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Macroeconomic Models

Introduction to Basic Theory

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Model

A Model describes the theoretical relationshipbetween variables.

Macroeconomic model would thus describe

the relation between macroeconomicvariables

Models are estimated using Statistical

Methods, Econometric Theory (MathematicalModelling of Economic Theory and estimatedusing Statistical Data)

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Example

We can model the relation between GDP andInvestment following one of the most simpleprocedures.

First take, GDP(y)=f(Investment(i)) as one of thebasic and assumed model

The mathematical function will then describe theexpected model where we can findtheory/literature which will help us define thenature of the model

Is it a linear, non-linear?

Hence the linear function will be y=a +b (i)

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Contd.

Then the non-linear model will be any type of

Quadratic, cubic, exponential or logarithmic

type of functions

Y=a+b(i)+c(i^2) ::: where ^ is power

Y=e^I

Y=a+b(log_i) etc.

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Estimation

Estimation of the specified model is then theMathematical procedures to determine the valueof a and b of the function in example for a linear

function. The a and b can be estimated using a Procedure

known as OLS, Ordinary Least Squares or ML,Maximum Likelihood. Common is OLS. So we will

use it all the way along the course. But note that to estimate the a and b, we will

need to use Matrices, and Statistical data.

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Contd.

Statistical data on GDP and Investment will beused for any country, for example Pakistan formore than 30 years or for 30 or more countries

for a single year. The datasets are attached withthe email/link you will receive for thesedocuments.

OLS details are given in the attached reading

material. So how to estimate the a and b of the example

model, we will use Eviews.

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Eviews

Open the given data/workfile

Note the y and I

Select the series containing data on y and I

Click Quick

Click Estimate Equation

Type the following line

y c I Note the data points equal the number of years

for which we have the data

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Estimation Checking

How to see if the estimated model is the best

We use tests which are used for the checkingof OLS assumptions BLUE

Also will check some other Econometricproblems in the estimated models

These include Autocorrelation,

heteroscedasticity, Multi-collinearity andNormality of the error terms etc.

Why?

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Model Selection

For example we estimated two types of models

A Linear

A Non-linear as described above

How would you select which model is the good one(technically we will explore these and related issues innext week sessions when our main point of discussionwill be Estimation and Selection of a Model among alist of Possible Models

Why? Because we need to be sure that the model usedfor forecasting the best model used on grounds ofMathematical, Statistical and Econometric reasons.

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Eviews Session

Now see how we estimate each type of model

First Estimate the Linear Models

The Estimate the Quadratic Models Signs and Interpretation of Estimates

Theoretical Justifications for the Signs

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Questions & Answers

Any Questions and Answers?

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HomeWork

Now select a country of your choice, collect annual orquarterly data on GDP (y), Labour Force (L), AgricultureProduction Values (ag), Industrial Values (il), Land (ArableLand, Area under Cultivation) (area) and estimate thefollowing Model. You can use World Bank databank, IMF

Statistics.

Gdp=f(L, il, ag/area)?

Interpret the estimate model?

Any theoretical Reason? Any issues you find in literature (search google scholar)

related this type of models?

What Alternatives are presented?