appropriate five-year planning periods. For the first year of each five-year interval simulation starts from historical values of the variables (with the exception of p and w, which are fixed at the level of pB and wB, respectively), and for the second, third, fourth and fifth year previously simulated values of dependent variables are used in the case of lags. Excess demand estimates as results of the PW(2?) policy are compared with the historical ones (e.g. derived from original data) in Table 5.1. The table indicates that the policy of keeping prices and wages at balancing levels would have been too strong (in comparison with the originally implemented one) at least for the period 1963-1972. For these years a Keynesian unemployment regime would have come into being. For 1961-1962 and 1973-1975, an underconsumption regime is estimated, and for 1976-1980 repressed inflation is estimated. It must be stressed that in all the experiments considered in this chapter, consumption supply is invariant. Hence, negative consumption excess demand does, in fact, mean a decrease in the consumption level (in comparison with the historical policy), since quantity consumed is equal to the minimum of demand and supply. Nevertheless, for 1976-1980 the results for PW(B) are superior to the historical ones. The average historical excess demand for this period is equal to 9.0%, and the simulated one is 6.0%.

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TABLE 5.1

Excess demand under the PW(Z?) policy (in percentages of transacted quantities) Year 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Consumption historical

6.2 5.7 4.4 4.8 5.0 5.5 5.1 4.5 3.5 2.8 5.8 8.1 9.3 10.3

9.3 8.5 7.7 6.5 6.8 7.7

Labour PW(Z?) -1.3 -2.1 -4.8 -5.9 -7.3 -1.9 -3.6 -4.7 -4.5 -4.1 -0.4 -2.3 -2.6 -3.3 -2.7

3.4 1.8 1.5 4.6 7.6

historical

2.8 4.1 1.8 2.3 1.0 0.6 2.5 1.8 2.8 1.8 0.3 1.6 6.0 5.6 7.7 7.9 5.0 7.0 12.0 12.9

PWCß)

1.4 1.6 -2.1 -2.0 -3.6 -0.1 -0.4 -2.7 -2.2 -3.4 -2.4 -1.9

1.6 0.3 2.1 6.9 2.9 3.6 8.3 8.5

The appearance of the unemployment regime for 1963-1972 raises questions about the place of this policy in the socio-demographic and political realities. In particular, the effect the changes in labour would have on the employment/population ratio in the case of a simulated increase of the transacted quantity of labour. If this ratio is too high in simulation, the results are unacceptable from the socio-demographic point of view. Furthermore, is the negative labour excess demand a serious limitation for the full employment policy? If so, due to political principles, unemployment would probably be forcibly reduced (either by involuntary employment or by the artificial stimulation of labour demand), which would, in turn, lead to underconsumption (through underemployment), and then to repressed inflation. The labour-

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89

unemployment results with regard to the working-age population are given in Table 5.2 (where L and L(S) stand for the observed and simulated transacted labour, respectively, and T is the working-age population). TABLE 5.2

Labour, unemployment and working-age population under the PW(JB) policy

Year

m

(LIT) (in %)

(US)IT) (in %)

1.38 2.54 1.79 2.35 1.03 0.64 2.54 1.80 2.84 1.77 0.25 1.65 4.39 5.45 5.42 0.97 1.97 3.34 3.42 4.11

77.03 78.15 78.86 78.17 79.26 79.86 81.65 82.12 82.43 82.81 82.91 83.57 83.83 83.93 83.02 81.45 80.64 79.59 78.75 77.76

78.09 80.13 82.00 81.61 82.93 80.45 84.06 85.85 86.62 87.13 85.00 86.58 87.51 88.32 87.51 82.23 82.23 82.25 81.44 80.96

(in %)

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Unemployment in millions of workers

. — 0.286 0.271 0.485 0.013 0.061 0.405 0.337 0.522 0.350 0.306

— — — — — — — —

It seems that the socio-demographic structure of the Polish population would have been a serious limitation for the PW(2?) policy. For all the years the simulated transacted labour (e.g. supply for 1961-1962 and 1973-1980 and demand for 1963-1972) is greater than the historical one. The difference is not high; it exceeds 5% for two years: 1974 and 1975. On the one hand, it would had led to a slight reduction in labour

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excess demand, but on the other it would have simultaneously affected the employment/population ratio, which seems to be at its limit, even for real data. According to this data, the ratio of employment to workingage population was greatest for 1972-1974 (84%), while in the PW(£) experiment it reached 87-88% for 1973-1975. Such a high ratio hardly seems acceptable for society.1 Unemployment would not have caused a real problem in the PW(#) policy. In absolute values, unemployment would have varied from thirteen thousand in 1966 to over half a million in 1970. The latter figure corresponds to the highest unemployment rate of 3.4%. This is low enough for these estimates to be regarded as not greater than structural or short-term unemployment, which is in fact admissible in a fullemployment economy. However, it would be worthwhile to look closer at the unemployment generating mechanism. Since labour demand is invariant with respect to prices and wages in its structural and reduced form, it remains the same in the historical and PW(i?) experiments. As a result, unemployment would have been reached through an increase in labour supply by an appropriate price and wage movement. The expected and estimated partial derivatives of U are positive with respect to wages, and negative with respect to prices. This has made the 'shadow effect' of prices relatively stronger than the direct influence of wages. 5.3. Planning distance and expectations errors In the simulation experiments annual plans have been treated as fully consistent with appropriate five-year plans. Although we have not used any figures connected with five-year planning, we have stated that after every five-year planning period planners have an opportunity to correct recent mistakes by forgetting them. Technically, this means that inside each of the four five-year planning intervals simulation is provided dynamically (on close loops) without intervention. A situa1

It must be stressed, however, that in this highly aggregated model we have ignored changes in labour time and labour allocation. In practice, an increase in the number of workers would have been substituted by an increase in working time and (or) by changes in the allocation of labour which would have kept the labour/population ratio at a reasonable level.

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tion arises where the annual plans are fixed at the beginning of each five-year interval and a five-year plan is created which cannot be corrected in the intervening time. After five years a new plan, consistent with historical data, is implemented. In other words, the external correction of planning behaviour can be attended to every five years, at the beginning of the five-year planning period. According to this, it seems to be intuitively understandable that a plan for the first year of a five-year plan would be 'better' (more precise and easier to implement) than a plan for the second year, because of a shorter planning horizon. Possible planning errors would arise over a period of time and would be dealt with in subsequent years. We have called this phenomenon a planning distance error (PDE). If a PDE exists in every five-year interval, it should generate an effect similar to a cyclical five-year fluctuation of simulation residuals, while residuals are deviations from appropriate control values of particular variables. Therefore the simplest way to evaluate a PDE is to calculate PDE coefficients in a way similar to the calculation of seasonal coefficients for monthly or quarterly time series. The PDE coefficients are calculated by evaluating the means of simulation errors for particular five-year plan intervals, dividing the errors by appropriate means, and then averaging the results for all the first years of the five-year plans (1961, 1966, 1971, 1976), second years (1962, 1967, 1972, 1977) etc. To facilitate interpretation, particular coefficients are expressed as ratios of the first-year average planning errors, which in fact means that no planning distance errors are made for the first years. The PDE coefficients are calculated for particular demand and supply variables and for the XDP in order to find out the accuracy of planning and its effects on demands and supplies subject to different planning horizons. In Table 5.3, the PDE coefficient, as calculated for Cf, U and XDP in the PW(i?) experiment, is given. The relative increase in PDE is evaluated for the second years of the five-year planning intervals. In other words, it seems that sensible plan corrections, if made immediately after a first year, were more efficient on average than those made in other years. The self-correction mechanism of planning errors is not evident (although for some years a decrease in PDE for the fourth and fifth years has been estimated), nevertheless the PDEs have a ten-

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TABLE 5.3

PDE coefficients for the PW(J5) policy Planning distance 1 2 3 4 5

year years years years years

Cd

Ls

1 1.56 2.08 2.74 3.14

1 2.00 2.99 3.31 3.56

XDP 1 1.90 2.67 2.87 3.07

dency to stabilize over time. Generally, the planning process in Poland from 1961-1980 is regarded as relatively stable, without the cumulative effects of destructive errors in time. Moreover, since the stabilizing tendency is observed for the PDE coefficients, it seems that a mediumterm five-year plan was, for the most part, consistent with a yearly planning procedure.2 The average corrections for XDP would have been relatively smaller than those for Cd and ΖΛ For the second and third years of a five-year plan the average planning distance errors would have increased the most, particularly for labour supply. Consumption demand seems to be relatively more stable in a planning period; for the second years the PDE coefficient is much smaller than for U and even for XDP. To evaluate the impact of a time horizon on planning under the PW(i?) policy in more detail, an auxiliary control experiment has been carried out. It consists in simulating the PW(i?) policy, without any corrections after each five-year planning period. In that case the closed loop in simulation is only one which begins in 1961 and ends in 1980. In Table 5.4, appropriate disequilibrium estimates are compared for the PW(2?) policies, with and without the five-year planning control loop in 1966-1980 (for the first five-year plan, 1961-1965, the simulation techniques are identical, and the excess demand estimates are the same). The results seem to point in the direction of applying the planning control mechanisms in five-year planning, while implementing 2

The above considerations relate only to the planned domestic expenditures, which are a rough approximation of planned output. It seems dubious to extend these conclusions to 'soft' and 'inactive' plans for consumption and employment.

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TABLE 5.4

Disequilibria under the PW(5) policy with and without planning control loop (excess demand in percentages of transacted quantities) Consumption

Labour

ear

with planning loop

without planning loop

with planning loop

without planning loop

1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

-1.9 -3.6 -4.7 -4.5 -4.1 -0.4 -2.3 -2.6 -3.3 -2.7

-8.0 -7.3 -6.9 -5.8 -4.9 -4.9 -5.4 -4.3 -4.3 -3.2 -2.0 -2.3 -1.0

-0.1 -0.4 -2.7 -2.2 -3.4 -2.3 -1.9

-4.5 -3.1 -4.3 -3.1 -4.0 -5.9 -4.3

Y

3.4 1.8 1.5 4.6 7.6

3.1 6.7

1.6 0.3 2.1 6.9 2.9 3.6 8.3 8.5

0.3 -0.3

1.8 2.5 -0.5

1.5 7.1 7.7

the PW(i?) policy. In the case of an absence of the five-year planning control (the estimated consumption excess demand is positive only for 1979 and 1980), the negative consumption excess demand would have lasted almost the entire period investigated, which would have led to a decrease in the absolute level of consumption. Moreover, for 1966-1975 the negative consumption excess demands are greater than for planning loop experiments, and unemployment figures would have been relatively higher. For instance, for 1971 the unemployment level would have reached over 900,000 workers (e.g. about 400,000 more than the highest estimate for the controlled five-year PW(£) policy received for 1970). This figure seems to be too high to be regarded as structural or temporary unemployment, and is inconsistent with the full-employment principle. In the PW(1?) policy, not only subjective expectations (plans), but also rational expectations, are subject to change. During the policy

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implementation the households' expectations p%1 and (Cd — Cs)e+l change, indicating the inclinations of households' expectations subject to price and wage changes. Technically, the methods of obtaining the simulated time paths for these two variables are different. For the (Cd — Cs)e+i variable it is simply a result of conditional forecasting from the appropriate dynamic regression equation (for a description of the rational expectations estimation, see Section 3.2). For pe+x the procedure is somewhat more complicated. The original dynamic regression equation which was used in estimation is not useful any more, since the dependent variable differed (from p to pB) as a result of simulation assumptions. Therefore the equation generating pe has to be reestimated and the expectations have to be recalculated using pB values instead of p. In Table 5.5, the expected and realized indicators of inflation and disequilibrium are compared for historical data and for the PW(B) policy. Historical excess demands (realized and observed) are expressed in pB prices to enable a direct comparison with the policy simulation results. Prices are in the form of chain indices, i.e. pc — p/p_ t , pec = pe/p_1. For description purposes, we have introduced a somewhat ambiguous notion of 'realized' excess demand, as corresponding to the difference between simulated demand and supply. As a result, we can distinguish between the realized (columns (1) and (3) of Table 5.5) and expected (columns (2) and (4)) excess demands. Similarly, realized prices are in columns (5) and (7), and expected prices in columns (6) and (8). The results indicate substantial changes in households' expectations in the case of the PW(#) policy. The expected excess demand, while generated by observed prices and wages, is usually greater than the realized excess demand. It is interesting to note that after 1970 the years in which the difference between the realized and expected excess demands was the greatest are 1976 and 1980—years which saw the eruption of social dissatisfaction. On the contrary, the expected price movement, while based on observed prices, indicates smaller price increases than those which appeared in reality. In general, households' expectations based on historical data indicate that they have become accustomed to repressed inflation. They used to expect more severe

TABLE

5.5

Expected and realized consumption disequilibria and inflation under the historical and Ρ\ν(β) policies Consumers' prices

Consumption excess demand

(c'-σ)·

ρ (1)

17.5 17.2 14.0 15.9 18.0 21.4 21.2 20.5 16.8 14.3 32.6 52.3 68.6 88.0 88.9 93.3 94.3 85.6 98.4 126.8

Pt

Pt Pt

Pt

ρPt

Pt

Pt

PW(B)

historical

(c'-ay

Pc

P!

Pc

Pt

(2)

(3)

(4)

(5)

(6)

(7)

(8)

19.8 13.6 14.3 13.0 16.6 21.8 22.8 27.8 30.0 35.0 51.8 71.7 82.0 72.1 84.7 82.1 106.8 110.7 114.6 110.2

-3.7 -6.0 -14.2 -18.3 -24.3 -70.3 -14.5 -20.4 -20.3 -19.9 -2.2 -14.7 -19.0 -27.5 -25.5 37.0 22.2 19.7 65.7 124.1

-3.8 -8.2 -2.9 -5.7 -3.4 -0.6 1.8 8.6 14.7 22.4 24.9 32.9 35.1 18.2 34.0 33.7 58.9 67.3 66.4 51.1

100.9 102.6 100.8 101.6 101.5 100.9 101.7 101.7 101.5 101.3 101.0 100.2 103.2 106.5 102.9 105.7 105.3 108.0 106.7 110.0

99.9 100.2 100.3 100.5 100.8 101.3 101.3 101.3 101.1 101.0 101.0 101.4 103.3 103.8 104.0 104.4 105.0 105.6 105.4 105.9

101.3 101.7 99.5 102.0 101.7 101.4 101.2 101.2 100.5 100.7 103.9 102.3 104.4 107.5 101.8 104.9 104.6 106.8 107.0 111.0

100.4 100.3 100.6 100.6 100.6 100.7 100.9 101.0 101.3 101.4 101.8 101.9 102.4 102.7 102.7 103.3 104.2 105.4 106.6 108.7

Internal monetary policies

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

PW(5)

historical

Year .

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quantity constraints (identified by households as shortages) and relatively low price movements. A slightly different situation occurs when the observed prices and wages are replaced by the balancing ones. The signs of expected and simulated excess demands are identical for 1961-1965 (negative) and for 1976-1980 (positive). For the remaining years, expectations would have been more pessimistic than the simulated reality; households expected positive excess demand while the realized one would have been negative. This situation would have changed at the end of the period investigated. For 1980 the substantial difference between the expected (small) and realized (great) excess demands indicates the end of a somewhat successful era for the PW(i?) policy. In the PW(i?) experiment, households' price movement expectations are in general more optimistic (from the households' point of view), than the reality. For only three years: 1963, 1970 and 1975 was the expected price increase greater than the increase of realized prices; for the remaining years households' price expectations were, as is revealed in historical calculations, biased downwards. This tendency to bias expectations towards a repressed inflation regime would have caused additional problems in the implementation of a price-wage policy which tended to reduce repressed inflation. Households seem to accept high, unforeseen price increases less favourably than having to queue. 5.4. PW(B) policy and labour hoardings In the experiment described previously, we assumed that planners can influence the market only by manipulating prices and wages. In fact their opportunity to intervene would have been much greater; they could also havefixedthe quantities. In the next section we have described a rather drastic planner's intervention into the households' side. In the present one we have analysed a more moderate planners' policy which affects quantities on their own side. It is a policy of reducing labour demand by decreasing labour hoardings. As has been stated in Section 2.2, labour demand is regarded as a function of planned rather than observed total final domestic expen-

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ditures {ΧΌρ+τ). Therefore, if a plan for XD is not fulfiled, the labour demand as corresponding to XD (defined as productive labour and denoted by LPd) is smaller than Ld, and the difference between Ld and LPd is equal to labour hoardings. More explicitly, labour hoardings (LH) are defined as LH = max{0,i d -£P d }, where LPd = Led(XD) (see (2.17)). The labour hoardings' effect on excess demand can be simulated by repeating the PW(2?) experiment with a modified labour demand function (3.13), in which a compound τχ(1) · XDP + (I - τχ(\)) · XDP_1 variable is replaced by XD. This corresponds to a policy where the government, together with implementing a balancing price-wage policy (which affects households), also tries to reduce the state labour demand to its 'productive' level. In practice this could be done by implementing a stricter policy against enterprises and state institutions, e.g. by taxation over wage bills, while the taxes are paid by employers. In Table 5.6, excess demand, as calculated for the simulated FW(B) policy, excluding hoarded labour (denoted as PWH(2?)), is compared with the 'pure' PW(2?) experiments. It seems that this policy would have been relatively soft; it would have affected labour demand slightly. Only for one year (1980) would the reduction of demand to its 'productive' level have exceeded 2% of the total labour demand. In the sixties, the estimated hoarded labour would have exceeded 1% only in 1962. The results for 1966-1972 indicate no hoarded labour. Its level for 1973-1980 would have been reasonably higher than for 19611965. This higher level of hoarded labour would have decreased slightly in 1977-1980, which corresponds to a job-freezing policy implemented in these years, which resulted in greater restrictions for labour demand. It seems that the estimated labour hoardings do not reflect the overall hoarded labour, whose level was probably much higher in the period investigated. This relatively soft policy would have caused a significant easing of tensions on the labour market, while comparing to the 'pure' PW(#) policy. The only year in which the estimated labour excess demand was less favourable in the case of PWH(5) rather than PW(5) was 1974.

TABLE 5.6

Disequilibrium effects of labour hoardings under the PW policies year

Labour excess demand in percentages of transacted labour

in percentages of total labour demand

1.4 1.6

1.2 0.5

19.3 143.8

-2.1 -2.0 -3.6 -0.1 -0.4 -2.7 -2.2 -3.4 -2.3 -1.9

-2.1 -2.2 -3.6

27.5 11.9

0.1 1.1 0.1 0.2 0.1 0 0 0 0 0 0 0 0.9 1.9 1.9 1.6 0.7 0.8 1.9 2.1

1.6 0.3 2.1 6.9 2.9 3.6 8.3 8.5

0.1 -0.1 -1.4 -2.0 -2.6 -0.9 -0.5

0.7 -1.6

0.2 5.2 2.2 2.7 6.3 6.2

8.9 0 0 0 0 0 0 0 147.1 323.7 338.9 285.6 126.5 143.1 344.7 383.3

W. Charemza, M. Gronicki

PWH(5)

PWCB) 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Estimated labour hoardings in thousands of workers

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99

For the remaining years the new estimates are at least as good as the 'pure' ones. The absolute values of the estimated labour excess demand are substantially smaller; the market would have been closer to equilibrium in both the unemployment and full employment cases. However, the general tendency remains unchanged. Labour positive excess demand would have reached its peak in 1979-1980, despite the fact that it corresponded to the highest level of hoarded labour.

5.5. Change of currency: Was it a solution? In the first three sections of the present chapter we have examined the policies which would have led to a reduction in consumption demand through appropriate price-wage fixing. Nevertheless, it is also possible to aifect demand in another way. Consumption demand fluctuates mainly due to fluctuations in households' money assets, particularly money which was accumulated previously, and current households' income. The price-wage policy would have affected the second component of households' money assets by reducing labour incomes through a decrease in wages (simultaneously the value of consumption supply increases because of increases in prices, while its volume remains the same). Consumption demand can also be reduced by a decrease in households' stock of money. In particular, when a large part of this stock consists of forced savings accumulated previously, it seems to be sensible (economically, but not socially) to annihilate a part of it in order to substantially decrease consumption demand. In practice, various techniques could be adopted—more or less effectively—which would cause hardship to the citizens. A soft way of doing this could be connected with e.g. a long-term compulsory subscription of state bonds (with or without interest), which would, in fact, be a postponement of demand pressure to, possibly, better times (or to distribute their payments over a certain period of time). The more drastic one would involve an immediate change of the currency unit into a new one, and an exchange of the households' money assets only up to a fixed limit (or at a given proportion, with a different schedule as applied to prices).

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In post-war Polish economic history, a change of currency took place in 1950, when an 'old' zloty was exchanged at a ratio of 100:3 for savings kept in banks and savings institutions (the level of these savings was very low), and at a ratio of 100:1 for cash. Since prices were revised at a ratio of 100:3, this meant that a part of the households' money assets has been annihilated, which caused a decrease in consumption demand. Obviously, the CC policy could only be effective in the long-run if it was accompanied by sensible price-wage decisions. We have simulated two types of the CC policy: passive (PCC) and active (ACC). In the first one, the planners intervened only to reduce the households' stock of money, without a further active price-wage and labour demand policy (this roughly corresponds to the currency change which took place in 1950). The second one consists in implementing the PWH(i?) simulation assumptions immediately after reducing the households' stock of money through the change currency. In both cases we have stated that the stock of money was reduced at the end of a five-year plan to a level of cash assets as held by households (as forced savings were kept mainly in banks in 1960-1980, it seems unlikely that a CC policy would have affected cash more than bank savings). We have also assumed that the change would have taken place either on the last day of 1970 (the PCC10 and ACC10 policies), or on the last day of 1975 (the PCC5 and ACC5 policies). In the first case, the stock of money was reduced by 70.9%, and in the second by 71.4%. The effects of the active and passive policies are shown in Table 5.7. It is clear that even such a strong passive policy would not have been the key to reducing shortages in goods and labour. The Keynesian unemployment regime would have been reached in the first year after the currency change had taken place. It would later have turned back to repressed inflation (with a short period of underemployment in the second year). Although consumption excess demand would have been smaller than the historical one for some first years after the change (namely for 1972-1977 in PCC10 and for 1977-1979 in PCC5), for later years the estimated excess demand would have been significantly greater. Since the CC policy is very hard and probably connected with

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TABLE 5.7

Excess demand under the currency change policies (in percentages of transacted quantities) Consumption Year

historical

PCC

Labour ACC

historical

PCC

ACC

1971-1980 (PCC10 and ACCIO) 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

5.8 8.1 9.3 10.3

9.3 8.5 7.7 6.5 6.8 7.7

-1.2

3.4 6.2 8.2 7.9 7.6 7.3 6.6 7.5 9.5

-8.0 -6.7 -5.2 -4.8 -3.6 -2.3 -1.6 -0.6

0.3 1.6 6.0 5.6 7.7 7.9 5.0 7.0

-6.2 -1.3

3.3 6.8

12.0 12.9

10.4

4.8 5.4 7.8 8.1 5.0 6.4 9.5

-6.7 -3.8 -1.1 -2.6 -0.4

0.7 -0.6

1.1 5.3 5.7

1976-1980 (PCC5 and ACC5) 1976 1977 1978 1979 1980

8.5 7.7 6.5 6.8 7.7

-4.0

0.5 2.5 5.0 8.0

-8.2 -5.0 -2.6

7.9 5.0 7.0

2.1 6.1

12.0 12.9

-1.0 -0.6

2.9 8.2 8.2

-3.4 -3.1 -0.5

4.3 5.1

great social discontent, the PCC policy should be regarded as ineffective. The results of the active experiments are not more favourable. The estimated consumption excess demand is reasonably smaller in its absolute values than the PCC one. However, unemployment would have lasted longer at a relatively high level. In ACC10 the unemployment ratio 6.7% for 1971 corresponds to over one million unemployed, and in ACC5 the figure 3.4% for 1976 stands for about 600,000 unemployed. The estimated labour/population ratio also increases up to 0.9 (for 1971 in ACC10; it exceeds 0.89 for 1972-1974 in ACC10, and for 1976 in ACC5). Negative labour excess demand coincides, in most cases, with negative consumption excess demand (which, as has been

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mentioned before, means a decrease in the volume of consumption). In the last two years of each policy the system would have returned to repressed inflation. In Section 5.1 we have described the possible effects of these policies on the change in the money velocity. The appropriate results are compared in Table 5.8. TABLE 5.8

Estimated velocity of money under the PW and CC policies Policies Year

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

historical 2.5 2.3 2.2 2.0 1.9 2.0 2.2 2.3 2.4 2.6

PWCB) and PWH(5)

PCC10

3.3 4.2 4.0 3.9 3.3 2.4 2.8 3.0 2.9 3.0

4.2 3.0 2.4 2.1 2.0 2.1 2.2 2.3 2.4 2.6

PCC5

— — — — 3.5 2.9 2.7 2.6 2.7

ACC10

ACC5

6.4 6.4 4.9 4.3 3.5 3.1 3.3 3.3 3.1 3.1

_ — — — — 4.2 4.1 3.7 3.2 3.1

It is interesting that the velocity for PW(#) is higher than the historical one, and even higher than the velocity received for the passive CC policies (with the exception of the first years after the currency change). This indicates that its long-run effect in reducing money stock would have prevailed, acting in the opposite direction. The short-run effect would have caused a decrease in velocity by decreasing households' incomes. This makes the PW(i?) policy more attractive in the long-run. The increase of velocity in the active CC policies is the highest, although once more with the exception of the first years after the currency reform. It is not substantially high when compared to the PW(i?) results. The long-run effects of the passive policies would have been insignificant; after 1976 the estimated velocity for PCC10 is practically the same as the historical one (a similar situation is observed for PCC5).

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103

This means that the households' money assets would have been rebuilt relatively quickly, and after two years (in PCC10), or three years (in PCC5), the level of forced savings would have been almost unaffected. In general, the ACC policy does not seem to be superior to the PWH(£) policy, which was implemented without the painful annihilation of the households' money assets. The comparison of the estimates of consumption excess demand (Tables 5.1 and 5.7), and labour excess demand (Tables 5.6 and 5.7) leads to the conclusion that it would have been better to avoid a change in currency at the beginning of the price-wage reform. The PWH(i?) policy would itself have been strong enough to reduce a substantial part of households' idle money. For 1971-1975 the PWH(2?) negative consumption excess demand is smaller, which in fact means a higher volume of consumption for households, since in all the experiments the consumption supply remains unchanged. For 1976-1978 the positive consumption excess demand in PWH(5) also corresponds with a higher consumption volume; in this case all the consumption supply is transferred to households. Only for the last two years of the period investigated would the situation on the consumption market have been favourable towards the ACC policy. For the labour market the comparison is not straightforward, although it still indicates that the PWH(2?) policy is superior. Unemployment would have been observed for only three years instead of six in ACC; furthermore, disequilibrium would have been substantially smaller for these three years.

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Chapter 6

SEARCHING FOR AN OPTIMAL MONETARY POLICY

6.1. Disequilibrium neutralization as an optimal control problem In Chapter 5 we analysed the impact of some a priori given changes in the levels of monetary variables (namely prices, wages and households' stock of money) on consumption and labour excess demand. The procedure applied was the following: firstly we fixed instrument variables on arbitrarily chosen levels (which, we believed, would have been better than the observed time paths of these variables in reducing excess demand), and secondly we simulated the impact of these variables on the targets (excess demands). In this chapter we analyse an inverse problem. Let us suppose that an aim of a more or less complex economic policy is to find the state of an economy which is as close as possible to equilibrium, and with transacted quantities as close as possible to the levels of demand. The crucial question of such a policy is: 'How large would the values of policy instruments have to be in order to achieve the desired levels?' In this study this question is called the disequilibrium neutralization problem (it is primarily analysed for the consumption market in Poland by Charemza and Gierusz (1980)). The simplest exercise of this type has already been shown in Chapter 4. If the examined model is of the type z?*

Cd = O · — , P where p* is a policy instrument variable, and a target is Cs which is to be fixed at a level of Cd, then p* = pB. As has been shown in Chapter

W. Charemza, M. Gronicki

106

5, even such a simple way of fixing 'better' prices than the observed ones would, in most cases, have led to an improvement in the market situation. For instance, if Cd > C s , then the balancing price must be greater than the observed one. Nevertheless, if the entire model is considered, a price which would have neutralized the market would, in some cases, have been lower than the observed one. If its shadow effect on labour supply was strong enough, its reduction would have caused a decrease in labour supply, which would in turn have helped to reduce consumption demand. Similarly, a decrease in wages would have decreased consumption demand, which would have increased labour supply through the spillover effect, and would also have improved the situation on the labour market (it is helpful to look on partial derivatives of consumption demand and labour supply functions in their linearized forms, as given in Tables 3.1-3.8). Consequently, the results of the neutralization of the entire model would have been different from the assumptions which act as a base for the PW experiments. However, the entire model is much bigger and more complicated. If we expressed the model as

y=

y(y-r,x,s),

where y and y_x represent sets of current and lagged target variables, x is a set of policy instruments and s stands for the remaining part of the model, our aim would be to find its solution x = x(yT,y~T,s), T (where y is a set of target values for y) simultaneously for all the years of the desired time interval. This solution usually does not exist; however, we are able to find an optimal value for x of a given objective function, maximized with the restrictions as imposed by the model. We have, therefore, regarded the disequilibrium neutralization as a special case of the optimal control problem. Much has been written on the general and specific topics of optimal control applications for the evaluations of economic policies (see Aoki (1976), Chow (1975), Friedman (1975), Hughes Hallett and Rees (1983), Pindyck (1973) and Theil (1964)). The basic problem is to define the objective function and to find a feasible numerical algorithm used for finding an optimum of this function. We have adopted the method

Searching for an optimal monetary policy

107

proposed by Hughes Hallett and Rees (1983). In general, it consists in minimizing a loss function Ψ = Ψ(ζ), (6.1) where z is a set of deviations of targets and instruments from its ideal and desired levels (e.g. y—yT and x—x*, where x* is a set of desired values of policy instruments) for all the years as covered by the time interval investigated. The function is minimized with the restrictions imposed by an econometric model given in a condensed form z = z(s).

(6.2)

The function (6.2) is usually complicated, since it includes impact and interim multipliers calculated for the considered time intervals. Hughes Hallett and Rees (1983) found a feasible algorithm for a linear dynamic model, where the loss function (6.1) is approximated by its quadratic form with a given weight. In calculations we have used a slightly modified original computer program, as described by Brandsma and Hughes Hallett (1982). The modifications have been made because the analysed model is nonlinear and particular impact and interim multipliers are usually not constant. Therefore we have to apply the linearized version of the model (see 3.4), with multipliers evaluated for the means of particular derivatives for eachfive-yearplan. As a result, we have received five separate linearized forms of the model, which have been used in succession while running the original program for subsequent five-year intervals. 6.2. Households9 optimal income and money policies In this section we attempt to evaluate a disequilibrium neutralization policy provided by central planners, by manipulating some households' income and money components. For the income components which are likely to be treated as policy instruments (e.g. which could, over a period of time, be changed by decisions independent of households) we have regarded prices (/?), non-labour incomes (NF), the allowed level of private investment (F, expressing state pressure on the expanding private sector), and credits advanced to the private sector (HC).

108

W. Charemza, M. Gronicki

It is important to note that wages are no longer treated as a policy instrument, but rather as a target. The reason for this lies in the substantial difference between the aims of the disequilibrium neutralization and simulation experiments. Through the former we have tried to find a set of policy instruments values which are close to a set generating an ideal state of the market. In the latter we have traced the impact of changes in some policy instruments on the market situation. Consequently, in the last section we should regard a more complex set of targets which would roughly correspond to the 'maximization of social needs fulfilment' principle of a socialist economy. If we regard the wages at a reasonable level as an additional target, we move somewhat closer to the principle. As has been mentioned in the previous section, dynamic optimal control experiments have been provided separately for the consecutive five-year plans (i.e. for 1961-1965, 1966-1970, 1971-1975, and 19761980). The experiments are denoted by Ej, where / is a number of the five-year period (e.g. / = 1 means 1961-1965), and j is the number of an experiment. Dropping the superscript ί shows a consideration of a>th experiment (and a policy) for the entire 1961-1980 period. In this section we have described two experiments E[ and E{ (i — 1, ..., 4). In Ex the set of target variables consists of two variables: consumption demand and supply, while in E2 we have added wages as an additional target variable. In both experiments the desired values of consumption demand and supply have been fixed on a par with Cd, as calculated from historical data (see Section 4.1), which correspond to a tendency of equilibrating the market at the highest possible level. In E2 for the target values of wages we have used their observed time paths. Similarly, actual data of the policy instruments have been applied as their desired values. In E1 we have used the full set of policy instrument variables; however, in E2 we have dropped credits advanced to the private sector, as it was shown in Ex that its target would always have been reached. We have used an identity matrix of weights in the minimized loss function, which in fact means that no additional 'penalties' have been assumed a priori when targets have not been reached. The results of the experiments are given in Tables 6.1-6.3, where the optimal values for Cd, Cs, NE, Fand/? are similar in both cases. Therefore,

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109

TABLE 6.1

Optimal values of targets and instruments in the experiment £Ί (in percentages of target and desired values) Year

Cd

σ

NF

V

P

HC

1961

101.3 100.8

97.2

108.9

86.4

97.0 96.7

115.7

78.2

103.7 102.9

100.0 100.0

110.7

85.6

101.6 99.8

97.0

108.9 115.4

79.6

101.8 102.3

100.0 100.0

75.0

104.3

100.0

1966

101.8

96.5

82.8

101.6 99.6

96.9 98.7

102.6 102.5

100.0

1967 1968

111.3 110.9

1969

100.0

1970

100.0

1971 1972

102.4 102.3

96.7

105.6

96.4

109.3

1973 1974

103.2 103.0

93.2 93.4

125.9

1975

100.9 102.3 101.2

93.1 94.1

13.9 52.3

105.2 104.3

100.0 100.0

112.6

74.1 81.4

105.5 104.1

100.0

96.1 101.7

100.9 96.0

106.6 109.4

100.0 100.0

1962 1963 1964 1965

1976 1977 1978 1979 1980

101.3

101.6 101.8 100.1

98.3

114.3

75.3 79.0

100.6

95.6

100.0

100.1

96.6 96.6 98.5 99.7

126.3 147.2 122.9 117.1

103.8

100.0 100.0

107.1

105.1

100.0

99.6 92.2

100.0 100.0

89.7

103.9 105.4 106.4

58.7 45.2

103.9 105.4

100.0 100.0 100.0

100.0

it is possible to conclude that the inclusion of wages into the set of targets in policy E2 has not substantially changed the optimal time paths of the other variables. It seems that despite fixing targets for consumption demand and supply at the same level, excess demand would still have dominated the market. However, the results given in Table 6.3 indicate that in general the demand would have been much smaller than the historical one. This can be shown more explicitly by comparing average excess demand estimates for particularfive-yearperiods. Appropriate quadratic means of excess demand estimates as expressed in percentages of transacted quantities are given (the means for historical estimates are given in brackets) : 1961-1965: for ^—4.0, for £2—2.6 (5.3),

W. Charemza, M. Gronicki

110

TABLE 6.2

Optimal values of targets and instruments in the experiment E2 (in percentages of target and desired values) Year

Cd

σ

w

1961 1962

101.2 101.0

98.8

94.0

96.7

1963

100.9

97.1 97.8

98.2 113.0

111.6 108.5

1964 1965

99.9

98.8

115.5 100.4

110.2

99.5

1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

100.0

99.9

101.7 101.6 100.1 100.0

96.6 96.7 98.2 99.8

100.0

100.0

102.4 102.4 102.8 103.0

96.7

100.9 103.0 101.3 101.6 101.8

93.0 94.1

100.2

99.6

92.9 93.7 93.8

96.5 96.6 98.5

100.2 116.4 102.7 100.0 100.5 104.5 101.4 99.5 98.5 102.6 93.9 97.2 92.5 83.1

NF

V

P

105.3 81.5

98.0 97.1

82.6 83.8

102.3 104.2

100.8

98.7

106.2

111.9 111.6 113.2 101.6

82.8

101.9 102.4

100.0 105.5 135.9 125.9 123.1 147.6 123.0 117.4 112.5 96.1 101.4

77.4 78.1 97.8 100.0 91.8 43.0 60.4 50.6 12.9 52.1 73.7 81.5 101.2 96.6

103.3 104.1 104.0 103.5 102.9 104.5 106.0 105.1 104.3 105.3 104.1 106.5 109.4

1966-1970:for ^—3.3, for E2—3.4 (4.4), 1971-1975 : for E1—S.5, for E2—9.0 (8.9), 1976-1980: for Ex—5.2, for E2—5.5 (7.5). These results indicate that only in the case of E2, implemented for 1971-1975, would the neutralization policy have not led to a decrease in consumption excess demand. The results of E1 and E2 also seem to be better than those reached in PW(5). For 1961-1975, while negative excess demand is estimated for PW(i?), E1 and E2 indicate higher consumption volumes. The results of neutralization policies are relatively worse for 1976-1980, but much better for the last two years of the period investigated. It is interesting to compare optimal prices and wages with the bal-

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111

TABLE 6.3

Historical and optimal consumption excess demand (experiments EL and E2) (in percentages of transacted quantities) Year 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Historical

6.2 5.7 4.4 4.8 5.0 5.5 5.1 4.5 3.5 2.8 5.8 8.1 9.3

El

E2

4.2 3.9 4.8 4.8 1.5 5.5 4.9 0.9

2.4 4.0 3.2 1.1 0.1 5.3 5.1 1.9 0.2 0.0 5.9

-0.6

0.0 5.9 6.1

10.3

10.7 10.3

9.3 8.5 7.7 6.5 6.8 7.7

8.4 8.7 4.8 5.2 3.4 0.4

10.2

9.7 9.8 8.5 9.5 5.0 5.2 3.4 0.6

ancing ones. According to their definition, given in Section 4.2, they should be regarded as static marginal (e.g. under the assumption that demand remains unelastic) optimal prices (wages) for separate consumption and labour markets. If there are no spillover and shadow effects, the optimal prices would not be greater than pB. In fact, the estimated optimal prices are, in most cases, lower than the balancing ones (with the exception of 1969-1970 and 1980 for El9 and 1965, 1969-1970 and 1980 for E2). The wage neutralization policy would have been slightly more severe for households than the PW(5) policy. With the exception of five years (1963, 1964, 1968, 1971, 1972) the estimated optimal wages are below the balancing ones. However, with the exception of 1980, they are relatively close to observed wages and, as can be seen from Table 6.2, they even exceed them in several cases.

112

W. Charemza, M. Gronicki

The evaluated optimal paths of the remaining policy instrument variables (non-labour incomes, investment in the private sector and credits advanced to households) look somewhat ambiguous. In particular, low estimates of private investments seem to contradict the widespread opinion that enlarging economic activity in the private sector would improve Poland's economic situation. It also contradicts the short-run analysis of derivatives of consumption demand subject to V; if V increases, households' incomes decrease, which would lower consumption demand. However, the estimated results show that in the case of the neutralization policies such an increase would not have been necessary. Obviously, the above conclusion is only valid with the assumption of fixed production output. ^11 the investments are wasted if the volume of consumption supply remains unchanged. In fact, private investment does increase output (especially of consumption goods) in a long-run, and considering it would lead to different conclusions (see Chapter 7). The optimal time paths for non-labour income are easier to interpret. The estimates are usually greater than the corresponding desired values. The dispersion of the optimal NF as expressed in percentages of observed NF is relatively high. It is worth comparing the optimal time paths of non-labour income and wages in E2. For all the years, with the exception of two (1961 and 1979), a fall in optimal wages below their observed level corresponds with an increase in NF above its observed level. This suggests that a possible increase of non-labour income would have been a convenient substitute for decreasing households' labour income caused by a reduction in wages. In conclusion, Et and E2 are simple deflationary policies which consist in keeping a rate of wage growth lower than prices, together with flexible managing of non-labour incomes and credits. For the condensed measure of these policies' 'costs', as implemented for particular five-year plans, we have used values of the quadratic approximation of loss function (6.1). The computed values of this loss function are as. follows : 1961-1965: Ψ = 2,707 for Ex 1966-1970: Ψ = 1,966 for E±

and Ψ = 1,801 for E29 and Ψ = 2,105 for E2,

Searching for an optimal monetary policy

1971-1975: Ψ = 16,331 for Et 1976-1980: Ψ = 4,573 for E,

113

and Ψ = 20,046 for E2, and Ψ = 5,012 for E2.

These values show that the 'cost' of implementing a neutralization policy would have been smaller for the first five-year period under investigation. In other words, the neutralization of consumption excess demand would have required in total the slightest changes in time paths of targets and instruments. The largest 'costs' would have occurred in the third five-year plan. However, although the optimal time paths are similar for both policies, the computed values of the loss function indicate the superiority of Et rather than E2 ; the latter is, with the exception of 1961-1965, less 'costly'. 6.3. Optimal policies and plans So far, we have not considered consumption plans, stating that these plans should be regarded as the 'soft' constraints, without a significant influence on consumption demand or supply (see Section 2.3). In this section we have analysed some hypothetical planners' efforts to make consumption plans harder. In particular, we have tried to answer the question: 'What would have happened if consumption plans were regarded as target values for consumption demand and supply in a disequilibrium neutralization policy?' The main difference between the neutralization assumptions as applied in the previous and present section lies in the way households' and planners' preferences are regarded. In El and E2 households' preferences were treated as superior in the sense that appropriate targets were fixed on their historical levels, whereas here we have treated the planners' preferences as superior. It is clear that usually the households' and planners' preferences would not be identical. As consumption is 'residual' for the planners, consumption plans would, in general, be lower than households' consumption demand. We have presented the results of two further optimal control experiments, denoted by E3 and £ 4 . As before, Cd, Cs and w are targets, and NF, V and p are instruments. In both cases the target values of w have been fixed on its observed levels. In E3 the target time paths

114

W. Charemza, M. Gronicki

for Cd and Cs are equal to a time path of annual consumption plans, expressed in prices appropriate for the year when the plan was postulated. In E4. the target values for Cd and Cs are the five-year rather than the annual plans. Since the five-year plans have been announced mainly by quoting a planned five-year rate of growth subject to the last year of a preceding five-year period, we have to compute appropriate figures for each year. We have done this by calculating the annual average planned rate of growth and by upgrading the base from year to year (i.e. the observed consumption for the last year of the previous plan). The upgraded variable has been given in constant prices, then converted again into a current-price variable in the last step of the procedure. It must be stressed, however, that figures computed in this way are usually lower than the corresponding one-year plan figures. More precisely, they were greater than the one-year plan figures for only 1964-1966, 1971 and 1979-1980. The results of the E3 and E± experiments are given in Tables 6.4, 6.5 and 6.6 (as before, the desired values for the policy instrument variables have been fixed at their historical levels). The disclosed figures seem to be different in various respects from those derived in Et and E2. In particular, the estimated optimal demand and supply values would have been much closer to their target values. As has been shown in Table 6.6, consumption excess demand would, as a result, have been smaller than the historical demand, and smaller than the demand which is simulated in Ex and E2 (the only exception is 1972 for £3). The estimated negative excess demand values are very small and should in practice be regarded as equilibrium figures. The positive excess demand estimates prevail, although they are reasonably small; they would have exceeded 5% for only two years of the E3 policy. Therefore, from the point of view of the minimization of consumption excess demand the £4 policy is ideal, and E3 is close to the ideal. However, the outlook is not so optimistic if we consider other target and instrument variables. First of all, it is evident that the price-wage policy would, in that case, have been quite different from the policy as derived for Et and E2. According to E3 and £ 4 , wages and prices are to be kept on a relatively low level. Since the optimal non-labour incomes are, in general, to be lower than those calculated for Ex

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115

TABLE 6.4

Optimal values of targets and instruments in the experiment E3 (in percentages of target and desired values) Year

Cd

σ

1961 1962 1963

101.0

102.4

98.2

80.1

100.5 100.6

100.1 100.2

98.4

1964 1965

100.8 100.2

100.0 100.0

102.8 100.1

102.6 100.6 101.1

1966 1967

100.7

99.7

91.5

100.5

1968

100.0 100.0

98.8 99.5

93.3 103.5

100.0 100.0 100.6

100.9 100.0

100.4 100.0

87.6 135.5

92.3 135.2

89.1 87.1 93.0

112.2

104.2

110.1 106.7 111.7

1969 1970 1971 1972 1973 1974

100.0 100.5 101.6 101.2 101.1 100.7

93.2 97.0 96.8

w

93.4

1975 1976

101.5

1977

101.1 100.7 100.6

97.9 97.6

89.2

1978 1979 1980

100.6

99.9

100.9

84.1 79.2

99.5 97.1

92.2

NF

V

P

122.4 101.4

99.6 98.8 99.1

99.8

101.8

100.0 98.7

95.7 104.8

105.9 91.6

103.3

94.6 99.6 100.0 116.0

115.3 133.4

40.3 80.1 71.2 38.7 80.7 87.7

91.9

81.7 112.9

94.9

112.1

99.8 100.1 98.6 97.8 98.2 100.2 99.5 98.6 92.2 98.9 99.7 94.1 98.8 96.8 101.3 102.1 103.0

and E2 (but in most cases still higher than the observed ones), it is clear that these policies would have led to a substantial decrease in households' money assets. In other words, harder consumption planning would have corresponded to a lower inflation rate and to a stricter monetary policy consisting of some rationing of the money supply. It is interesting that these policies are connected with relatively greater freedom for private activities (as expressed by the private investment level), although the freedom is not as great as the historical one. It seems that the main shortcoming of the E3 and E± policies is in keeping a low level of wages. A decrease in nominal wages would, in some cases, have exceeded 15%, which would hardly have been accepted in reality. Moreover, for E4 (which is the best from the point of view

W. Charemza, M. Gronicki

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TABLE 6.5

Optimal values of targets and instruments in the experiment £4 (in percentages of target and desired values) Year

Cd

σ

w

NF

V

P

100.7

102.0

98.7

100.1 100.4

99.4 99.5

98.5

79.0 104.1

128.1 102.6

98.9 98.4

91.6

101.1

1964 1965

100.5

99.8

101.0

100.8 99.7

100.0

100.0

99.7

104.6 100.2

102.8

96.8

99.7

1966 1967

100.6 99.9 99.9 100.0

99.7

91.4

96.4

99.6

91.0

98.6 97.6

100.4 100.2

87.4 98.6

105.0 98.9

102.4 92.6 102.4 102.7

96.0

98.4

100.0

100.0

100.0

100.0

100.0

95.8

100.6 100.5 100.1

99.7

89.8

96.9

97.8 98.5

89.6

110.8 108.3

104.3 80.3 82.6

99.2

99.3

101.4 95.2 92.9 90.0

100.4 100.9 100.2 100.7

96.1

1961 1962 1963

1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

101.2 101.1

83.2 77.4

111.3

98.6

88.3 85.7

121.2 102.3

98.9 98.1 99.7 100.2

84.7 90.6 87.6 81.5

106.1 108.1 91.7 98.7

84.3 61.1 92.8 91.9 89.9 111.0 102.6

98.6

96.4

85.5 96.0 94.4 97.7 102.2 106.6

of consumption excess demand minimization), optimal wages are usually even lower than for the 'second best' E3. In general, the comparison of E3 and i?4 confirms the suggestion put forward in Section 4.3, thatfive-yearplanning would have been regarded as superior to annual planning in the minimization of consumption excess demand. It would appear that providing a policy according to five-year plans not only reduces planning distance errors, but is also more effective in disequilibrium neutralization. Nevertheless, the plans must be hard. As has been mentioned previously, it is not our intention to find out whether the harder planning would have been possible in 1961-1980. It is clear, however, that harder consumption planning has to be the result of better financial practice, improved work organization, and possibly substantial changes in administration.

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117

TABLE 6.6

Historical and optimal consumption excess demand (experiments E3 and E*) (in percentages of transacted quantities) Year 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Historical

6.2 5.7 4.4 4.8 5.0 5.5 5.1 4.5 3.5 2.8 5.8 8.1 9.3 10.3

9.3 8.5 7.7 6.5 6.8 7.7

E3

£4

-1.4

-1.3

0.4 0.4 0.8 0.2 1.0 1.7 0.5 0.0 0.0

0.7 0.9 0.7 0.3 0.9 0.3

-0.1

9.0 4.3 4.4 6.6 4.5 3.3 3.2 0.0 -1.0

-0.5 -0.2

0.0 0.9 2.8 1.6 -0.1

4.5 2.3 1.3 2.7 1.5 -0.1

It would be worthwhile to compare the consumption plans and realizations in the historical and the E3, E± policies (Table 6.7). As consumption is evaluated in comparable prices in these policies, it is possible to find out whether a policy would have led to a decrease in the households' consumption volume. In particular, if the historical plan is overfulfiled for a given year and simultaneously a plan evaluated in a neutralization experiment is not fulfiled or fulfiled by a smaller amount, this means that the neutralization policy would have caused a decrease in the volume of consumption. In Table 6.7 it has been shown that a decrease in the volume of consumption (although relatively small) would have been permanent for EA and frequent for E3. In 2s4, where plans would have been underfulfiled for most years,

W. Charemza, M. Gronicki

118

TABLE 6.7

Deviations from consumption plans (historical and calculated for E3, E± in percentages of planned values) Year 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

Annual plans

Five-year plans

historical

£3

historical

3.5 -2.1 1.3 1.5 2.2 1.6 2.1 2.1 -0.8 1.1 3.2 5.2 0.1 -1.0 2.2 0.9 2.5 -2.6 -0.3 -0.4

2.4 0.1 0.2 0.0 0.0 -0.3 -1.2 -0.5 0.0 0.0 0.6 -6.8 -3.0 -3.2 -0.5 -2.9 -2.1 -2.4 0.6 0.9

4.4 2.4 1.8 0.2 1.4 1.4 2.9 5.2 4.4 4.7 0.6 6.2 8.4 9.0 12.7 5.8 6.5 1.7 -1.1 -4.4

E* 2.0 -0.6 -0.5 -0.2 -0.3 -0.3 -0.4 0.4 0.2 0.0 -0.3 -2.2 -1.5 -0.7 -3.9 -1.4 -1.1 -1.9 -0.3 0.2

the decrease in consumption volume is estimated for the entire 1961-1980 period. In E3> where plans would have been fulfiled more frequently, the consumption volume would not have decreased in 1961-1968 (with the exception of 1962) and in 1979-1980. It follows that these policies should be relatively less 'costly', since the distances to targets are smaller. Indeed, for all the five-year planning periods the values of the loss function for E3, Ε^ are below the corresponding E1 and E2 figures : 1961-1965: Ψ = 981 for E3 and Ψ = 1,382 for E4, 1966-1970: Ψ = 330 for E3 and Ψ = 486 for £ 4 ,

Searching for an optimal monetary policy

119

1971-1975: Ψ = 13,549 for E3 and Ψ = 4,793 for £ 4 , 1976-1980: Ψ = 2,478 for E3 and Ψ = 1,660 for £ 4 . The distribution of 'costs' over the five-year plan intervals is similar for all the compared policies; the most 'costly' (i.e. with the longest distance to targets) are E3 and EA in the third period, 1971-1975, followed by the last 1976-1980 period. The policy EA is generally less 'expensive', although in the sixties it would have been more difficult to implement. For the most 'expensive' 1971-1975 five years, the 'cost' of E3 would have been several times smaller than for the remaining neutralization policies. Disequilibrium neutralization policies connected with harder consumption planning look somewhat similar to the policies provided in CPE countries in the fifties. A strict plan-adjustment discipline (not necessarily connected with plan fulfilment), low prices, low wages, a low consumption level, and some margin for private activity, provide the general outlook. As these policies were not approved in practice (mainly for social reasons), it seems unlikely that they could have been an important alternative to PW(2?), if they had been implemented in the sixties and seventies. They do, however, have one strong point—they show the stimulating role of (sensible) planning in the consumption market organization.

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PART 3

EXTENSIONS

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Chapter 7

DISEQUILIBRIA AND INVESTMENTS: SOME INWARD POLICIES

7.7. Production and investments: First extension of the model The policy experiments analysed in Chapters 5 and 6 are, according to the terminology introduced in Section 5.1, 'outward' for planners. These policies do not require the real efforts on the state side, but delivery of more or less money and ordering of lower or higher prices and wages. Consequently, in all these cases the volume of consumption supply remains unchanged. The value of consumption supply would fluctuate according to fluctuations of consumers' prices. Neither a better organization nor changes in the amount and structure of investment outlays have been assumed. Moreover, in the PW policies we have deliberately ignored (since we have traced only the monetary aspects of these policies) a possible impact of increasing labour supply on production output and indirectly on consumption supply. In other words, all the components of the consumption supply identity (excluding prices) have been identical for all cases. It seems to be interesting to examine more inward policies as well. In particular, it appears that it would have been possible to implement a somewhat smoother investment-production scheme by getting rid of some exo- and endogenous bottlenecks, which possibly caused delays, inefBciency and the 'locking-up' of investments. Moreover, the production-stimulating effects of the PW policies could also be evaluated. Finally, a long-established question in CPE's about the 'best' division between consumption and investments could be recon-

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sidered: 'Would a decrease in investment expenditures have prevented the consumption market from collapsing?' For these purposes we require a larger model than used previously. We have decided to enlarge the existing model consisting, after estimation, of equations (3.36a)-(3.46) by adding a corresponding production-investment block. It is linked with the consumption-labourmoney section through the consumption supply identity (3.41). Let us re-write this identity again

Cslp = XD +

BT-I-G-S.

Previously the variables representing total final domestic expenditures (XD) and total investment expenditures (/) have been regarded as extraneous, together with a balance of trade (BT), government spendings (G) and changes in stock level (5). In the present chapter we have dropped the assumption about the extraneous character of the first two of these variables (the balance of trade is considered as endogenous in the next chapter). The total final domestic expenditures correspond, according to their definition (see Appendix), to the total output as derived from the internal sources. It is described by a Barro-Grossman type production function (Barro and Grossman (1976)), modified by direct exploitation of assumption of the positive labour excess demand. The original BarroGrossman production function could be expressed as XD = XD(Ld9K,G)9

(+) (+) (+)

where K stands for capital (or, as in our case, for the level of fixed assets). The positive derivative of XD subject to G expresses the aim of the government to intervene in a positive way in the production process by exogenous stimulation of managerial and technological progress. Since, in repressed inflation, Ld is unobservable, it seems to be reasonable to separate the unobserved from the observed part of labour by modifying the production function in the form XD = XD(Ls9Ld-Ls9K,

G9)9

if Ld > ΖΛ

(7.1)

In this case the labour excess demand represents another type of stimulation of technical progress connected with a forced substitution

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of labour by innovations implemented by production enterprises because of labour shortages. To summarize, the technological progress as expressed by G is of an exogenous (to enterprises) nature, while the technological progress as produced by labour excess demand is endogenously generated. For estimation purposes we have stated that (7.1) has a linear form and the first derivatives of XD subject to U and (Ld — Ls) are identical (the latter assumption is further relaxed in simulation exercises). Moreover, a dummy variable Z4 is added (Z4 = 1 for 1980 and zero otherwise) for marking the first year of the collapse of domestic production growth due to the social and economic crisis. Consequently, the XD equation is estimated in the form XD =