1

Modeling the Global Economy: Lessons from the MSG3/G-Cubed

Multi Country Models

Warwick J. McKibbinCentre for Applied Macroeconomic Analysis ANU

& Lowy Institute for International Policy, Sydney

& The Brookings Institution.

Presentation prepared for MLC, 30 April 2007

2

Overview

• Intertemporal general equilibrium models as a modeling strategy• The G-Cubed and MSG3 models• Benchmarking the model to a base year for projections• Some lessons

– Composition of household wealth matters– Volatility of financial prices when sticky physical capital– Relative prices matter for macroeconomic outcomes– Real exchange rates important for potential output– Policy transmission

• Fiscal/ versus monetary• Permanent versus temporary versus anticipated

– Role of international financial capital flows which sticky physical capital in transmission

• Conclusion

Types of Structural Global Models

Structural Global Models

Input/Output Models

Old Style Macroeconometric Models

1960s/70s

Computable General Equilibrium Models (CGE)

Models

Dynamic Intertemporal General Equilibrium Models

Modern Macroeconometric Models 1980s/90s

Dynamic Stochastic General Equilibrium (DSGE) Models

4

Intertemporal GE models

• Domestic– Jorgenson-Wilcoxen US model

• Multi-Country– The MSG2 Multi-Country Model

– (McKibbin & Sachs)– The G-Cubed Multi-Country Model

– (McKibbin & Wilcoxen)• G-Cubed Environment• G-Cubed (Asia Pacific)• G-Cubed (Agriculture)• G-Cubed (Demographics)• The MSG3 Multi-Country Model

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Dynamic Intertemporal GE Models

• integrates the key features of the other types of models• mix of econometric estimation and calibration of large

structural models• annual frequency• problem with large degree of disaggregation because of

complexity of the numerical algorithms needs

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Features of MSG/G-Cubed models

• Dynamic • Intertemporal • General Equilibrium • Multi-Country • Multi-sectoral • Econometric • Macroeconomic

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The MSG2 Multi-country model(1984-1994)

McKibbin and Sachs

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The MSG2 Model

• Countries• United States - Taiwan• Japan - Malaysia• Germany - Indonesia• France - Thailand• Canada - India• United Kingdom -Philippines• Italy - Hong Kong• Austria - Singapore• Australia - Korea• New Zealand• China

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The MSG2 Model

• Classic Mundell-Fleming Model with extensions• 1 production sector in each country• macroeconomic focus• International capital and trade flows • Forward looking expectations by some agents• Rigidities in physical capital formation but highly

mobile financial capital• Unemployment is labour markets due to institutional

factors

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The G-Cubed Model(1991- )

McKibbin & Wilcoxen

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The G-Cubed Model– Countries (8+ including combinations of the following)

• United States• Japan• Australia• New Zealand• Canada• Mexico• Europe• Rest of OECD• Brazil• Rest of Latin America• China• India• Eastern Europe and Former Soviet Union• Oil Exporting Developing Countries• Other non Oil Exporting Developing Countries

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The G-Cubed Model

– Sectors

– Electric Utilities

– Gas Utilities

– Petroleum Refining

– Coal Mining

– Crude Oil and Gas Extraction

– Other Mining

– Agriculture, Fishing and Hunting

– Forestry and Wood Products

– Durable Manufacturing

– Non Durable Manufacturing

– Transportation

– Services

Capital Producing sector

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The G-Cubed (Asia Pacific) Model

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Countries

• United States Japan

• Australia New Zealand

• Canada Korea

• Rest of the OECD

• Thailand Indonesia

• China Malaysia

• Singapore Taiwan

• Hong Kong Philippines

• India

• Oil Exporting Developing Countries

• Eastern Europe and the former Soviet Union

• Other Developing Countries

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G-Cubed (Asia Pacific)

– Sectors• Energy• Mining• Agriculture• Durable Manufacturing• Non-Durable Manufacturing• Services

Capital producing sector

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The G-Cubed (Agriculture) Model

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G-Cubed (Agriculture)

– Countries– United States– Japan– Australia– EU12– Canada– Mexico– ROECD– China & Hong Kong– ASEAN– Taiwan– Korea– ROW

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– Sectors• Food grains (rice and wheat)• Feed grains• Non-grain crops• Livestock and its products • Processed food• Forest and Fishery• Mining• Energy• Textile and Clothing• Other non-durable consumer goods• Durable consumer goods• Services

Capital Producing sector

G-Cubed (Agriculture)

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G-Cubed (Demographics)

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G-Cubed (Demographics)

• Countries– Japan– USA– Western Europe– Rest of OECD– Eastern Europe and the Former Soviet Union– China– India– Other Asia– Latin America– Other Developing Countries

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Sectors

• Energy• Non-Energy

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Structure of the Models

• AGENTS MARKETS • Households Goods & Services • Firms Factors of Production• Governments Money

Bond Equity Foreign Exchange

: The Structure of the G-Cubed Use Table

A) Interindustry transactions.B) Industry sales to final demand sectors.C) Purchases of primary factors by industries.D) Purchases of primary factors by final demand sectors.

1

...

12

C

I

G

X M

1

...

A

B

12

R

K

C

Kc

D

L

Sector Model

Output

Capital Energy Materials Labor

CES

Electricity Natural Gas Refined Oil Coal Crude Oil

Mining Agriculture Forestry and Wood Durables Nondurables Transportation Services

CES CES

Sector Model

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Key Features

• Significant dis-aggregation of the demand and supply side of the major economies ;

• demand and supply equations are based on a combination of intertemporal optimizing behavior and liquidity constrained behavior;

• Explicit treatment of asset markets including money;

• Sticky wages based on labour market institutions imply unemployment can persist for many years

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Key Features

• Distinction between stickiness of physical capital within sectors and countries and the flexibility of financial capital which immediately flows to where expected returns are highest

• Extensive econometric estimation of key consumption and production substitution elasticities

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Financial Markets

• Financial markets exist for– Money– Government Bonds– Equity– Foreign Assets– Foreign Exchange

• Each financial asset represents a claim over real resources

– Money over purchasing power– Bonds are claims over future tax collections– Equity is a claim over the future dividend streams– Foreign assets are claims over the future exports

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Generating a Baseline Projection

• Usually 2 approaches to policy analysis in the new generation of global models (CGE or macro)

– Assume at a steady state and analyze deviations from steady state

– Assume the observed data in a given year is on the stable manifold of a system dynamically adjusting to a long run steady state

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Generating a Baseline Projection

• Given values for all exogenous variables the model is solved for an equilibrium over time in which all equations hold given current and expected future variables.

• Underlying the projection is a convergence model for sectoral productivity growth and exogenous population projections

• We adjust the model so that we exactly generates the base year data set (2002).

• Adjustments are made to constants in behavioral equations– In arbitrage equations this is equivalent to calculating

risk premia

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Generating a Baseline Projection

• This generates a baseline projection or forecast from 2002

• We then step the model forward to 2003 adjusting the information set for 2003 to generate a baseline from 2003 to 2100

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Running Scenarios

• Once the baseline is generated we run scenarios by changing exogenous variables or initial conditions

• The information set for markets is critical– Suppose we expect a shock what does the

anticipation do before the actual shock occurs• Information sets can be changed by the user

unexpectedly over time so we can ask questions like:– Suppose we expected a shock but it doesn’t happen– Suppose we don’t expect a shock and it suddenly

occurs

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Research Projects/ Challenges

• Model Development• Estimation at a more detailed level (with Peter

Wilcoxen) to enable more flexible aggregation.• Incorporating uncertainty in long term projections

(Peter Wilcoxen and various students at Syracuse)• Incorporating learning by agents (Kang Yong Tan)• Incorporating demographic variables following

Blanchard/ Yaari/ Weil (Jeremy Nguyen)• Projecting productivity and convergence (Alison

Stegman)• Emissions projections for climate predictions

(Alison Stegman) - testing convergence

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Research Projects/ Challenges

• Model Development• Modeling developing countries

– Modeling transition economies such as Vietnam (Hong Giang-Le)

– Tajikstan (Zavkiev Zavkijon)• Incorporating Infectious diseases (WHO project)

(with Alexandra Sidorenko)

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Research Projects/ Challenges

• Improving Macroeconomic Dynamics

• Need to integrate the global structural models with the more data intensive VAR approach– Using the G-Cubed model to generate restrictions on

multi-country VARS following Pagan and others• With Dungey, Fry, Pagan

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Background Papers

www.gcubed.com

www.economicscenarios.com

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Trade Liberalization in a Dynamic Setting

by

Warwick J. McKibbin

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A New Millenium Round

• In 2000, it is announced that existing tariffs will be reduced by 1/3 from 2000 to 2010 in most countries

• Tariffs on goods trade are based on the GTAP4 database (see Table 3a)

• For services it is assumed there is a cost reduction based on work by Centre for International Economics (see Table 3b)

Figure 1: Impact of a new WTO Round on Real GDP (OECD Economies)

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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m b

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USA

Japan

Australia

Korea

ROECD

Figure 2: Impact of a new WTO Round on Real GDP (non OECD)

-0.5

0

0.5

1

1.5

2

2.5

3

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Indonesia

Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

Figure 3: Impact of a new WTO Round on Real Consumption (OECD Economies)

-0.2

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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USA

Japan

Australia

Korea

ROECD

Figure 4: Impact of a new WTO Round on Real Consumption (non OECD)

-2

-1

0

1

2

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4

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6

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

Figure 5: Impact of a new WTO Round on Real Exports (OECD Economies)

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Japan

Australia

Korea

ROECD

Figure 6: Impact of a new WTO Round on Real Exports (non OECD)

-6

-4

-2

0

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Indonesia

Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

Figure 7: Impact of a new WTO Round on Trade Balances (OECD Economies)

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% b

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P d

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USA

Japan

Australia

Korea

ROECD

Figure 8: Impact of a new WTO Round on Trade Balances (non OECD)

-4

-3

-2

-1

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1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% b

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Indonesia

Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

Figure 9: Impact of a new WTO Round on Real Effective Exchange Rates (OECD Economies)

-0.8

-0.6

-0.4

-0.2

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0.2

0.4

0.6

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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USA

Japan

Australia

Korea

ROECD

Figure 10: Impact of a new WTO Round on Real Effective Exchange Rates (non OECD)

-1.5

-1

-0.5

0

0.5

1

1.5

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2.5

3

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

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Indonesia

Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

Figure 11: Impact of a new WTO Round on Employment (OECD Economies)

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020% d

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USA

Japan

Australia

Korea

ROECD

Figure 12: Impact of a new WTO Round on Employment (non OECD)

-1

-0.5

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0.5

1

1.5

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Indonesia

Malaysia

Philippines

Thailand

China

India

Taiwan

Hong Kong

Figure 13: Impact of a new WTO Round on Real Interest Rates (OECD Economies)

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% p

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t d

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USA

Japan

Australia

Korea

ROECD

Figure 14: Impact of a new WTO Round on Real Interest Rates (non OECD)

-0.5

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

0.5

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

% d

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Malaysia

Philippines

Singapore

Thailand

China

India

Taiwan

Hong Kong

53

Summary

• Largest gains to countries liberalizing most• short run losses outweighed by long run gains• trade impacts /exchange rate adjustments tend to be the

opposite in the short run relative to the medium run (role of intertemporal budget constraints)