Post on 19-Jan-2016
description
The BNB Quarterly Projection Model
Emilia Penkova and Svilen Pachedzhiev
The BNB Quarterly Projection Model
Twinning Project “Adjustment of the Bulgarian National Bank to operate as a full-fledged member of the European System of Central Banks and the Euro-system”
Component 2: Research and preparation for monetary policy operations in line with ECB best practices
Introduction The first version of the Bulgarian National Bank Quarterly
Projection Model (BNBQM) which belongs to the group of traditional structural macroeconomic models.
The model is similar to the European System of Central Banks multi-country model country blocks. The guiding principle in designing the country blocks is that of close compatibility with the ECB Area-Wide Model.
The development of a model over the period 1998-2007 poses formidable challenges, given the short and volatile time series – we calibrate coefficients.
The model is continuously tested and simulated in order to improve it. It should be viewed as work in progress and an area for future empirical research within the BNB, rather than as a finished product.
Introduction
The theoretical background – Neo-Classical Synthesis. The long-run equilibrium is determined by supply side factors (Neo-Classical theory) and short-run fluctuations are demand driven (Keynesian theory).
Backward looking -expectations are reflected via lagged variables, which is considered adequate for the purpose of generating short- to medium-term forecasts.
Behavioral equations – error correction form (Engle Granger two step procedure has been employed).
The purpose of the BNBQM is twofold:
First, to produce macroeconomic forecasts for the Bulgarian economy.
Second, to assess the effects of economic shocks on the Bulgarian economy in simulated scenario analyses.
Outline of Presentation
Theoretical background
Structure of the model and estimated equations
Simulations
Concluding remarks and extensions of research
Supply side of the Economy
The standard theory of monopolistic competition is applied.
Profits of an individual firm are determined by returns from sale with costs of labour and capital subtracted.
The production process is represented by a Cobb Douglas function.
Supply side of the Economy
iiiii cKwLYPY )(
)(i
iP
PYY
1)( it
ii LeAKY
Supply side of the Economy
where Π(Yi) are profits of the firm, Li is the labour force used by the firm, Ki is the capital stock of the firm, α’s are the income shares; ρ is the exogenous growth rate of technological progress, σ is the elasticity of the demand for goods produced by the firm i to their relative price; w is the nominal wage level, c is the nominal cost of capital with
where r is the real rate of interest, δ is the physical depreciation rate of capital, PI is price of investment goods, Pi is the price of goods produced by the firm, P is the price of generic goods, Yi is the output of the firm i, Y is the aggregate supply of generic goods.
)( rPc I
Supply side of the Economy
ii
it
iiiii
iiiii
cKwL
LeAKPYcKwLYY
YP
cKwLYPY
1
111
))(()(
)(
Supply side of the Economy
First order conditions are:
0)1
())((1)
1(
11
1
cKLeAPY
Kii
t
i
0)1
)(1()(1)
1)(1(
1)1(
1
wLeAKPY
Li
t
ii
Supply side of the Economy
Using the assumption of symmetric equilibrium (Pi=P, Yi=Y, Li=L, Ki=K), we receive:
1)( LeAKY t
0)1
()( 1)1(
c
K
LPAe
Kit
0)1
)(1()()1(
w
L
KPAe
Lit
Supply side of the Economy
The aggregate output and the long-run demand for capital and labour are given by:
1)( LeAKY t
PcY
K
)1(
Pw
YL
)1)(1(
Structure of the model and estimated equations The simulation and projection features of the BNB Quarterly
Projection Model are driven by twenty behavioural equations and additional forty three identities. Around one hundred and sixty variables enter the model.
The model is in Eviews 5.1 (a program file which imports the data, estimates equations, solves the model and produces forecasts output).
The model is structured into five blocks: production function and factor demand equations, aggregate demand, prices and wages, monetary, and fiscal sector.
Model linkages
Labour market
External sector
Rest of the world Domestic demand
Monetary sector
Fiscal sector
Wages Prices
Error correction form
Most of the dynamic equations take the following general form:
where log(yt-1)-log(y*t-1) is the error correction term;
γ(.) and σ(.) – are polynomials;
l - the lag operator
ttt
tt
yy
ylyl
))*log()(log(
)log()()log()(
11
Potential output
R_YP_R = Potential output, prices of 2005R_TFP_TD = Total factor productivity, trend (2005=100)L_EMPL_TD = Employment, trendR_K_R = Capital stock, prices of 2005
4.0
6.0
__*
*__*____
RKR
TDEMPLLTDTFPRRYPR
Potential output
Total factor productivity is estimated as a residual from the production function for the estimated period then using Hodrick-Prescott filter we receive the trend.
The potential employment is received from a labour force forecast and estimated NAIRU.
NAIRU is assumed to be at around 7.7% level (slightly decreasing over the forecasting period) and is estimated using Elmeskov (1993) approach.
Employment
Log(L_EMPL_STAR) = 3.278 + 0.600*log(R_Y_R) - (5.607) (-)
- 0.400 *log(L_W/I_HICP_P)
(-)
Dlog(L_EMPL)= -0.089 - 0.296*(log(L_EMPL (-1)) –
(18.365) (5.138)
- log(L_EMPL_STAR(-1)))+ 0.001* Dlog(L_EMPL(-1))
(0.002)
L_EMPL = Employment (employees + self employed)R_Y_R = GDP, prices of 2005L_W = Nominal wage bill per workerI_HICP_P = Harmonised index of consumer prices, 2005 = 100
Employment
Employment
3000310032003300340035003600370038003900
TRUE
FORECAST
Gross fixed capital formationLog(R_KF_R_STAR)= 1.942+ 0.700*log(R_Y_R)- (4.338) (-)- 0.108*M_LTIR_N - 0.007*I_I_P (9.451) (2.516)
Dlog(R_KF_R) = 0.242 -0.003*(log(R_KF_R(-1))- (6.285) (-)
- log(R_KF_R_STAR(-1))) - 0.363*Dlog(R_KF_R(-1)) (2.135)
R_KF_R = Gross fixed capital formation, 2005 pricesR_Y_R = GDP, 2005 pricesI_I_P = Inflation, in percentagesM_LTIR_N =Nominal long-term interest rate, in percentages
Gross fixed capital formation
Gross fixed capital formation
1500
2000
2500
3000
3500
4000
4500
TRUE
FORECAST
Private consumption
Log(R_C_R_STAR) = 2.365 + 0.800*log(R_DI_N/I_HICP_P) + (21.979) (-)
+ 0.300*log(R_K_R) (-)
Dlog(R_C_R) = 0.077 - 0.483*(log(R_C_R(-1)) – (3.743) (2.200)
- log(R_C_R_STAR(-1))) -0.343*Dlog(R_C_R(-1)) (2.074)
R_C_R = Private consumption, prices of 2005 R_DI_N = Disposable income (wages and salaries+ pensions and social benefits + imputed rent +compensation of employees(BOP) + current transfers (BOP)) I_HICP_P = Harmonised index of consumer prices, 2005 = 100R_K_R = Capital stock, prices of 2005
Private consumption
Private consumption
6500.00000
7000.00000
7500.00000
8000.00000
8500.00000
9000.00000
9500.00000
TRUE
FORECAST
ExportsLog(E_EX_R_STAR) = 6.108 + log(A_WTV_R)- (2.024) (-)
- 0.451*log(E_EX_P/(A_MEPAE_P*E_ER_PI)) (4.758)
Dlog(E_EX_R) = -0.265 -0.206*(log(E_EX_R(-1))- (8.268) (1.448)
-log(E_EX_R_STAR(-1))) + 0.020*Dlog(E_EX_R(-1)) (0.151)
E_EX_R = Exports, prices of 2005 A_WTV_R = Volume of world trade (weighted average), 2005 = 100E_EX_P = Export deflator, 2005 = 100A_MEPAE_P = Manufacturing export price for advanced economies, 2005=100E_ER_PI = Exchange rate BGUSD, 2005=100
Exports
Exports
400050006000700080009000
1000011000
TRUE
FORECAST
ImportsLog(E_MP_R_STAR) = -2.473 + log(R_DD_R) – (13.023) (-)
- 0.305*log(E_MP_P/R_GDP_P) (3.821)
Dlog(E_MP_R) = 0.072 – 0.052*(log(E_MP_R(-1)) – (4.811) (0.645)
-log((E_MP_R_STAR(-1)))
E_MP_R = Imports, prices of 2005R_DD_R = Real domestic demand, prices of 2005 (private consumption expenditure + government consumption expenditure + gross fixed capital formation)E_MP_P = Import deflator, 2005 = 100 R_GDP_P= GDP deflator, 2005 = 100
Imports
Imports
6000
7000
8000
9000
10000
11000
TRUE
FORECAST
GDP deflator
Log (R_GDP_P_STAR) = -0.011 + log(L_ULC)
(0.482) (-)
Dlog(R_GDP_P)=0.017-0.030*(log(R_GDP_P(-1))-
(2.202) (1.002)
log(R_GDP_P_STAR(-1)))-0.071*dlog(R_GDP_P(-
(0.397)
-1))+0.100*R_YG_R (-)
R_GDP_P = GDP deflator, 2005=100L_ULC = Unit labour cost, 2005=100R_YG_R = Output gap (% potential GDP)
GDP deflator
GDP deflator
0.99
1
1.01
1.02
1.03
1.04
1.05
TRUE
FORECAST
HICP without administered prices
Log(I_HICPEXA_P_STAR) = 0.007 + 0.488*log(R_GDP_P) + (0. 588) (4.155)
+0.512*log(E_MP_P) (-)Dlog(I_HICPEXA_P) = 0.029 - 0.381*(log(I_HICPEXA_P(-1)) (5.701) (3.891) -log(I_HICPEXA_P_STAR(-1))) +
+0.220*Dlog(I_HICPEXA_P(-1))
(1.526) I_HICPEXA_P = Harmonized Index of Consumer Prices without administered prices, 2005 = 100L_ULC = Unit labour cost, 2005=100E_MP_P = Import deflator, 2005 = 100
HICP without administered prices
HICP without administered prices
0.98
1
1.02
1.04
1.06
1.08
1.1
1.12
TRUE
FORECAST
Export deflatorLog(E_EX_P_STAR) = -2.313 + 0.592*log(R_GDP_P) + (5.052) (3.376)
+ 0.408*log(A_MEPAE_P*E_ER_PI) (-)
Dlog(E_EX_P) = 0.010 – 0.853*(log(E_EX_P(-1))- (2.110) (4.548)
- log(E_EX_P_STAR(-1))) -0.071*Dlog(E_EX_P(-1))- (0.697)- 0.058*Dlog(E_EX_P(-2)) +0.381*Dlog(E_EX_P(-3))- (0.580) (3.798)- 0.264*Dlog(E_EX_P(-4))) (2.590)E_EX_P = Export deflator, 2005 = 100
A_MEPAE_P = Manufacturing export price for advanced economies, 2005=100
R_GDP_P = GDP deflator, 2005 = 100E_ER_PI = Exchange rate BGUSD, 2005=100
Export deflator
Export deflator
11.021.041.061.081.1
1.121.141.16
TRUE
FORECAST
Import deflatorLog(E_MP_P_STAR)=-2.284 + 0.360*log(A_EU15MP_P*E_ER_PI)
(2.810) (4.710)
+ 0.640*log(R_GDP_P) (-)Dlog(E_MP_P) = 0.025 -0.116*(log(E_MP_P(-1)) – (2.400) (0.827)
-log(E_MP_P_STAR(-1)))- 0.381*Dlog(E_MP_P(-1)) (2.530)
E_MP_P = Import deflator, 2005 = 100A_EU15MP_P = EU 15 Import deflator, 2005 = 100E_ER_PI = Exchange rate BGUSD, 2005=100R_GDP_P = GDP deflator, 2005 = 100
Import deflator
Import deflator
1.04
1.05
1.06
1.07
1.08
1.09
1.1
1.11
TRUE
FORECAST
Wages
Log(L_W_STAR) = -5.822+ log(L_LPR) – 0.001*L_UR + (3.087) (-) (0.712)
+ log(I_HICP_P) (-)
Dlog(L_W) = 0.131 -0.207*(log(L_W(-1)) – (10.598) (1.138)
- log(L_W_STAR(-1))) - 0.352*Dlog(L_W(-1)) (1.739)
L_W = Nominal wage bill per workerL_LPR = Labour productivity: GDP in prices of 2005/Number of employees L_UR = Unemployment, in percentagesI_HICP_P = Harmonised index of consumer prices
Wages
Nominal wage bill per worker
200
250
300
350
400
450
500
TRUE
FORECAST
Fiscal sector
Government expenditures and government revenues are modelled separately:
The government expenditures are disaggregated into five parts: government consumption, government investment, government transfers, government interest payments and other expenditure.
The government revenues consist of five components: revenues from personal income tax, social security contribution, revenues from corporate income tax, revenues from indirect taxes and other revenue items.
Personal income taxes
G_PIT = G_PIT_TR*R_CE_N
G_PIT = Personal income taxes (million leva)
G_PIT_TR =Personal income effective tax rate
R_CE_N = Compensation of employees (million leva)
Social security contribution
G_SSC=G_SSC_TR*R_CE_N
G_SSC = Social security contribution (incl. employers’ and employees’ contribution in million leva)
G_SSC_TR = Social security effective tax rate
R_CE_N = Compensation of employees (million leva)
Indirect taxes
G_IND=G_IND_TR*R_C_N
G_IND = Indirect taxes (incl. VAT, customs revenue, excise duties)
G_IND_TR = Indirect effective tax rate
R_C_N = Private consumption, in current prices
Corporate income tax
G_CIT = G_CIT_TR*R_GOS_N
G_CIT = Corporate income tax
G_CIT_TR = Corporate income effective tax rate
R_GOS_N = Gross operating surplus and mixed income
Simulations
To illustrate the simulation properties of the BNBQM, we assess the response of the model’s main variables to the following standard shocks:
an increase in government consumption by 1% of GDP
an increase in volume of world trade by 1%
a depreciation of the lev against the US dollar by 1%
an increase in the price of oil by 10%
an increase in EURIBOR by 100 basis points
Simulation of an increase in government consumption by 1% of GDP (Q1’2002 – Q4’2008)Levels, percentage deviations from baseline
Year 1 Year 2 Year 3 Year 4 Year 5 Year 7
HICP 0.031 0.162 0.319 0.476 0.607 0.666ULC -0.506 0.040 0.316 0.538 0.670 0.709Comp. per employee 0.385 0.794 0.917 0.933 0.840 0.450Productivity 0.896 0.753 0.599 0.393 0.168 -0.256
GDP 1.012 1.058 0.973 1.053 0.498 -0.119 Private consumption 0.060 0.333 0.517 0.575 0.534 0.257Investment 0.003 0.009 0.014 0.017 0.020 0.020Exports -0.009 -0.086 -0.198 -0.300 -0.387 -0.427Imports 0.042 0.196 0.386 0.595 0.781 1.099
Government consumption shock
An increase in the government consumption boosts domestic demand and raises GDP by 1.01% as a primary effect. This effect remains for 5 years, after which it gradually dies out due to secondary effects.
The fiscal expansion stimulates production and investment.
Nominal wages and prices go up. Higher employment and wages lead to higher personal incomes and to an increase in consumption.
Larger investment and stronger private and government consumption leads to increasing imports.
Expanding economic activity translates into widening of the output gap that pushes up the price level.
Simulation of an increase in world demand by 1% (Q1’2002 – Q4’2008)Levels, percentage deviations from baseline
Year 1 Year 2 Year 3 Year 4 Year 5 Year7HICP 0.005 0.071 0.204 0.379 0.564 0.807ULC -0.255 -0.205 0.077 0.366 0.551 0.788Comp. per employee 0.101 0.554 0.884 1.076 1.144 1.010Productivity 0.357 0.760 0.807 0.708 0.589 0.220
GDP 0.395 0.971 1.175 1.173 1.100 0.545Private consumption 0.007 0.158 0.397 0.576 0.662 0.571Investment 0.001 0.005 0.011 0.016 0.021 0.027Exports 0.725 1.546 1.583 1.497 1.426 1.320Imports 0.001 0.029 0.106 0.235 0.390 0.728
An increase in world demand This simulation is particularly important because of the openness of
the Bulgarian economy. The external demand shock leads to a stronger domestic demand. The external shock directly drives up the volume of exports by 1.55% (second year), which in turn also increases imports.
Employment and nominal wages increase which leads to higher private consumption (0.57%-seventh year).
Higher aggregate demand widens the output gap that pushes up the aggregate price level.
Simulation of a depreciation of the lev against the US dollar by 1%(Q1’2002 – Q4’2008)Levels, percentage deviations from baseline
Year 1 Year 2 Year 3 Year 4 Year 5 Year 7HICP 0.008 0.065 0.129 0.190 0.250 0.310Import deflator 0.067 0.190 0.279 0.337 0.390 0.005Export deflator 0.336 0.565 0.493 0.511 0.572 0.006ULC -0.067 -0.009 0.056 0.137 0.203 0.003Comp. per employee 0.032 0.145 0.236 0.328 0.387 0.004Productivity 0.099 0.154 0.180 0.191 0.184 0.001
GDP 0.110 0.205 0.266 0.308 0.325 0.288Private consumption 0.003 0.044 0.090 0.118 0.133 0.011Investment 0.000 0.001 0.002 0.003 0.004 0.001Exports 0.198 0.289 0.294 0.308 0.295 0.002Imports -0.003 -0.028 -0.066 -0.098 -0.110 -0.098
An exchange rate shock The decrease in the value of the lev against the US dollar has an
immediate impact on both the import and export deflators – they both increase.
HICP increases by 0.25% in the fifth year. Compensation per employee adjusts and income increases which drives the consumption up.
Because of the relative increase in foreign prices, imports decrease and exports increase slightly. The reaction of real GDP to an exchange rate shock achieves its maximum in the fifth year (0.32%).
Simulation of an increase in the price of oil by 10%(Q1’2002 – Q4’2008)Levels, percentage deviations from baseline
Year 1 Year 2 Year 3 Year 4 Year 5 Year7
HICP 0.016 0.110 0.177 0.227 0.296 0.413 Import deflator 0.160 0.468 0.656 0.851 1.052 1.299Export deflator 0.481 0.814 0.618 0.886 1.031 1.103ULC 0.032 0.110 0.084 0.117 0.185 0.204Comp. per employee -0.005 -0.055 -0.048 0.028 0.088 0.352Productivity -0.037 -0.164 -0.132 -0.089 -0.097 0.148
GDP -0.041 -0.194 -0.186 -0.140 -0.146 0.220 Priv. consumption 0.000 -0.012 -0.067 -0.125 -0.171 -0.231 Investment 0.000 -0.001 -0.003 -0.004 -0.005 -0.006
Exports -0.081 -0.394 -0.413 -0.432 -0.593 -0.621 Imports -0.005 -0.057 -0.154 -0.280 -0.424 -0.774
An oil price shock An oil price shock leads to increasing domestic prices through direct
channels - rising import prices. The response grows gradually and achieves its maximum - 0.41% for HICP in the seventh year.
The rise in prices causes a reduction in the demand for domestic and
foreign goods and the consequent fall in household consumption, imports and exports. As a result, GDP and real disposable income are below baseline till year six.
Higher oil price has a negative impact on output and domestic demand (private consumption declines by 0.17% and GDP falls by 0.15% in the fifth year).
Reduced economic activity leads to a lower demand for imports, real exports are also decreasing due to an increase in domestic prices.
Simulation of an increase in EURIBOR by 100 basis points (Q1’2002 – Q4’2003) Levels, percentage deviations from baseline
Year 1 Year 2 Year 3 Year 4 Year 5 Year7HICP -0.001 -0.007 -0.017 -0.021 -0.015 0.015ULC 0.026 0.011 -0.049 -0.054 -0.031 -0.010Comp. per employee -0.010 - 0.051 -0.054 -0.001 0.041 0.082Productivity -0.086 -0.195 -0.156 -0.052 0.037 0.220
GDP -0.096 -0.269 -0.291 -0.182 -0.059 0.239Private consumption -0.066 -0.182 -0.243 -0.289 -0.342 -0.359Investment -0.283 -0.933 -1.256 -1.118 -1.038 -0.890Exports 0.000 0.000 0.001 0.001 0.000 0.001Imports -0.006 -0.071 -0.214 -0.396 -0.571 -0.865
Interest rate shock Because of the fixed exchange rate regime the exchange rate does not
react to domestic interest rate changes. The main effect is through investment- raising costs of capital and reducing output. Investment decreases by 1.12% and GDP is reduced by 0.18% in the fourth year.
The effect on domestic prices is negative due to a weaker domestic demand.
Due to lower internal aggregate demand, employment and wages fall.
Concluding remarks and extensions A first step towards building a structural
macroeconomic model.
This practical work gives valuable information for the future development of the model which needs to be continuously developed and could be improved in a number of respects:
Availability of new data will require re-estimation and re-calibration of the model;
Concluding remarks and extensions
Developing a long-run baseline that reflects a fully theory-consistent long-run steady state;
To consider policy rules in the simulations;
Developing a more detailed representation of the trade block by including services on the one hand and different regions on the other hand;
An extension of forward-looking behaviour. Expectations should be incorporated, particularly to allow for a specific role in price and wage formation.
Baseline (work in progress)Real exports to GDP
35
40
45
50
55
60
65
70
2000 2025 2050 2075 2100 2125 2150 2175 2200
Baseline (work in progress)Real imports to GDP
30
40
50
60
70
80
90
100
2000 2025 2050 2075 2100 2125 2150 2175 2200
Baseline (work in progress)Real private consumption to GDP
45
50
55
60
65
70
75
80
2000 2025 2050 2075 2100 2125 2150 2175 2200
Baseline (work in progress)Real capital formation to GDP
5
10
15
20
25
30
35
2000 2025 2050 2075 2100 2125 2150 2175 2200