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Modeling the Global Economy: The MSG3/G-Cubed Multi Country Models

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Title: Climate Change Author: Warwick J McKibbin Last modified by: wmckibbin Created Date: 2/23/1999 6:34:34 PM Document presentation format: On-screen Show – PowerPoint PPT presentation

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Title: Modeling the Global Economy: The MSG3/G-Cubed Multi Country Models


1
Modeling the Global Economy The MSG3/G-Cubed
Multi Country Models
  • Warwick J. McKibbin
  • Centre for Applied Macroeconomic Analysis (CAMA),
    CBE, ANU
  • Lowy Institute for International Policy, Sydney
  • The Brookings Institution.

Lecture Notes for ANU Course on Modeling Open
Economy, May 2007
2
Overview
  • Using Models
  • A Short History of Global Modeling
  • Intertemporal general equilibrium models as a
    modeling strategy
  • The G-Cubed and MSG3 models
  • Issues in estimation versus calibration
  • Benchmarking the model to a base year for
    projections
  • Simulations and Scenarios
  • An Example of why dynamic models are useful
  • Running the G-Cubed model
  • Inflation target
  • Country risk shock (bubble bursting)

3
What Features are Important in a Model?
  • Does the model explain anything we observe today
    or in the recent past?
  • Model validation is important
  • Estimation of parameters
  • Replication of history over time and key case
    studies
  • Evaluation of projections or forecasts
  • Is the model continually reviewed by experts who
    actually use it?
  • Is the model published in the refereed academic
    literature?
  • Is there a full listing of all equations
    available on request?
  • Is the model generally open to evaluation by
    others?

4
Types of Structural Global Models
5
Intertemporal GE models
  • Domestic
  • Jorgenson-Wilcoxen US model
  • Multi-Country
  • The MSG2 Multi-Country Model
  • (McKibbin Sachs)
  • The G-Cubed Multi-Country Model
  • (McKibbin Wilcoxen)
  • G-Cubed (Environment)
  • G-Cubed (Asia Pacific)
  • G-Cubed (Agriculture)
  • G-Cubed (Demographics)
  • The MSG3 Multi-Country Model
  • Oz Cubed (Australia detail)
  • I- Cubed (India detail)

6
Dynamic Intertemporal GE Models
  • integrates the key features of the other types of
    models
  • mix of econometric estimation and calibration of
    large structural models
  • annual frequency
  • problem with large degree of disaggregation
    because of complexity of the numerical algorithms
    needs

7
Features of MSG/G-Cubed models
  • Dynamic
  • Intertemporal
  • General Equilibrium
  • Multi-Country
  • Multi-sectoral
  • Econometric
  • Macroeconomic

8
Overall model development strategy
  • Funding is both through research grants and
    private consulting
  • Hub and spoke approach to coordinating a global
    research project (different strategy to Project
    Link)
  • The model is managed/developed in the core
    research team in Australia and Syracuse
  • Users (researchers/ governments/ financial
    investors) in different countries feed back to
    the core group both their own developments of
    the model as well as funding the core for new
    developments. All of which which we are able to
    incorporate into the model over time

9
The MSG2 Multi-country model(1984-1994)
  • McKibbin and Sachs

10
Development and Subscription Funding
  • McKibbin Software Group Inc
  • US Congressional Budget Office
  • The Brookings Institution
  • US Department of Commerce
  • US Government
  • United Nations
  • World Bank
  • Australian Treasury
  • Centre for International Economics
  • Nomura Research Institute
  • Daewoo Research Institute (Korea)
  • Warwick Modeling Bureau
  • Many Academic Colleagues

11
The MSG2 Model
  • Countries
  • United States -
    Taiwan
  • Japan -
    Malaysia
  • Germany -
    Indonesia
  • France -
    Thailand
  • Canada -
    India
  • United Kingdom
    -Philippines
  • Italy
    - Hong Kong
  • Austria - Singapore
  • Australia - Korea
  • New Zealand
  • China

12
The MSG2 Model
  • Classic Mundell-Fleming Model with extensions
  • 1 production sector in each country
  • macroeconomic focus
  • International capital and trade flows
  • Forward looking expectations by some agents
  • Rigidities in physical capital formation but
    highly mobile financial capital
  • Unemployment is labour markets due to
    institutional factors

13
The G-Cubed Model(1991- )
  • McKibbin Wilcoxen

14
Development and Subscription Funding
  • Major Funding
  • The Brookings Institution
  • United States Environmental Protection Agency
  • United States National Science Foundation
  • McKibbin Software Group Inc
  • Minor Funding through consultancies
  • United Nations
  • World Bank
  • Australian Dept of Environment/AGO
  • New Zealand Department of Commerce
  • Canadian Dept of Finance

15
The G-Cubed Model
  • Countries (8 including combinations of the
    following)
  • United States
  • Japan
  • Australia
  • New Zealand
  • Canada
  • Mexico
  • Europe
  • Rest of OECD
  • Brazil
  • Rest of Latin America
  • China
  • India
  • Eastern Europe and Former Soviet Union
  • Oil Exporting Developing Countries
  • Other non Oil Exporting Developing Countries

16
The G-Cubed Model
  • Sectors
  • Electric Utilities
  • Gas Utilities
  • Petroleum Refining
  • Coal Mining
  • Crude Oil and Gas Extraction
  • Other Mining
  • Agriculture, Fishing and Hunting
  • Forestry and Wood Products
  • Durable Manufacturing
  • Non Durable Manufacturing
  • Transportation
  • Services
  • Capital Producing sector

17
The G-Cubed (Asia Pacific) Model
18
Countries
  • United States Japan
  • Australia New Zealand
  • Canada Korea
  • United Kingdom Rest of the OECD
  • Thailand Indonesia
  • China Malaysia
  • Singapore Taiwan
  • Hong Kong Philippines
  • India
  • Oil Exporting Developing Countries
  • Eastern Europe and the former Soviet Union
  • Other Developing Countries

19
G-Cubed (Asia Pacific)
  • Sectors
  • Energy
  • Mining
  • Agriculture
  • Durable Manufacturing
  • Non-Durable Manufacturing
  • Services
  • Capital producing sector

20
The G-Cubed (Agriculture) Model
21
G-Cubed (Agriculture)
  • Countries
  • United States
  • Japan
  • Australia
  • EU12
  • Canada
  • Mexico
  • ROECD
  • China Hong Kong
  • ASEAN
  • Taiwan
  • Korea
  • ROW

22
G-Cubed (Agriculture)
  • Sectors
  • Food grains (rice and wheat)
  • Feed grains
  • Non-grain crops
  • Livestock and its products
  • Processed food
  • Forest and Fishery
  • Mining
  • Energy
  • Textile and Clothing
  • Other non-durable consumer goods
  • Durable consumer goods
  • Services
  • Capital Producing sector

23
Oz-Cubed
  • Countries
  • Australia
  • Rest of World
  • Sectors
  • 57 sectors

24
I-Cubed Model
  • Countries
  • India
  • USA
  • Rest of World
  • Sectors
  • 21 sectors

25
MSG3 Model
  • Many countries
  • 2 sectors
  • Energy
  • Non-energy

26
Structure of the Models
  • AGENTS MARKETS
  • Households Goods Services
  • Firms Factors of Production
  • Governments Money Bond
    Equity Foreign Exchange

27
The Structure of the G-Cubed Use Table
A) Interindustry transactions. B) Industry sales
to final demand sectors. C) Purchases of primary
factors by industries. D) Purchases of primary
factors by final demand sectors.
28
Sector Model
Sector Model
29
Data Used in Estimation
  • Value data from US benchmark input-output tables
  • 1958, 1963, 1967, 1972, 1977, 1982
  • Prices from US Bureau of Labor Statistics
  • Standardized industry classifications
  • Redefinition and reclassification
  • Eliminated secondary products
  • Redefinition and reclassification
  • Aggregated to 12 sectors
  • Corrected treatment of consumer durables
  • Investment rather than consumption
  • Reallocated construction to final investment

30
Key Features
  • Significant dis-aggregation of the demand and
    supply side of the major economies
  • demand and supply equations are based on a
    combination of intertemporal optimizing behavior
    and liquidity constrained behavior
  • Explicit treatment of asset markets including
    money
  • Sticky wages based on labour market institutions
    imply unemployment can persist for many years

31
Key Features
  • Distinction between stickiness of physical
    capital within sectors and countries and the
    flexibility of financial capital which
    immediately flows to where expected returns are
    highest
  • Extensive econometric estimation of key
    consumption and production substitution
    elasticities

32
Households
  • 2 types
  • A) maximize an intertemporal utility function
    consisting of all goods and services produced
    domestically and overseas, subject to an
    intertemporal budget constraint that the present
    value of consumption is bounded by the present
    value of after tax income from all sources
  • B)Base aggregate consumption expenditure on an
    optimal rule of thumb with current consumption of
    each good allocated so as to maximize
    contemporaneous utility

33
Firms
  • 2 types
  • A) Maximise their share market value (the
    present value of the future stream of dividends)
    subject to production technology, a cost of
    adjustment model of capital and taking prices as
    given. They base their calculation on a summary
    of the future measured by Tobins Q.
  • B) Base investment on a backward looking Tobins
    Q that eventually converges to the long run
    Tobins Q

34
Investment Model
  • Firms invest to maximize share market value
  • Capital specific to each sector
  • Household capital modeled as well
  • Adjustment costs
  • Some firms have adaptive expectations about q

35
Effect of Adjustment Costs
Sharp swings in investment are expensive.
36
Financial vs. Physical Capital
  • Physical capital immobile
  • Difficult to move once installed
  • Financial capital is perfectly mobile
  • Ownership of physical assets or debt instruments
  • Can be traded at will
  • Together, these imply that shocks have
  • Large short-run effects on asset prices
  • Little short-run effect on stocks
  • Physical capital stocks adjust slowly to new
    conditions

37
Effect of Shocks on Financial Assets
  • Effect of an adverse shock to demand for an asset
  • Initial large drop in price of assets (red arrow)
  • Over time, K falls and P slowly recovers (blue
    arrow)

38
Governments
  • Governments provide public goods that enter into
    the utility functions on households (additively
    separable) and transfer payments
  • They collect a wide variety of taxes on income of
    firms households, imports, sales.
  • Governments are subject to the intertemporal
    budget constraint that the present value of
    spending and transfers is bounded by the present
    value of future tax collections.

39
Countries
  • Countries are collections of individual firms,
    households and governments that trade goods and
    services as well as financial assets
  • Labor is immobile between countries but mobile
    within countries
  • Financial capital is mobile within and between
    countries
  • Physical capital is sector and country specific
    at any point in time and subject to adjustment
    costs over time.

40
Role of Money
  • Money is required for transactions between all
    agents. There is a technology that combines
    money with produced goods and services and the
    combined product is what is available in the
    market.
  • The supply of money is determined by a central
    bank in each economy in conjunction with
    assumptions about the monetary regime which is
    represented by a Henderson-McKibbin- Taylor type
    rule of the form

41
Henderson-McKibbin-Taylor Rule
42
Financial Markets
  • Financial markets exist for
  • Money
  • Government Bonds
  • Equity
  • Foreign Assets
  • Foreign Exchange
  • Each financial asset represents a claim over
    real resources
  • Money over purchasing power
  • Bonds are claims over future tax collections
  • Equity is a claim over the future dividend
    streams
  • Foreign assets are claims over the future exports

43
Goods and Services Markets
  • Households, Firms and Governments trade goods and
    services and price for each is assumed to clear
    the markets at an annual frequency

44
Factor Markets
  • Labor Markets
  • Nominal wages are set by different institutional
    structures in each country
  • Given the nominal wage and the market prices for
    goods and services firms higher labor until the
    real wage in each sector equals the marginal
    product of labor
  • Aggregate unemployment can result although over
    time it is assumed that unemployment tends to
    force the nominal wage towards the labor market
    clearing level.

45
Factor Markets
  • Capital
  • once installed physical capital is costly to
    move
  • Capital produces a flow of services for firms
    that have installed a capital stock through
    investment decisions in the past
  • Investment is subject to rising marginal costs
    of installation and depreciation over time.

46
Factor Markets
  • Energy and Materials in GCUBED
  • Firms purchase the output of other sectors as
    inputs in production
  • Total demand for the materials and energy sectors
    is final demand plus demand for intermediate
    inputs in each sector

47
Generating a Baseline Projection
  • Usually 2 approaches to policy analysis in the
    new generation of global models (CGE or macro)
  • Assume at a steady state and analyze deviations
    from steady state
  • Assume the observed data in a given year is on
    the stable manifold of a system dynamically
    adjusting to a long run steady state

48
Generating a Baseline Projection
  • Given values for all exogenous variables the
    model is solved for an equilibrium over time in
    which all equations hold given current and
    expected future variables.
  • Underlying the projection is a convergence model
    for sectoral productivity growth and exogenous
    population projections
  • We adjust the model so that we exactly generates
    the base year data set (2002).
  • Adjustments are made to constants in behavioral
    equations
  • In arbitrage equations this is equivalent to
    calculating risk premia

49
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Generating a Baseline Projection
  • This generates a baseline projection or forecast
    from 2002
  • We then step the model forward to 2003 adjusting
    the information set for 2003 to generate a
    baseline from 2003 to 2100

51
Running Scenarios
  • Once the baseline is generated we run scenarios
    by changing exogenous variables or initial
    conditions
  • The information set for markets is critical
  • Suppose we expect a shock what does the
    anticipation do before the actual shock occurs
  • Information sets can be changed by the user
    unexpectedly over time so we can ask questions
    like
  • Suppose we expected a shock but it doesnt happen
  • Suppose we dont expect a shock and it suddenly
    occurs

52
Use of Scenarios
  • The most effective way to undertake scenario
    analysis is with an internally consistent and
    empirically relevant framework
  • The models form the analytical and empirical
    basis for designing alternative scenarios

53
Use of Scenarios
  • Ask the question
  • What are the likely consequences of the Iraq War?
  • Design the scenarios that give different insights
    to the question
  • Examine history (Gulf War I, Afghanistan,
    Vietnam, Korea)
  • Wars always cost more than expected
  • Costs are more than the fiscal outlays
  • Shocks to
  • Government spending for the war (US, Aust, UK)
  • Government spending for the peace (Europe/Japan)
  • Increased global risk
  • Impose the shocks in a consistent framework (a
    model)
  • Interpret the results
  • Assess the key sensitivities that drive the
    results
  • Do people expect it to be temporary or more
    permanent?

54
Scenario Examples
  • The Aftermath of the Sept 11 Terrorist Attacks
  • What if Japan Adopted a Sensible Macroeconomic
    Policy?
  • The Consequences of WorldCom and Enron Collapses
  • The War with Iraq the compounding Effects of Oil
    Prices, Budgetary Costs and Uncertainty
  • The SARS Outbreak How Bad can It Get?
  • Exploding Fiscal Deficits in the United States
    Implication for the World Economy
  • What if China Revalues Its Currency
  • China The Implications of Policy Tightening
  • Oil Price Scenarios and the Global Economy
  • The United States Current Account Deficit and
    World Markets

55
Current Research Programs
  • Global Demographic Change (Japanese Govt, IMF,
    G20)
  • Economics of Infectious Diseases (WHO, NHMRC)
  • Global trade policy (WTO)
  • Macroeconomic imbalances
  • Climate Change Policy
  • Impact of China and India on the Global Economy

56
Research Projects/ Challenges
  • Model Development
  • Estimation at a more detailed level (with Peter
    Wilcoxen) to enable more flexible aggregation.
  • Incorporating uncertainty in long term
    projections (Peter Wilcoxen and various students
    at Syracuse)
  • Incorporating learning by agents (Kang Yong Tan)
  • Incorporating demographic variables following
    Blanchard/ Yaari/ Weil (Jeremy Nguyen)
  • Projecting productivity and convergence (Alison
    Stegman)
  • Emissions projections for climate predictions
    (Alison Stegman) - testing convergence

57
Research Projects/ Challenges
  • Model Development
  • Modeling developing countries
  • Modeling transition economies such as Vietnam
    (Hong Giang-Le)
  • Tajikstan (Zavkiev Zavkijon)
  • Incorporating Infectious diseases (WHO project)
    (with Alexandra Sidorenko)

58
Research Projects/ Challenges
  • Improving Macroeconomic Dynamics
  • Need to integrate the global structural models
    with the more data intensive VAR approach
  • Using the G-Cubed model to generate restrictions
    on multi-country VARS following Pagan and others
  • With Dungey, Fry, Pagan

59
An Example of the Importance of Dynamics
60
Trade Liberalization in a Dynamic Setting
  • by
  • Warwick J. McKibbin

61
A New Millenium Round
  • In 2000, it is announced that existing tariffs
    will be reduced by 1/3 from 2000 to 2010 in most
    countries
  • Tariffs on goods trade are based on the GTAP4
    database
  • For services it is assumed there is a cost
    reduction based on work by Centre for
    International Economics

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Summary
  • Largest gains to countries liberalizing most
  • short run losses outweighed by long run gains
  • trade impacts /exchange rate adjustments tend to
    be the opposite in the short run relative to the
    medium run (role of intertemporal budget
    constraints)

77
Background Papers
  • www.gcubed.com
  • www.economicscenarios.com

78
Using the G-Cubed Model
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