1. Byron Gangnes Econ 427 lecture 20 slides Econometric Models

2. 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 Byron Gangnes

3. 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.

4. Byron Gangnes Klein Model I Behavioral equations: Cons t = a 1 + a 2 P t + a 3 P t-1 + a 4 (PWB t + GWB t ) I t = b 1 + b 2 P t + b 3 P t-1 - b 4 K t-1 PWB t = d 1 + d 2 PSO t + d 3 PSO t-1 + d 4 TIME t Identities: PSO t = Cons t + I t + (G t - GWB t ) P t = PSO t - PWB t - T t K t = K t-1 + I t GNP t = CONS t + I t + G t 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.

5. Byron Gangnes 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.

6. Byron Gangnes Estimated Equations Cons t = 16.60 + 0.017 P t + 0.216 P t-1 + 0.81 (PWB t + GWB t ) I t = 20.3 + 0.15 P t + 0.616 P t-1 - 0.158 K t-1 PWB t = 1.50 + 0.439 PSO t + 0.147 PSO t-1 + 0.13 TIME t PSO t = Cons t + I t + (G t - GWB t ) P t = PSO t - PWB t - T t K t = K t-1 + I t GNP t = Cons t + I t + G t (Klein’s data for 1920-1941. Estimates using 2SLS due to Greene, 2000.)

7. 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 Byron Gangnes

8. Solving simultaneous models Byron Gangnes 1. Solve simultaneous block For period = t, loop over these until convergence: Cons t = a 1 + a 2 P t + a 3 P t-1 + a 4 (PWB t + GWB t ) I t = b 1 + b 2 P t + b 3 P t-1 - b 4 K t-1 PWB t = d 1 + d 2 PSO t + d 3 PSO t-1 + d 4 TIME t PSO t = Cons t + I t + (G t - GWB t ) P t = PSO t - PWB t – T t 2. Calculate equations in recursive block Then calculate these: K t = K t-1 + I t GNP t = CONS t + I t + G t 3. Step ahead to next period t = t+1 4. Go to step 1.

9. 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 Byron Gangnes