Inside a Modern Macroeconometric Model

1 - Setting the Scened.- 1 How to Use this Book.- 2 Distinguishing Features of MM.- 2.1 Overview of MM's relationship to other macro models.- (a) Size.- (b) Eclecticism.- (c) Relationship to macro and micro paradigms.- (d) Long-run properties.- (e) Specification testing.- 2.2 Main economic features.- (a) Dornbusch Model attributes.- (b) Lona-run optimizina behaviour in production.- (c) Feedback effects from assets.- 3 Principal Mechanisms in MM.- 3.1 Introduction.- 3.2 The Mundell-Fleming model.- (a) The MF model's equations.- (b) Monetary and fiscal policy under flexible exchange rates in the MF model.- 3.3 Dombusch's 1976 model.- (a) Basic assumptions.- (b) Underlying structural model.- (c) Partially reduced form.- (d) More on the underlying structural model - portfolio balance.- (e) Equilibrium exchange rate.- (f) Model consistent expectations.- (g) The effects of a monetary expansion under rational expectations.- 3.4 Insights from 1980s developments in open-economy macroeconomics.- 3.5 Synopsis of illustrative simulations with MM.- (a) Monetary expansion.- (b) The NAIRU and the neoclassical long run.- (c) Fiscal policy and public debt feedback.- (d) Private consumption and foreign debt feedback.- (e) Non-Ricardian equivalence.- 3.6 A highly stylized miniature model of balanced growth (HSM).- (a) Main assumptions underlying HSM.- (b) Production function and resource endowment.- (c) Capital accumulation and the rate of return; domestic inflation and exchange rate determination.- (d) Growth in capital stock, workforce, output and real wages.- (e) Intertemporal budget constraint.- (f) Balance of trade.- (g) Qualitative behaviour of HSM under parameter shifts.- (h) Growth rates of prices and of nominal and real magnitudes in HSM and in MM.- 3.7 Conclusions from this chapter.- 2 - Structural Form of MM.- 4 Overview of Part Two.- 4.1 Introduction.- 4.2 Notation.- 4.3 Nomenclature for equations.- 4.4 Estimation methods, specification searches and 82 hypothesis testing.- (a) General considerations.- (b) Data sources.- (c) Computing.- (d) Estim ation methods.- (e) Obtainina a preferred eauation.- (f) Diagnostic testing.- 4.5 Equation count and standard closure for simulations.- 4.6 Brief account of solution method.- 5 Wage Behaviour.- 5.1 Introduction.- 5.2 Technological change - basic ideas.- (a) Numerical example.- (b) Factor-augmenting technical change.- (c) Efficiency units.- 5.3 The role of Harrod-neutral technical progress in MM.- 5.4 Notation - Variables in wage equation SO3.- 5.5 Inflationary expectations augmented Phillips Curve.- Steady state.- 5.6 Estimated coefficients.- 6 Labour Force Participation.- 6.1 Introduction.- 6.2 Notation.- 6.3 Finding the underlying trend in the potential size of the workforce.- 6.4 Labour supply equation SO2.- 6.5 Estimated coefficients.- 6.6 Steadu state.- 6.7 Encouraged/discouraged worker effect.- 7 Private Consumption Behaviour.- 7.1 Introduction and notation.- 7.2 Equilibrium consumption - equations SO4A.- 7.3 Dynamic disequilibrium consumption equation S04.- 7.4 Steady state.- 7.5 Parameter Estimates.- 8 Behaviour of the Rental Price of Housing.- 8.1 Introduction and notation.- 8.2 Allocation of consumption into housing rental services and other.- 8.3 Dwelling rental price dynamics - within sample - equation S01.- 8.4 Steady state.- 8.5 Dwelling rental price dynamics - forecast period.- 8.6 Estimated coefficients.- 8.7 Behavioural identity 103 - consumption price index and identity I01, definition of real consumption.- 9 Production of Housing Rental Services and Investment in Dwellings.- 9.1 Introduction.- 9.2 Notation - Levels variables.- 9.3 Notation - Depreciation, interest, growth and inflation rates.- 9.4 Notation - Coefficients.- 9.5 Production of housing rental services - identity 104.- 9.6 The natural real growth rate - identities 171 and 172.- 9.7 Dwelling investment - equation SO5.- Present value calculation.- Expectations of investors in housing stock.- Steady state.- 9.8 Estimated coefficients.- Estimated risk premium.- 9.9 Some weaknesses of the approach.- 10 The Enterprise Production Block of the Business Sector.- 10.1 Introduction.- 10.2 An overview of the production structure of the enterprise economy.- 10.3 Preliminaries on the CES/ CET production technology.- Input-output separability.- 10.4 Lengths of run in MM and in the enterprise production block.- (a) Introduction.- (b) Concepts of length of run.- Short (or Keynesian) run of MM as a whole.- Medium (or classical) run of MM as a whole.- Long (or neoclassical) run of MM as a whole.- (c) The medium run of the enterprise production block.- (d) Parameter estimation of the medium-run neoclassical sub-model.- (e) The long run of the enterprise production block.- (f) Role of the medium- and long-run closures of the enterprise production block in generating the long run of MM as a whole.- 11 Business Fixed Investment.- 11.1 Introduction and notation.- 11.2 Expected present value of the net revenue stream.- 11.3 Tobin's (average) q ratio.- 11.4 Stochastic dynamic investment equation S13.- Steady state.- 11.5 Estimated coefficients.- 12 Business Sector Employment.- 12.1 Introduction and notation.- 12.2 Business sector employment equation S1O.- 12.3 Steady state.- 12.4 Estimates.- 13 Import Supply and Demand.- 13.1 Introduction and notation.- 13.2 Import supply under the small country assumption.- 13.3 Import deniand - introduction and notation.- 13.4 Equilibrium import demand equation.- 13.5 Dynamic demand equation for imports S09.- Steadty state.- 13.6 Estimates.- 13.7 Trade-weighted exchange rate index.- 14 Aggregate Export Supply.- 14.1 Introduction, notation and specification.- Steady state.- 14.2 Estimates.- 15 Disaggregation of Export Supply.- 15.1 Introduction; notation and specification for export compositional equation S06; its steady state.- 15.2 Estinates.- 15.3 Supply of 'other' exports.- 15.4 Supply of 'commodity' exports.- 15.5 Price index for aggregate exports.- 16 Overseas Demand for 'Commodity' Exports.- 16.1 Introduction and notation.- 16.2 Form of the demand equation.- 16.3 Steady state.- 16.4 Estimates.- 17 Inventory Investment in 'Commodity' Exports.- 17.1 Introduction and generic notation; form of the inventory equations.- 17.2 Inventory investment in 'commodity' exports.- (a) Notation for stochastic inventory equation SO7 and accumulation identity 107.- (b) Export 'commodity' inventory investment equation SO7.- (c) Estimates.- (d) Steady state.- 18 Demand for Non-'Commodity' Exports.- 18.1 Introduction and notation.- 18.2 Form of the denand andflexibility equations.- 18.3 Estimates.- 18.4 Steady state.- 19 Domestic Good Inventory Investment.- 19.1 Introduction and notation.- 19.2 Desired stock of non-farm inventories.- 19.3 Partial adjustnient eqqvation.- 19.4 Estimated coefficients.- 19.5 Steady state.- 20 Price Dynamics for the Domestic Good.- 20.1 Introduction, notation and specification.- Steadu state.- 20.2 Estimated coefficients.- 21 Sales of the Domestic Good; Miscellaneous Identities for Investment and Capital.- 21.1 Introduction and notation for identities 108, 109, 113 and 144.- 21.2 Demand for, and sales of, the domestic good, and miscellaneous identities.- (a) Demand determination of output of the domestic good in the veny short run.- (b) Public-private split of business fixed investment.- 22 The Government Sector.- 22.1 Introduction.- 22.2 General government sector spending.- 22.3 The public sector deficit -identities 135-138 and 145-149.- 22.4 Public sector portfolio allocation.- 22.5 Target publicdebt to GDP ratio and the tax reaction function.- (a) The tax reaction function 148.- (b) Steadu state.- (c) Calibration.- 23 Financial Markets.- 23.1 Introduction.- 23.2 Formation of interest rates - identities 131-133, Il 5-I17, 126.- (a) Notation for interest rate formation and uncovered interest parity.- (b) Expectations theoru of the term structure of interest rates.- (c) Inflation and inflationary expectations.- (d) Real 10-year bond rate.- (e) Long-run actual rate of return on business fixed capital.- (f) Definitions offoreign short- and long-term interest rates.- 23.3 Uncovered interest parity - identity 127.- 23.4 Two key exchange rates.- 23.5 Money demand - equation S16.- (a) Specification and notation.- (b) Estimates.- 23.6 Balance of pauments identity 151.- 24 National-Accounting, Stock-Flow and Miscellaneous Identities.- 24.1 Introduction.- 24.2 National-accountinq identities.- 24.3 Stock-flow Identities.- 24.4 Lead-lag Identities.- 24.5 Three definitional identities.- Appendices to Part.- 2.1 List of variables in MM.- 2.2 List of coefficients and parameters in MM.- 2.3 Classification of MM equations.- 2.4 Consolidated equation list.- 2.5 Concordance between original MM notation for variables and notation used in Part 2.- 3 - Simulations with MM.- 25 Introduction to the Simulations.- 25.1 Preamble.- 25.2 Use of miniature models in Part 3.- 25.3 Guide to Chapters 26 and 27.- 26 Monetary Shocks.- 26.1 Introduction and notation.- 26.2 Features shared with the Dornbusch model.- 26.3 Overshooting and undershooting exchange rates revisited.- (a) Inevitability of overshooting in DBM.- (b) Possible sources of different exchange rate behaviour in DBM and MM.- (c) Rigorous definition of undershooting and overshooting exchange rates.- (d) Reporting simulation results for the exchange rate as deviations.- (e) MM's undershooting exchange rate.- 26.4 An extended Dornbusch model with inertia.- (a) Inertia in the IS curve.- (b) Solution sequence for the extended DBM.- (c) Form of the lag distribution for aggregate demand in the extended DBM.- (d) Factors responsible for inertia in aggregate demand in MM.- (e) Solutions of the extended DBM.- 26.5 Detailed analysis of MM responses to a monetary shock.- (a) Effects on the interest rate via the demand for money curve.- (b) Strategy for explaining the path of the exchange rate after the initial devaluation.- (c) Simplified price system for MM.- (d) Calibrating the simplified price system.- (e) Explaining short-term interest rate movements.- (f) Responses of dwelling investment and consumption.- (g) Responses of business fixed investment.- 26.6 D4M - a descriptive miniature Murphy Model for the analysis of a monetary shock.- (a) GNE, the price of the domestic good, and the interest and exchange rates.- (b) Calibrating D4M to MM.- (c) Completing the miniature model: the trade account and GDP.- (d) Extending the coverage of D4M: investment, imports and employment.- 26.7 Summary.- 27 A Fiscal Shock.- 27.1 The nature of the shock and general introduction.- 27.2 Strategy for constructing a shock-specific miniature.- 27.3 Identifying important initial consequences of the fiscal shock.- (a) The initial jump in GNE.- The jump in consumption.- Contribution to GNE of increased general government employment via labour market and wealth effects in MM's consumption function.- Direct contributions to GNE of government spending.- (b) Price behaviour in quarters 1 and 2 followinq the shock.- Regaining our bearings, I.- 27.4 Terminal conditions, I : Insights from HSM.- 27.5 Terminal conditions, S3MM-A stylized steady-state Murphy Model.- (a) Introduction to S3MM.- (b) Sustainability offoreign debt.- (c) Effects offiscal expansion in S3MM.- Macro comparisons with MM.- Increased public consumption.- Increased public employment.- Regaining our bearings, H.- 27.6 F3M-A fiscal miniature Murphy Model.- (a) Steady-state values for nominal GNE, the price of the domestic good, and the nominal exchange rate.- (b) Calibration ofF3M.- 27.7 MM's dynamic response.- (a) Wealth, foreign debt, labour income and consumption.- Portfolio changes.- (b) The real exchange rate and the trade account.- (c) Investment and GDP.- (d) Employment.- 27.8 Summary.- Appendices to Part.- 3.1 Parameter file for MM used in Part 3.- 3.2 Excel spreadsheet used to solve the Extended Dornbusch Model.- 3.3 Values of variables for calculating ratios in MM's steady state.- References.- Author and Personal Names Index.- Tables.- Figures.- Exercises.