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Econ 427 lecture 20 slidesPowerPoint Presentation

Econ 427 lecture 20 slides

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

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

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

- 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

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

- 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 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

- 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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