1 quarterly economic model nico van der windt marián vávra michal andrle
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Quarterly Economic Model
Nico van der WindtMarián VávraMichal Andrle
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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
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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
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Choice of the modelling paradigm (II)
Fitting data
Theoretical rigor
VAR’s
DSGE with solid microfoundations
Large-scale fully estimated Keynesian models
Structural neoclassical top-down models (QEM)
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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and Vávra: An Economy in Transition and DSGE: What the Czech National Bank’s New Projection Model Needs, CNB WP, Unpublished DRAFT
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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 medium-size nonlinear models. It also requires a lot of “tricks” (habit formation, ROT consumers…) to bring the model closer to stylized facts.
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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
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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
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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(K,L) assumed CES with low elasticity of substitution (approx 1/3)
F(GDP,M)
F(K,L)MK
L
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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
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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
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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
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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…
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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
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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
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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
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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
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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
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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
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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…
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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
2004 2005 2006
Gross domestic product -0,40 -0,65 -0,77Private consumption -0,22 -0,47 -0,71Exports of goods and services -0,83 -1,47 -1,99GDP deflator -0,06 -0,32 -0,64Private consumption deflator -0,07 -0,27 -0,47
Unemployment rate 0,03 0,09 0,16Current account deficit (% of GDP) 0,23 0,38 0,46Gen. government deficit (% of GDP) 0,10 0,22 0,33
change from the baseline scenario (in %)
absolute change from the baseline scenario
2004 2005 2006
Gross domestic product 0,15 0,51 0,66Private consumption -0,09 -0,12 -0,15Exports of goods and services 0,37 1,02 1,35GDP deflator 0,12 0,41 1,00Private consumption deflator 0,30 0,93 1,75
Unemployment rate -0,02 -0,06 -0,12Current account deficit (% of GDP) -0,08 -0,22 -0,32Gen. government deficit (% of GDP) -0,02 -0,12 -0,23
change from the baseline scenario (in %)
absolute change from the baseline scenario
World Trade Shock (Negative) Foreign Prices Shock
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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
UK Brent
Optimistic USD/barrel 51,3 49,5 45,8 42,3
Baseline USD/barrel 38,3 55,5 60,5 57,8 54,3
Pessimistic USD/barrel 61,8 77,0 75,8 72,3
GDP EU 15
Optimistic y/y in % 1,7 2,3 2,7 2,7
Baseline y/y in % 1,2 1,5 1,9 2,4 2,5
Pessimistic y/y in % 1,2 1,3 1,9 2,2
PPI EU 15
Optimistic y/y in % 2,4 0,8 1,2 1,6
Baseline y/y in % 2,3 3,1 2,0 1,7 1,7
Pessimistic y/y in % 4,1 3,7 2,4 1,9
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Example from using the model…
GDP (y-o-y, in %) Unemployment rate (in %)
Current account (in % GDP) Public debt (in % GDP)
-2
-1
0
1
2
3
4
5
6
1995 1997 1999 2001 2003 2005 2007
Baseline
Optimistic
Pessimistic
3
4
5
6
7
8
9
1995 1997 1999 2001 2003 2005 2007
Baseline
Optimistic
Pessimistic
-8
-7
-6
-5
-4
-3
-2
-1
0
1995 1997 1999 2001 2003 2005 2007
Baseline
Optimistic
Pessimistic
10
15
20
25
30
35
40
1995 1997 1999 2001 2003 2005 2007
Baseline
Optimistic
Pessimistic
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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
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EX1: Government Consumption/Investment
99.9
100.0
100.1
100.2
100.3
100.4
100.5
100.6
2000 2005 2010 2015 2020
Investment Consumption 99.96
100.00
100.04
100.08
100.12
100.16
100.20
100.24
100.28
00 02 04 06 08 10 12 14 16 18 20
IGP GGP
99.9
100.0
100.1
100.2
100.3
100.4
100.5
00 02 04 06 08 10 12 14 16 18 20
IGP GGP-.16
-.12
-.08
-.04
.00
00 02 04 06 08 10 12 14 16 18 20
IGP GGP
GDP (scenario/baseline)
Nominal Wages
GDP deflator
UR (p.b. from baseline)
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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…
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EX2: Increase in World Demand
99
100
101
102
103
104
00 02 04 06 08 10 12 14 16 18 20
M (Perm. vs. Baseline) E (Perm. vs. Baseline)
Imports and Exports response to the level shift in Y*
(scenario/baseline)
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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