SHAHWAR FATIMA

DEVELOPMENT ECONOMICS

DEPARTMENT ECONOMICS, NUML, ISLAMABAD

The Three Gap Models
Introduction

• The three gap models help to measure the gaps between

different variables in an economy and identify the
factors that contribute to these gaps
• The three gap models are the Domestic Gap Model,
Foreign Exchange Gap Model, and Fiscal Gap Model
 The domestic saving gap model is a
macroeconomic model that explains the
relationship between domestic savings and
investment​

1. Domestic It assumes that investment is a function of

Saving Gap domestic savings and foreign savings, and that

the level of investment is determined by the
level of savings available
Model
In this model, the domestic saving gap is the
difference between the level of domestic savings
and the level of savings needed to finance
domestic investment
 The implementation of the domestic saving gap
model involves measuring the level of domestic
savings and comparing it to the level of savings
needed to finance domestic investment​

If the domestic saving gap is positive, it indicates

Implementation that there is a surplus of savings that can be used to
finance domestic investment​

If the gap is negative, it indicates that there is a

shortage of savings and that the economy is relying
on foreign savings to finance investment​
Weaknesses

The main weakness of the domestic saving gap model is that it assumes

that the level of investment is solely determined by the level of savings
available, ignoring other factors such as interest rates and
government policies that can
 The Foreign Exchange Gap Model helps to
identify the gap between a country's foreign
exchange earnings and its foreign exchange
expenditures

2. Foreign
It considers the factors that influence these
Exchange Gap earnings and expenditures such as trade,
investment, and tourism

Model
The model assumes that a country's foreign
exchange earnings should be greater than its
foreign exchange expenditures, and any gap
between the two can create imbalances in the
economy
Implementation

• This model can be used to guide international trade

policy by identifying areas where a country may need to
increase exports or reduce imports to balance its foreign
exchange account
• It can also help to identify areas where a country may
need to attract foreign investment or increase tourism to
boost its foreign exchange earnings
Weaknesses

The Foreign Exchange Gap Model assumes that

a country's foreign exchange earnings and
expenditures are independent of each other,
which may not always be the case

Additionally, it does not take into account the

impact of capital flows and exchange rate
fluctuations on a country's foreign exchange
account
3. Fiscal Gap Model

• The Fiscal Gap Model helps to identify the gap between

a country's government spending and its government
revenues
• It considers the factors that influence these revenues and
expenditures such as taxes, subsidies, and public debt
• The model assumes that a country's government
revenues should be greater than its government
spending, and any gap between the two can create fiscal
imbalances in the economy
Implementation
• This model can be used to guide fiscal policy by
identifying areas where a government may need to reduce
spending or increase taxes to balance its budget
• It can also help to identify areas where a government may
need to reduce its public debt to avoid financial instability
 The Fiscal Gap Model assumes that
government spending and revenues are
independent of each other, which may not
always be the case

Weaknesses
Additionally, it does not take into account
the impact of monetary policy and
external factors on a country's fiscal
balance
Conclusion

It is important to recognize
The three gap models provide
their limitations and use them
a useful framework for
in conjunction with other
analyzing economic
economic models to develop
imbalances
effective policy solutions