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Econ 427 lecture 20 slides. Econometric Models. Econometric Forecasting Models. Term is general, but often used to refer to systems of simultaneous equations that are used for forecasting. Models are usually Dynamic Structural Estimated Simultaneous Models can be very small or very large

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Econ 427 lecture 20 slides

Econ 427 lecture 20 slides

Econometric Models


Econometric forecasting models
Econometric Forecasting Models

  • Term is general, but often used to refer to systems of simultaneous equations that are used for forecasting. Models are usually

    • Dynamic

    • Structural

    • Estimated

    • Simultaneous

  • Models can be very small or very large

    • Global Insight model of US has 516 behavioral equations and many more identities


Macro econometrics
Macro Econometrics

  • Macroeconomics was born with Keynes’s 1937 General Theory

  • Statistician began to measure macroeconomic variables (Kuznetts) and to try to model the macroeconomy (Klein)

  • In 1950, Lawrence Klein reported perhaps the first macro-econometric model of the U.S. economy, widely known as Klein Model I.


Klein model i
Klein Model I

Behavioral equations:

Const = a1 + a2 Pt + a3 Pt-1 + a4(PWBt + GWBt)

It = b1+ b2 Pt + b3 Pt-1 - b4 K t-1

PWBt = d1+ d2PSOt + d3PSOt-1 + d4TIMEt

Identities:

PSOt = Const + It + (Gt - GWBt)

Pt = PSOt - PWBt - Tt

Kt = Kt-1 + It

GNPt = CONSt + It + Gt

Cons = private consumption expenditure.

P = profits net of business taxes.

PWB = wage bill of the private sector.

GWB = wage bill of the government sector.

I = (net) private investment.

K = stock of (private) capital goods (at the end of the year).

PSO = aggregate output of the private sector.

TIME = an index of the passage of time, 1931 = zero.

G = government expenditure plus net exports.

T = business taxes.

GNP = gross national product.


Variables
Variables

  • Cons = private consumption expenditure.

  • P = profits net of business taxes.

  • PWB = wage bill of the private sector.

  • GWB = wage bill of the government sector.

  • I = (net) private investment.

  • K = stock of (private) capital goods (at the end of the year).

  • PSO = aggregate output of the private sector.

  • TIME = an index of the passage of time, 1931 = zero.

  • G = government expenditure plus net exports.

  • T = business taxes.

  • GNP = gross national product.


Estimated equations
Estimated Equations

Const = 16.60 + 0.017 Pt + 0.216 Pt-1+ 0.81 (PWBt + GWBt)

It = 20.3 + 0.15 Pt + 0.616 Pt-1 - 0.158 Kt-1

PWBt = 1.50 + 0.439 PSOt + 0.147 PSOt-1+ 0.13 TIMEt

PSOt = Const + It + (Gt - GWBt)

Pt = PSOt - PWBt - Tt

Kt = Kt-1 + It

GNPt = Const + It + Gt

(Klein’s data for 1920-1941. Estimates using 2SLS due to Greene, 2000.)


Solving simultaneous models
Solving simultaneous models

  • Gauss-Seidel method.

  • For time t:

    • Compute each equation’s value

    • Re-compute each equation’s value based on results of step 1

    • Iterate until “convergence”

  • Go to next period, t+1…

  • Eviews also has alternative solution algorithms


Solving simultaneous models1
Solving simultaneous models

1. Solve simultaneous block

For period = t, loop over these until convergence:

Const = a1 + a2 Pt + a3 Pt-1 + a4(PWBt + GWBt)

It = b1+ b2 Pt + b3 Pt-1 - b4 K t-1

PWBt = d1+ d2PSOt + d3PSOt-1 + d4TIMEt

PSOt = Const + It + (Gt - GWBt)

Pt = PSOt - PWBt – Tt

2. Calculate equations in recursive block

Then calculate these:

Kt = Kt-1 + It

GNPt = CONSt + It + Gt

3. Step ahead to next period t = t+1

4. Go to step 1.


Advantages and disadvantages
Advantages and disadvantages

  • Advantage of structural interpretation, detail, what-if scenarios

  • Usually models are too large to estimate simultaneously—potential parameter bias

  • Traditional macro equations may include parameters that are not invariant to changes in the environment—The Lucas critique

  • Large models are expensive to maintain


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