Download Quarterly Economic Model

Quarterly Economic Model
Nico van der Windt
Marián Vávra
Michal Andrle
1
Introduction

Joint development of the quarterly economic model (QEM)
with SEOR, Erasmus Univ.

Two parts of the project:
• Development of the core model
• Upgrade and refinement of the model

The model is a story-telling device, with focus on medium
term consistency of economic scenaria
2
Choice of the modelling paradigm (I)


Variety of possibilities to choose from
Capacity, time and technical constraints command
compact structural model

The model is a structural keynesian model with
neoclassical supply side

The model is built using top-down approach – emphasis
put on joint and compact derivation of main behavioral
relationships

Emphasis on long-run properties of the model
3
Choice of the modelling paradigm (II)
Fitting data
VAR’s
Large-scale fully
estimated Keynesian
models
Structural neoclassical
top-down models (QEM)
DSGE with solid
microfoundations
Theoretical rigor
4
Models
Structural neoclassical models:





Euroarea-Wide Model (AWM), ECB
NiGEM (NIESR, UK)
JADE (CPB, NL) redesigned in 2003
TRYM (Australian Treasury)
… and many others
DSGE:




IMF’s GEM (Laxton, Pesenti et al.) Multicountry DSGE model,2004
Bank of Canada QPM
Bank of England (BEQM) 2005
October 2005 – Beneš, Hlédik, Kumhoff and Vávra: An Economy in Transition
and DSGE: What the Czech National Bank’s New Projection Model Needs, CNB
WP, Unpublished DRAFT
5
Treatment of expectations


Not much explicit treatment of the expectations
In the course of derivation of main behavioral eqs.
adaptive expectations imposed

Idea – adjustment to new information is costly, partial
adjustment used extensively
The model is fully backward-looking

We are not able to simulate expected shocks, etc


It is technically demanding to work with model-consistent expectations in mediumsize nonlinear models. It also requires a lot of “tricks” (habit formation, ROT
consumers…) to bring the model closer to stylized facts.
6
Estimation vs. Calibration

Earlier versions of the model mostly estimated with
theoretical priors imposed

Current version mostly calibrated using all relevant
information, strong reliance on theoretical priors

The model is not suited to capture short-term dynamics,
but provides consistency needed in medium-term

ALL results are model-dependent and are subject to
great uncertainty
7
Structure of the model (I)



Small Open Economy
Significant import intensity of exports
Sizeable ER pass-through

Elasticity of substitution between K and L lower than unity
Labor and goods market nominal and real rigidities

Markets do not clear in the model  output-gap

8
Supply Side (I)

Aggregate good in the economy produced using domestic
value added (GDP) and imported goods (total supply)

Domestic value added (GDP) formed by services of labor
(L) and capital (K)
F(GDP,M)
K
M
F(K,L)
L

F(K,L) assumed CES with low elasticity of substitution
(approx 1/3)
9
Supply Side (II)

Demands for labour and capital are linked with the same
price elasticity (elasticity of substitution) and unit income
elasticity… -> consequence of using CES

Total factor productivity is exogenous exponential trend

Cost-per-unit of output derived as a theoretical
counterpart to GDP deflator

Output gap is a part of the supply side

LR properties – Open-Economy Solow Model
10
Labour Market

Demand for labour derived together with demand for
capital from the production function

Labour supply and population exogenous

Wage bargaining – “right-to-manage” approach to derive
the wage equation

Reliance on theoretical priors
11
Investment and Capital Stock

Aggregate capital-stock in the economy enters the PF

Private investment derived from the firm’s profit
optimization problem – demand for capital with large
adjustment costs and investment/capital identity

Government nominal investment exogenous, entering PF
and thus productive and capacity-enhancing

Initial (1993) government capital stock set approx 20 % of the total
12
Household sector

Consumption derived using RA model, assuming
households view their wage income to follow random walk

Households are backward-looking in their decisions

Limited scope for wealth effects – empirical ambiguities,
data problems…
13
Foreign Trade

Export demand driven by world trade and real exchange
rate (demand approach)

Import demand driven by domestic demand, including
exports, to account for the import intensity of exports
(due to the supply side structure, where it is derived)

Price elasticity of exports twice as high as the one of
imports

Current version does not distinguish goods and services
14
Price Block (I)

Price deflators derived as a theoretical counterparts to
quantity variables

Cost-per-unit of output is the cost-of-living index from
domestic value added PF. It is the weighted index of the
price of labour and price of the capital.

Cost-per-unit of output is a counterpart to GDP deflator

Domestic/foreign content of the price indices calibrated.
The domestic component consist of cost-per-unit of
output, foreign component is the import deflator
15
Price Block (II)

Export deflator is derived under Semi-Small Open
Economy Assumption, i.e.

The cycle-sensitive markup is represented by the output
gap

The CPI is decomposed into administrative prices and core
inflation, which is modeled. Overall CPI is then linked with
consumption deflator

The existence of CPU allows us to treat GDP deflator as a
residual variable, I.e. YP/Y
16
Fiscal Block (I)

Expenditures:






Government Investment (exog)
Government Wage Bill (LG exog, WG exog/rule)
Goods Consumption (exog in nominal terms)
Transfers and Benefits (UR Benefits, Pensions,…)
Interest rate payments
Incomes



Corporate and Personal Income Tax
VAT and excise tax
Social security contributions
17
Fiscal Block (II)

Disaggregated expenditure and revenue side allows us to
assess the fiscal effects of economic shocks

Debt accumulation in the model moderately affects
interest rates

Data issues:


The model has its own definitions not corresponding exactly
to GFS or ESA…
Add-variables used to rescale the debt and deficit
18
Fiscal and Monetary Policy…

Monetary policy operates through simple IR rule
(a la Taylor – inflation and output gaps sensitive)

What is the definition of the fiscal policy… ??


Tax-rates and expenditures set.. Do we need more?
Is the “fiscal policy rule necessary” in the model…??

Technically – NO, since expectations are not model-consistent and current
response of the model is NOT affected by steady-state result and the model is
solvable…

Economically – YES,
• since permanent shocks let the debt explode/implode, which is even
aggravated by interest response
• Solvency of the government must be assured
19
Fiscal and Monetary Policy…

Fiscal policy then must be specified…

Intuitive and often questions:
“What is the effect of increase in XY on … output, inflation… holding fiscal policy
variables unchanged?”
ARE problematic…
20
Example from using the model…

Variants of the model are used

2003 – Pre-Accession Economic Program sensitivity
analysis carried out using previous version of QEM
World Trade Shock (Negative)
2004
2005
change from the baseline scenario (in %)
Gross domestic product
-0,40
-0,65
Private consumption
-0,22
-0,47
Exports of goods and services
-0,83
-1,47
GDP deflator
-0,06
-0,32
Private consumption deflator
-0,07
-0,27
absolute change from the baseline scenario
Unemployment rate
0,03
0,09
Current account deficit (% of GDP)
0,23
0,38
Gen. government deficit (% of GDP)
0,10
0,22
Foreign Prices Shock
2006
-0,77
-0,71
-1,99
-0,64
-0,47
0,16
0,46
0,33
2004
2005
change from the baseline scenario (in %)
Gross domestic product
0,15
0,51
Private consumption
-0,09
-0,12
Exports of goods and services
0,37
1,02
GDP deflator
0,12
0,41
Private consumption deflator
0,30
0,93
absolute change from the baseline scenario
Unemployment rate
-0,02
-0,06
Current account deficit (% of GDP)
-0,08
-0,22
Gen. government deficit (% of GDP)
-0,02
-0,12
2006
0,66
-0,15
1,35
1,00
1,75
-0,12
-0,32
-0,23
21
Example from using the model…

Since 2004 – more elaborated sensitivity analysis using
scenaria is presented in the Convergence Program

Baseline, optimistic and pessimistic scenaria defined
Year
Year
Year
Year
Year
2004
2005
2006
2007
2008
51,3
49,5
45,8
42,3
55,5
60,5
57,8
54,3
61,8
77,0
75,8
72,3
1,7
2,3
2,7
2,7
1,5
1,2
1,9
1,3
2,4
1,9
2,5
2,2
2,4
0,8
1,2
1,6
3,1
2,0
1,7
1,7
4,1
3,7
2,4
1,9
UK Brent
Optim istic
USD/barrel
Baseline
USD/barrel
Pessim istic
USD/barrel
38,3
GDP EU 15
Optim istic
y/y in %
Baseline
Pessim istic
y/y in %
y/y in %
1,2
PPI EU 15
Optim istic
y/y in %
Baseline
y/y in %
Pessim istic
y/y in %
2,3
22
Example from using the model…
Unemployment rate (in %)
GDP (y-o-y, in %)
6
9
Baseline
5
Optimistic
4
8
Pessimistic
7
3
2
6
1
5
Baseline
4
Optimistic
Pessimistic
0
-1
-2
3
1995
1997
1999
2001
2003
2005
2007
Current account (in % GDP)
1995
1997
1999
2001
2003
2005
2007
Public debt (in % GDP)
0
40
-1
Baseline
-2
Optimistic
-3
Pessimistic
35
30
-4
25
-5
-6
-7
-8
1995
1997
1999
2001
2003
2005
2007
20
Baseline
15
Optimistic
Pessimistic
10
1995
1997
1999
2001
2003
2005
2007
23
EX1: Government Consumption/Investment

What is the result of the same increase (in bill CZK) of


Government consumption?
Government investment?

Both are government expenditures… BUT investment is assumed to be
productive and thus enhance the potential output of the economy…

Higher capacities lower the output gap and demand pressures, allowing
for higher and more persistent growth of the economy.

The higher domestic prices, the lower exports and higher imports

Impact on unemployment… output effect vs. increase of real wages
24
EX1: Government Consumption/Investment
GDP (scenario/baseline)
GDP deflator
100.28
100.6
100.24
100.5
100.20
100.4
100.16
100.3
100.12
100.2
100.08
100.04
100.1
100.00
100.0
Investment
99.96
Consumption
00
99.9
2000
2005
2010
2015
02
04
06
2020
Nominal Wages
08
10
IGP
12
14
16
18
20
GGP
UR (p.b. from baseline)
100.5
.00
100.4
-.04
100.3
100.2
-.08
100.1
100.0
-.12
99.9
IGP
00
02
04
06
08
IGP
10
12
14
GGP
16
18
20
GGP
-.16
00
02
04
06
08
10
12
14
16
18
20
25
EX2: Increase in World Demand

Assume permanent increase in foreign demand
(level shift, not growth shift)

Exports reacts immediately… Import intensity of exports pulls imports
upwards
Income effects also stimulates imports… Positive output gap slowly
increase domestic prices… Having ER unchanged, changing RER shifts
domestic demand to foreign goods


In the model, export prices are moderately affected by domestic prices,
which have increased…
26
EX2: Increase in World Demand
Imports and Exports response to the level shift in Y*
(scenario/baseline)
104
103
102
101
100
M (Perm. vs. Baseline)
E (Perm. vs. Baseline)
99
00
02
04
06
08
10
12
14
16
18
20
27
EX2: Fiscal Rules Sensitivity

The model must contain fiscal rules, specifying the behaviour of
the government

“No policy change” simulations are biased and/or inconsistent
28