Byron Gangnes

Econ 427 lecture 20 slidesEcon 427 lecture 20 slides

Econometric Models

Econometric Forecasting ModelsEconometric 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

Byron Gangnes

Macro EconometricsMacro 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.

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Klein Model IKlein Model IBehavioral equations:

Const = a1 + a2 Pt + a3 Pt-1 + a4 (PWBt + GWBt)It = b1 + b2 Pt + b3 Pt-1 - b4 K t-1

PWBt = d1 + d2 PSOt + d3 PSOt-1 + d4 TIMEt

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.

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VariablesVariables• 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.

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Estimated EquationsEstimated EquationsConst = 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 modelsSolving 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

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Solving simultaneous modelsSolving simultaneous models

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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 + d2 PSOt + d3 PSOt-1 + d4 TIMEt

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+14. Go to step 1.

Advantages and disadvantagesAdvantages 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