IMF MDSx Mod 12 Videos
Risks, Vulnerabilities, and the Risk Assessment Matrix (RAM)
This material was extracted from the International Monetary Fund's online course entitled Macroeconomic Diagnostics MDSx. To take the entire course, you must register for an account (free) on www.edx.org.
1. Introduction: Risks, Vulnerabilities, and the Risk Assessment Matrix (RAM)
Adverse economic events — ‘bad shocks’ — can disrupt and a country’s economic performance. These shocks can be either internally or externally based — and the country itself can be pursuing policies that may make such shocks even more likely. This module presents a framework to analyze how different kinds of shocks can be transmitted in a way that adversely impacts macroeconomic performance, how to gauge which shocks could be most important. This is the risk assessment matrix.
2. A Difficult Taxonomy - Different Kinds of Risks
To analyze the different kinds of shocks that a country might suffer is a complex task. To simplify this task, we need a way to classify different kinds of risks and their impacts on the economy: what might happen, over what time horizon might it happen, does the shock originate domestically — is it the result of ‘homegrown’ policies — or is the shock externally based and even entirely out of the country’s control?
3. Homegrown Risks: Structural and Growth Issues
Putting a number on a country’s economic growth over the medium term is a difficult task. Sometimes, even the world’s top economists can get growth wrong for years in a row. As stressed in a previous module, a growth projection should be linked to supply factors, and the assumptions regarding the growth rates of those supply factors — including policy reforms — should be plausible ones.
4. Homegrown Risks: Monetary and Inflation Issues
A country’s monetary authority may be creating conditions — for example, pursuing an excessively loose monetary policy — that may bring on inflationary pressures and/or fuel expectations of higher inflation at some point in the future. Belatedly, the central bank may then have to tighten monetary policy with the aim of reining in demand and reestablishing its credibility.
5. Homegrown Fiscal Risks
A country’s government may be stimulating the economy through an expansionary fiscal policy — one that may ultimately jeopardize the sustainability of its public debt. Belatedly, at some point the government may have to abruptly rein in spending or raise hike taxes. Also, creditors may demand a higher reward to hold government debt. This means higher financing costs for the government — a factor that may mean both a higher fiscal burden and disruption to economic activity.
6. Downturns in External Trade
As countries dedicate increasing amounts of their output to external trade, their exposure to externally based shocks to in world markets becomes ever more apparent. Reductions in the demand from trade partners or unexpected increases in supply from competitor countries can have adverse impacts on both external balances and economic output.
7. Tighter External Finance
Higher external interest rates may reflect conditions beyond a country’s control — for example tightening by industrial country central banks — or deteriorating economic fundamentals — for example an excessive fiscal or external deficit, high debt levels, low levels of international reserves, an overvalued exchange rate. In either case, an external financial tightening can disrupt economic activity at home.
8. Feedback – From Monetary to Fiscal and Financial
An abrupt domestic monetary tightening, as discussed earlier in this module, can have several indirect or spillover effects. Higher interest rates may mean more difficult conditions for fiscal financing. At the same time, these higher interest rates may also bring on a deterioration in financial system balance sheets.
9. Feedback – From External to Fiscal and Financial
A country that started with an already weak external position becomes an even riskier prospect for international investors after a fall in terms of trade. Market participants will likely pull back from the country or demand an even higher reward in the form of a risk premium. It can then be difficult for the country to prevent further disruption to the domestic economy — including to the fiscal position and financial sector balance sheets.
10. Domestic Financial Fragilities
Fragilities that are rooted in the domestic financial sector can no longer be left out of the picture as macroeconomists once did. Such weaknesses can often build up to sharp cutbacks in credit. Credit can be the lifeblood of an economy. Such cutbacks can bring about sharp disruption of macroeconomic activity itself.
11. What is a Risk Assessment Matrix (RAM)?
In recent years, IMF country reports have featured a structured discussion of risks faced by a country. The risks are classified in terms of the origin of the shock, how the shock is transmitted, and the likely impact of such a shock on the country’s macroeconomic performance.
12. Building a Risk Assessment Matrix (RAM)
You will now be asked to review the sector-by-sector results for a hypothetical country we call “Diagnostica”(the case study country for the MDSx course). Your job will be to properly classify the risks faced by Diagnostica, based on those previous results. In this way, you will build a risk assessment matrix for “Diagnostica.”
13. Summarizing What We Have Learned
“Don’t say it won’t happen just because it hasn’t happened yet!” Economies can suffer bad shocks that disrupt economic activity. Fortunately, policy makers can take preventative action. But, the first step is to evaluate the macroeconomic, external, fiscal, and financial risks that a country does face — and to do so in a systematic way. That first step, to construct and interpret the risk assessment matrix, is often the very first step in a preventative action plan for country.
14. Assessing Diagnostica
In this video, we review which of the risks and imbalances were more readily apparent for Diagnostica — i.e. what belongs in Diagnostica’s risk assessment matrix.
15. Alternative Views on Risks and Vulnerabilities
Conversation with Milana Kuzmanovic – who expresses some healthy skepticism regarding Evan Tanner’s view on “Diagnostica”.Milana is well -groomed and beautiful, while Mr. Tanner badly needed a haircut.