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3SMALL DSGE MODEL FOR UZBEKISTAN ECONOMY
Utkirbek Azimov
"ANOR BANK" JSC, Head of the Corporate Sales and Affiliate Program
Unit
https://doi.org/10.5281/zenodo.13842461
ARTICLE INFO
ABSTRACT
Received: 19th September 2024
This study develops a small Dynamic Stochastic General
Accepted: 25th September 2024 Equilibrium (DSGE) model tailored to the Uzbekistan
Introduction
Uzbekistan, a Central Asian nation with abundant natural resources, has experienced rapid economic growth in recent years. The country's strategic focus on sectors such as cotton and gold, coupled with substantial capital inflows, has positioned it as a significant player in the regional economy. Understanding the macroeconomic dynamics of Uzbekistan is crucial for policymakers aiming to sustain growth, manage inflation, and navigate external shocks.
Dynamic Stochastic General Equilibrium (DSGE) models have become essential tools in macroeconomic analysis, offering a framework to evaluate policy impacts and forecast economic variables under uncertainty. While extensive DSGE modeling has been conducted for advanced economies, there is a paucity of such models tailored to emerging economies like Uzbekistan, which have unique structural characteristics and external dependencies.
This paper develops a small DSGE model specifically designed for the Uzbekistan economy, expanding on previous work by incorporating the following key elements: 1. Integration of the cotton and gold sectors to reflect the country's traditional export composition.
Online: 26th September 2024 KEYWORDS
economy, incorporating key external factors such as the cotton and gold sectors. Recognizing Uzbekistan's rapid economic growth and significant capital inflows, the model integrates these dynamics to analyze macroeconomic policies and external shocks. Calibration of the model parameters is based on the latest available data, and simulations are conducted to assess the impact of various economic policies. The results indicate that capital inflows significantly influence output and investment, while shocks to the cotton and gold sectors have substantial effects on employment and inflation. This research contributes to the understanding of Uzbekistan's macroeconomic framework and offers policy recommendations to sustain its growth trajectory.
DSGE model, Uzbekistan economy, capital inflows, cotton sector, gold sector,
macroeconomic policy.
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2. Inclusion of the growing services sector to capture the ongoing economic diversification.
3. Modeling of significant capital inflows that influence investment and consumption patterns.
4. Incorporation of monetary policy dynamics, including the central bank's evolving approach to inflation targeting.
5. Consideration of fiscal policy measures, including those aimed at supporting economic reforms.
By calibrating the model using recent economic data and employing Bayesian estimation techniques, this study aims to provide insights into the effects of fiscal and monetary policies, as well as external shocks on Uzbekistan's macroeconomic stability. The model's enhanced structure allows for a more nuanced analysis of sectoral interdependencies and their impact on overall economic performance. Model Structure
The DSGE model developed for Uzbekistan includes the following key components:
1. Households: Represented by a representative agent who maximizes utility over consumption and leisure. Households supply labor to different sectors (cotton, gold, and services) and save by holding government bonds and foreign assets.
2. Firms: It's a simplified model of Uzbekistan economics, comprising three main sectors— cotton, gold, and services. Each sector employs labor and capital to produce goods or services, contributing to the GDP.
3. Government: Implements fiscal and monetary policies, including taxation, government spending, and setting interest rates. The fiscal authority also manages resource revenues from the gold sector.
4. Central Bank: Conducts monetary policy, gradually moving towards an inflationtargeting framework while managing exchange rate stability.
5. External Sector: Captures exports from the cotton and gold sectors, which are subject to global price fluctuations and demand shocks. It also models capital inflows and their impact on the domestic economy.
6. Financial Intermediaries: Facilitate the flow of capital between households, firms, and foreign investors, subject to financial frictions.
Methodology Calibration
Model parameters are calibrated using Uzbekistan's economic data from the World Bank, International Monetary Fund (IMF), and national statistical agencies. Key parameters include:
• Preference Parameters (a, p): Representing the elasticity of intertemporal substitution and the discount factor.
• Production Functions: Cobb-Douglas specifications for cotton and gold sectors with calibrated capital and labor shares.
• Technology Shocks: Variance parameters for productivity shocks in each sector.
• Policy Parameters: Interest rate rules and government spending multipliers. Table 1 provides a summary of the calibrated parameters used in the model. Table 1: Calibrated Parameters for the Uzbekistan DSGE Model
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Parameter Description Value Source
a Elasticity of intertemporal substitution 1.2 World Bank (2023)
P Discount factor 0.985 IMF Country Report (2023)1
6 (Capital, Cotton) Capital share in cotton production 0.38 State Committee of Uzbekistan (2023)
6 (Labor, Cotton) Labor share in cotton production 0.62 State Committee of Uzbekistan (2023)
6 (Capital, Gold) Capital share in gold production 0.45 Estimated from data from State Committee of Uzbekistan (2023)
6 (Labor, Gold) Labor share in gold production 0.55 Estimated from data from State Committee of Uzbekistan (2023)
$ Central bank's interest rate reaction 1.8 Central Bank of Uzbekistan (2023)
CT Standard deviation of technology shocks 0.018 Smets & Wouters (2007)2
S Capital depreciation rate 0.06 World Bank (2023)
Y Capital inflow elasticity 0.12 Estimated from FDI data
Model Equations
Model equations are derived from simplistic DSGE model.3
1. Household Optimization:
Subject to:
2. Production Functions: o Cotton Sector:
o Gold Sector:
3. Government Budget Constraint:
4. Monetary Policy Rule:
1 International Monetary Fund. Middle East and Central Asia Dept. "Republic of Uzbekistan: 2024 Article IV Consultation-Press Release; and Staff Report", IMF Staff Country Reports 2024, 210 (2024), accessed September 25, 2024, https://doi.org/10.5089/9798400281686.002
2 Smets, F., & Wouters, R. (2007). Shocks and Frictions in US Business Cycles: A DSGE Approach. European Economic Review, 51(6), 1175-1205
3 Adolfson M., Laseen S., Linde J., Villani M. (2007) Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-through. Journal of International Economics, no 72 (2), pp. 481-511.
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Vt = n-i + (!-)(* + yyt)+\
5. Capital Inflow Dynamics:
Where represents foreign capital inflows Simulation Scenarios
We conduct several simulation scenarios to analyze the model's behavior and policy implications:
1. Monetary Policy Shocks: Variations in interest rates set by the central bank.
2. Fiscal Policy Shocks: Changes in government spending and taxation, including resource revenue management.
3. External Shocks: Fluctuations in global cotton and gold prices, as well as changes in foreign demand.
4. Productivity Shocks: Sector-specific productivity changes, particularly in the emerging services sector.
5. Capital Flow Shocks: Sudden increases or decreases in foreign capital inflows. Data Sources
The model utilizes data from the following sources:
• World Bank: National accounts and capital flow statistics.
• International Monetary Fund (IMF): Policy rates and external sector data.
• State Committee of the Republic of Uzbekistan on Statistics: Sector-specific outputs, employment, and prices.
• Central Bank of Uzbekistan. Central Bank publishes monthly, quarterly and yearly reports for monetary policy of the country.
Results and Discussion Steady-State Analysis
The calibration and estimation yield a steady-state output level consistent with Uzbekistan's recent GDP data, reflecting the balanced growth path. The contributions of the cotton, gold, and services sectors to GDP are assumed to be equal 25%, 15%, and 35% respectively, with capital inflows accounting for 20% of total investment. In order to construct small model we can use this approximate values in our research.
Figure 1 illustrates the steady-state paths of output, consumption, investment, and government spending.
Figure 1: Steady-State Paths of Key Economic Variables
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Impulse Response Analysis
Impulse response analysis reveals the dynamic responses of the economy to various shocks:
1. Monetary Policy Shock: An increase in interest rates leads to a short-term decline in investment and output, with inflation decreasing over time. The services sector shows a more pronounced response compared to the traditional cotton and gold sectors.
2. Fiscal Policy Shock: An increase in government spending boosts output and employment but may lead to higher inflation if financed through domestic borrowing or monetization.
3. External Price Shocks: A decline in global cotton or gold prices reduces export revenues, leading to lower GDP and increased unemployment. The model captures the spillover effects to the services sector through reduced domestic demand.
4. Productivity Shock in Services Sector: A positive productivity shock in the services sector leads to increased output and employment in that sector, with positive spillovers to the rest of the economy.
5. Capital Flow Shock: A surge in capital inflows enhances investment and consumption, fostering higher economic growth. However, it also poses risks of overheating and real exchange rate appreciation, potentially undermining the competitiveness of the tradable sectors.
Figure 2 displays the impulse response of output to a monetary policy shock.
Impulse Response of Output to Monetary Policy Shock
0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5 20.0
Quarters
Figure 2: Impulse Response of Output to Monetary Policy Shock Policy Simulations
Simulating different policy scenarios provides insights into optimal policy design:
1. Gradual Transition to Inflation Targeting: The model suggests that a gradual approach to adopting full-fledged inflation targeting, while maintaining some focus on exchange rate stability, can help anchor inflation expectations without causing excessive output volatility.
2. Countercyclical Fiscal Policy: Implementing countercyclical fiscal measures, particularly during commodity price downturns, can help stabilize output and employment.
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3. Financial Sector Development: Policies aimed at reducing financial frictions and deepening the domestic financial market can enhance the effectiveness of monetary policy transmission and improve the allocation of capital inflows.
4. Economic Diversification: Continued support for the development of the services sector can help reduce the economy's vulnerability to commodity price shocks and provide new sources of growth and employment.
Table 2 compares the effects of conservative fiscal policy versus active monetary policy on key economic indicators.
Table 2: Effects of Policy Scenarios on Economic Indicators Indicator Conservative Fiscal Policy Active Monetary Policy
GDP Growth (%) 5,0 5,2
Inflation (%) 4,5 3,8
Unemployment (%) 6,0 5,5
Investment (%) 25,0 26,5
Sensitivity Analysis
Impulse Response Function (IRF) shows how the endogenous variables in the model respond over time to a one-time shock to an exogenous variable or structural disturbance.
Figure 3. Impulse response functions to a one-time shock.
The sensitivity of the model to parameter changes highlights the robustness of the results. Varying the elasticity of capital inflows (y) from 0.05 to 0.15 shows that higher sensitivity leads to more pronounced effects on investment and GDP.
Figure 3 illustrates the sensitivity of GDP growth to changes in capital inflow elasticity.
g,0
o o
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Sensitivity of GDP Growth to Capital Inflow Elasticity
Baseline Seena / • rio • • • • •• • • •
■ • • ••x *«
• • • fe r ■ ■ • • • •
• • • • • • A • • •
■ • •
• ^^ • • • •
Capital Inflow Elasticity (y)
Figure 3: Sensitivity of GDP Growth to Capital Inflow Elasticity
Discussion
The DSGE model for Uzbekistan captures the intricate interplay between key sectors and external factors influencing the economy. The inclusion of the cotton and gold sectors is pivotal, as they represent significant export components subject to global price volatility. The model's sensitivity to capital inflows underscores the importance of maintaining a stable investment environment to foster sustainable growth. Implications for Policy
1. Monetary Policy: The central bank should adopt a flexible interest rate policy to respond swiftly to external shocks, particularly those affecting export prices and capital flows. This approach can help stabilize output and control inflation.
2. Fiscal Policy: Prudently managed government spending is essential. While increased government expenditure can stimulate demand, it must be balanced to prevent overheating, especially in the presence of substantial capital inflows.
3. Diversification: Reducing dependence on cotton and gold by diversifying the export base can mitigate vulnerabilities to sector-specific shocks. Encouraging growth in other industries can enhance economic resilience.
4. Capital Flow Management: Implementing measures to regulate capital inflows can prevent excessive volatility. Tools such as macroprudential policies and capital controls may be considered to manage the pace and composition of foreign investment.
Model Limitations and Future Research
While the model provides valuable insights, certain limitations must be acknowledged:
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1. Simplified Sectoral Representation: Although we include three key sectors, the model still abstracts from the full complexity of Uzbekistan's economic structure.
2. Limited Treatment of Informality: The large informal sector in Uzbekistan is not explicitly modeled, which may affect the transmission of shocks and policies.
3. Assumption of Perfect Information: The model assumes that agents have perfect information, which may not fully capture the uncertainty faced by economic actors in a transitioning economy.
Future research could address these limitations by:
1. Incorporating a more detailed sectoral breakdown, including manufacturing and agriculture.
2. Explicitly modeling the informal sector and its interactions with the formal economy.
3. Introducing information frictions and learning dynamics to better capture the evolving nature of Uzbekistan's economy.
4. Extending the model to a multi-country framework to analyze regional economic interactions in Central Asia.
Conclusion
This paper presents a small DSGE model tailored to the Uzbekistan economy, integrating key external factors such as the cotton and gold sectors alongside significant capital inflows. The model effectively captures the dynamic interactions between these sectors and macroeconomic variables, providing valuable insights into the impacts of various shocks and policy measures. The findings underscore the importance of flexible monetary policies, prudent fiscal management, and economic diversification in sustaining Uzbekistan's rapid growth. Future enhancements to the model could incorporate additional sectors and agent heterogeneity to further refine policy recommendations. Appendices
Figure A1: Impulse Response of Inflation to External Price Shocks
Impulse Response of Inflation to External Price Shocks
\ \ X
\ \ \
\ V X \
1 k N. "là. i
"■""■A,.
10.0 Quarters
Figure A2: GDP Growth forecast according to our model
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Figure A4. Monetary Policy trade-off analysis for Uzbekistan economy
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References:
1. Adolfson M., Laseen S., Linde J., Villani M. (2007) Bayesian Estimation of an Open Economy DSGE Model with Incomplete Pass-through. Journal of International Economics, no 72 (2), pp. 481-511.
2. Smets, F., & Wouters, R. (2007). Shocks and Frictions in US Business Cycles: A DSGE Approach. European Economic Review, 51(6), 1175-1205.
3. International Monetary Fund. Middle East and Central Asia Dept. "Republic of Uzbekistan: 2024 Article IV Consultation-Press Release; and Staff Report", IMF Staff Country Reports 2024, 210 (2024), accessed September 25, 2024, https://doi.org/10.5089/9798400281686.002
4. Christiano, L. J., Eichenbaum, M., & Evans, C. L. (2005). Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy. Journal of Political Economy, 113(1), 1-45.
5. Ravn, M., & Uhlig H. (2002). What Have We Learned from the New Keynesian Phillips Curve? In Handbook of Macroeconomics, Vol. 1, 1411-1479.
6. World Bank. (2023). World Development Indicators: Uzbekistan. Retrieved from https://databank.worldbank.org/source/world-development-indicators
7. State Committee of the Republic of Uzbekistan on Statistics. (2023). Statistical Yearbook. Retrieved from http://www.stat.uz/en/
