Towards a general model of economic trade, investment and growth Terry Maidment Economists Conference 2003 ANU Globalisation and Distribution MON. 13:45 - 15:15 MCC T6

Introduction This paper covers topics related to economic welfare from trade and growth of relevance to: Australia, the developing economies of ASEAN and APEC as well as the leading industrial economies of the United States and Japan.

Story Line Commodity price shocks applied to a GTAP simulation would quantify the effects of the recent changes relative to total global trade flows Theory highlights the role of interest rates, exchange rates and inflation in long run ge models The empirical model is a Keynesian demand model of consumption, IS and LM for 16 economies

Main points Microeconomic foundations of investment include human capital in endogenous growth models (in particular see Beaudry and Green 2003) At the 2003 UNSW econometric conference there were two papers on the short term official interest rate the policy instrument. In addition, a paper on FDI observed that FDI should be placed in the context of total capital movements and complete capital markets. An empirical result that we state is that the real exchange rate Granger causes the real interest rate but not the reverse causality in the case of Japan.

Finer points Special note on the EU Policy of SLP for developing economies Stabilisation: Argentina and Brazil Liberalisation: APEC, WTO, China Privatisation: EU and Budget deficit, the Maastrict Treaty

Regional focus and theory CLMV (Cambodia, Laos, Myanmar, Vietnam) APEC and MFN ASEAN GE Theory

Input Output Statistics and CGE analysis It has been well known for some time that the statical Leontief system is the simplest form of Walrasian general equilibrium, it provides disaggregation within a macro model and in the simplest Leontief system, the linear programming solution is well defined. Dorfman, Samuelson and Solow, DOSSOL, Chapter 9, The Statical Leontief System, pp 204-264.

General equilibrium assumptions

Sensitivity analysis and model parameters Kim and Pagan 1997 have described calibration of CGE models as flowing from Johansen 1960. Johansen's linearised solution of equilibrium values presupposes the existence of a benchmark data set and also an evaluation of a stochastic equilibrium solution of a potential empirically identified economy. The solution however is not necessarily observable in a real economy. Sensitivity to parameter values and CGE model reliability are analysed in Pagan and Shannon, 1987 and Horridge, 1986. Hanslow and Pearson 1989 demonstrated the utility of TABLO in GEMPACK for performing local sensitivity analysis on any set of model parameters. Kim and Pagan 1997, page 364.

International Markets Commodity Markets Total trade and price effects Capital flows Trade agreements Regional issues Financial market dynamics Australia Exchange rate

Real effective exchange rate Japan 1980 to 2003

Real interest rate for Japan

Real interest rate for Japan and the United States

Euro Real effective exchange rate 1980Q1 to 2003Q1

Euro nominal Govt bond yield 1994Q1 to 2003Q1

Real EURO IR 1998Q1 to 2003Q1

Long bond rate global markets Recovery of Japan’s financial markets

Australia’s Long run real exchange rate

Australia’s Short run real exchange rate

10 year bonds rising at last in Australia and Japan

ASX Dividend yields

Real and nominal ASX

ASX Annual and real returns

Returns on the ASX since 1995 Monthly and annual

Financial sectors ASX levels: Recent patterns

Industrial ASX sectors: Recent patterns

Financial sectors ASX accumulation index levels

Industrial ASX sectors accumulation index: Recent patterns

Expected inflation and interest rate differentials

Australia’s environment The key industry sector in the current business cycle seems to be IT related and its characteristics have been well analysed. Trade linkages Financial markets Regional trade and growth Commodity Markets

Australia’s Commodity prices since 1993 with and without oil

Cumulative changes in Australia’s export commodities

Australia’s export prices per cent monthly changes

GTAP IRAQ price shock The GTAP simulation for the recent IRAQ, SARS shocks is based on a 7% commodity price decline. GTAP version 4 with ten regions and ten industry sectors.

GTAP results in percentage chages

Keynesian 3-equation model

Australia Consumption

Australia’s Investment equation

Australia’s money demand equation - Interest rate formation

Summary and conclusion Australia’s growth is related to world stability and equilibrium growth rates Japans markets indicate a return to stability and growth Trade liberalisation, competitition policy and microeconomic reforms focussing on efficiency and productivity offer key returns for welfare gains