Economic Models - Convex Optimization

Time Varying Responses 51
assistance which is an insignificant feature, FB is the total foreign borrowing,
assuming only the government can borrow from foreign sources.
We assume AF and LR as exogenous, whereas FB, G, and TY as policy
instruments. However, PF depends on the level of existing foreign debt and
the world interest rate, although a sizable part of the foreign borrowing can
be at a concessional rate
PF t = a 4 + a 5
t∑
r=−20
( ) WIR
FB r + a 6 .
EXR t
Government bond sales (GBS) depends on its attractiveness reflected on
the interest rate (IR), on the ability of the domestic economy to absorb (A)
on the requirements of the government (G) and on the alternative sources of
finances reflected on the tax revenue (TY) and on government’s borrowing
from the central bank i.e., the net domestic asset (NDA) creation by the
central bank.
GBS t = a 7 + a 8 A t + a 9 IR t + a 10 G t − a 11 TY t − a 12 NDA t
3.2. Monetary Sector
We assume the flow equilibrium in the money market, i.e.,
MD t = M t = MS t
where MD is the money demand and MS is the money supply. The stock
of money supply depends on the stock of high powered money and the
money-multiplier, as follows:
MS t = [(1 + CD)/(CD + RR)] t (R + NDA) t .
(R + NDA) reflect the stock of high-powered money and the expression
within the square bracket is the money-multiplier, which depends on credit
to deposit ratio of the commercial banking sector (CD) and the reserve to
deposit liabilities in the commercial banking sector (RR). Whereas NDA
is an instrument, R depends on the foreign trade sector. However, the
government can influence CD and RR to control the money supply. RR,
which is the actual reserve ratio, depends on the demand for loans created by
private sectors and the commercial bank’s willingness to lend. We assume
that the desired reserve ratio RR ∗ t is a function of national income and