Regional Financial CGE Model for Infrastructure Investment Policy

. In this paper, regional financial computable general equilibrium (RFCGE) model was developed. The RFCGE model is a useful tool in the evaluation of regional fiscal policies. So far, computable general equilibrium (CGE) models have often been used to evaluate regional infrastructure investment policies. However, conventional CGE models do not consider financial assets, such as deposits, equities, and government bonds and decision-making mechanism of government. Therefore, applying CGE models might overestimate the benefit incidence of policies on the rural society. To confirm this theory, the RFCGE model was applied to regional infrastructure investment policy.


Introduction
Over the past decade, various tools have been used to evaluate local fiscal policies, one of the most powerful tools being the computable general equilibrium (CGE) model 1) .CGE models make it possible to explicitly estimate the effects of policies.However, CGE models have a theoretical constraint in that they do not consider the financial economy.This means that CGE models do not consider the effects of financial assets, such as deposits, equities, and government bonds.For example, households use their assets not only for buying goods but also for buying equities, government bonds, and making deposits.In the real world, these financial assets may spill over from a local region to other regions through the financial market.Buying government bonds leads to spill-over effects.Further, if local firms borrow loans from banks in other regions, the payment of interest by the former leads to an outflow of assets.This means that the net wealth (assets of households) may spill over to other regions.Therefore, the benefit incidence on a local region owing to local fiscal policies might be overestimated by CGE models.Among policies, an infrastructure investment policy may have a major influence on the benefit incidence, because it involves a large amount of money.
In this paper, a regional financial computable general equilibrium (RFCGE) model was developed to include the financial economy in the CGE model.The RFCGE model is based on a financial computable general equilibrium (FCGE) model, which was developed by Lance Taylor (1990) 2) and Mark Thissen (2000) 3) .The FCGE model not only considers the real economy but also the financial economy.So far, the FCGE model has been used to evaluate national policy.In this paper, the FCGE model has been applied to evaluate the effect of policy on a local region.Therefore, some endogenous variables in the FCGE model have been changed to exogenous variables.Further, the RFCGE model considers inter-regional trade and asset movement between regions.In this paper, infrastructure investment policy was analyzed using the RFCGE model.

Model
The RFCGE model developed in this study has been presented in this section.The model consists of four economic agents-firms, households, local banks, and other regions, and six markets-the goods market, labor market, loan market, stock market, government bond market, and deposit market.The goods and labor markets are real markets.The stock market, government bond market, and deposit market are financial markets.

Firms
Three firms have been considered in the model: a service-sector firm, industry-sector firm, and an agricultural-sector firm.Firms receive income from the sale of goods, purchase intermediate inputs, pay direct taxes, make wage payments and investments, distribute dividends to households, and demand bank loans.The income that remains with firms after meeting their expenses is saved.Firms finance their expenditures through retained equities and borrowings from local banks as well as banks from other regions.Production is determined by the Cobb-Douglas production function with two inputs-labor and capital.In addition, production is assumed to be carried out with constant technological growth.

Households
The demand for goods by households is a result of the maximization of utility, subject to a budget constraint.The utility function of households is represented by equation (1).The budget constraint is determined by activity of households in the real economy.Households receive labor income from firms and firms in other regions and profit income (dividends) from firms.The remaining income is saved post the deduction of direct taxes.
Net wealth is held in the form of currencies, deposits, government bonds, equities, and savings (for the current period).Households divide their net wealth again to currencies, deposits, government bonds, and equities in the current period.Moreover, deposits and equities are classified on the basis of region as local and other regions.Equations ( 2)-( 15) represent the abovementioned flow of assets.

Local banks
Operating expenses such as labor costs are not taken into account.Moreover, local banks do not buy or sell goods.Funds of local banks come from deposits from households and remittances from other regions.Local banks provide loans to local firms.Because other regions require banks to hold funds in the form of reserves, some funds are held for that purpose.

Other regions
Other regions include consumers, producers, governments, and central banks.They are involved in the exchange of money with households and local firms through various markets.

Price and interest rate
The producer price, consumer price, and intermediate price are different for each of the three firms, while the equity price and wage rate are the same for all three firms.Thus, there are eleven different prices, all of them being endogenous variables.
There are four interest rates-deposit interest rate, equity interest rate, government bond interest rate, and bank loan interest rate.The bank loan interest rate is an endogenous variable.

Markets
Endogenous variables are determined by market equilibria.Each market equilibrium has been explained in this section.

Goods market
The goods market equilibrium is expressed by equation ( 16).Producer prices are determined from the goods market equilibrium equation.Consumer prices and intermediate prices are determined from producer prices.Consumer prices take into account direct taxes.

Labor market
The labor market equilibrium is expressed by equation ( 17).The wage rate is determined from the labor market equilibrium equation.
i L : Labor demand by firm i (i = 1 -3), L: Labor supply.

Equity market
Equity price is determined using equation (18).

Loan market
Bank loan interest is determined using equation ( 19).This equation indicates that the assets under management of local banks are equal to the loans demanded by firms.

Social accounting matrix
The numbers in a CGE model must be consistent with the national income and the inputoutput accounting equations the model contains.A social accounting matrix (SAM) represents the flow of all economic transactions that take place within an economy.An SAM for a local region has been developed in this paper.The SAM is based on the inputoutput table for Nara prefecture 4) .The exogenous variables in the model are determined by the numbers in the matrix, which have been provided in the appendix on the last page.

Comparative statics
This section comprises an analysis of the effect of infrastructure investment policy on a local region using comparative statics.Fig. 3 shows the result of comparative statics, which indicates that infrastructure investment policy increases the net wealth of households.Moreover, the productivity of firms in the subsequent period improves, because the amount of funds held by the firms depends on the deposits and equity held by households.However, these comparative statics do not take into account the financial effect.The negative effect on the local region, taking the financial market into consideration, has been shown in the next subsection.

Spill-over effects
In this subsection, the effects of the investment policy have been analyzed from the viewpoint of the financial economy.Fig. 3 shows that the investment policy results in increasing net wealth for households.However, there are some negative effects of the policy on the local region.These effects have been analyzed from two different viewpoints as follows: The first viewpoint involves the outflow of households' assets.Households categorize their net wealth as deposits, government bonds, equities, and currencies.Further, deposits and equities are categorized into those from the local region and other regions.Further, funds raised by sale of government bonds to government bonds spills over to the government.The government redistributes these funds to other regions, which means that some of the increased net wealth spills over to other regions.
The second viewpoint involves the outflow of firm assets.Local firms borrow funds from local banks or banks from other regions, for which they pay interest to the banks.If the firms choose to borrow from banks from other regions, assets from the local region will spill over to other regions in the form of interest payments.
As discussed above, asset outflow can occur in two different ways.Thus, it can be observed that benefit incidence on the local region may be overestimated by CGE models owing to spill-over effects.High-cost policies, such as an infrastructure investment policy, in particular, result in such negative effects.

Calibration
In this section, the effect of an infrastructure investment policy on a local region has been calibrated using the RFCGE model.In this case study, we assumed a 20% increase in  1 shows that net wealth increased by 100 billion yen after the policy was implemented.However, the total amount of financial assets in the other region (DEP h O + ZZ h O + GB ) increased by 14 billion yen.This implies that an amount of 14 billion yen spilled over to the other region owing to the policy.
Table 2 shows that there was an increase in producer prices.This increase was because producer prices depend on the wage rate, which rose because of the policy.Further, the increase in producer prices resulted in a decreased demand for goods.
In table 3, EV refers to equivalent variation, which is a measure of economic welfare changes associated with changes in prices.In this paper, EV represents the effect of the policy on the real economy in the local region.In addition, ΔNW represents the effect of the policy on the financial economy in the local region.Thus, EV + ΔNW represents the overall effect of the policy on the local region.EV + ΔNW is -93.This is because the demand for goods decreased owing to an increase in the prices.

Conclusion
In this paper, an RFCGE model was developed to solve the theoretical issue of CGE models.The effect of an infrastructure investment policy on a local region was assessed using the RFCGE model.As a result of calibration, the net wealth of households increased.However, a portion of the increased household assets spilled over to other regions.Moreover, producer prices increased owing to an increased wage rate.Further, the demand for goods decreased due to increased prices.Thus, EV+ NW had a negative value.This implies that infrastructure investment policy may, sometimes, result in negative effects on the local region.In conclusion, it is difficult to explicitly evaluate the effect of policy on the local region by merely using the CGE model.Therefore, it is important to evaluate infrastructure investment policy using the RFCGE model.

Fig. 1
Fig.1shows a schematic of the real side of the model.

BQL:
Funds of local banksL i BLN : Bank loan demand of firm i in a local region.
the local region.Because of space limitations, only a few results have been shown.Table

Table 1 .
Financial assets of households

Table 2 .
Prices of and demand for goods

Table 3 .
Effect of policy