The ECB's New Multi-Country Model for the euro area: NMCM - simulated with rational expectations

The model presented here is a New estimated medium-scale Multi-Country Model (NMCM) which covers the five largest euro area countries and is used for forecasting and scenarios analysis at the European Central Bank. The model has a tight theoretical structure which allows for non-unitary elasticity of substitution, non-constant augmenting technical progress and heterogeneous sectors with differentiated price and income elastiticites of demand across sectors. Furthermore, it has the explicit inclusion of expectations on the basis of three optimising private sector decision making units: i.e. firms, trade unions and households, where output is in the short run demand-determined and monopolistically competing firms set prices and factor demands. Labour is indivisible and monopoly-unions set wages and households make consumption/saving decisions. We assume agents optimise under limited information where each agent knows only the parameters related to his/her optimization problem. Therefore we estimate with GMM, which implicitly assumes limited information boundedly rational expectations. In this paper we provide some simulation results under the assumption of model-consistent rational expectations, we show that there is some heterogeneity across countries and that the reactions of the economies to shocks depends strongly on whether the shocks are pre-announced, announced and credible or unannounced and uncredible. JEL Classification: C51, C6, E5Macro model, open-economy macroeconomics, Rational Expectations

Current account benchmarks for central and eastern Europe: a desperate search?

This paper examines two competing approaches for calculating current account benchmarks, i.e. the external sustainability approach á la Lane and Milesi-Ferretti (LM) versus the structural current accounts literature (SCA) based on panel econometric techniques. The aim is to gauge the medium term adjustment in current account positions that may be required in some central and eastern European countries. As regards the LM approach, we show how the outcome is especially sensitive to (i) the normative choice for external indebtedness and (ii) the decision to exclude the foreign direct investment subcomponent from the NFA aggregate. Turning our search to the SCA approach, we assess its sensitivity to model and parameter uncertainty by setting different selection criteria to choose amongst the over 8000 possible combinations of fundamentals. Furthermore, to test the robustness of our findings we combine all models, attaching to each a probability (Bayesian Averaging of Classical Estimates). We show both the LM and SCA methodologies are not immune from severe drawbacks and conceptual difficulties. Nevertheless pulling together the results of both approaches point to the countries that may need a current account adjustment over a medium term horizon. JEL Classification: C11, C33, F15, F32, F34, F41, O52Capital flows, central and eastern Europe, current account, financial integration, model combination, Model uncertainty, panel data

Modelling intra- and extra-area trade substitution and exchange rate pass-through in the euro area

The paper proposes a modelling approach for euro area goods and services trade volumes and prices on the basis of a break-down of trade data into their intra- and extra-area components. Using the evidence from the newly estimated trade equations, the paper gives new insights into two important issues. The first issue concerns the exchange-rate pass-through (ERPT) to euro area import prices. The second issue relates to substitution effects between intra- and extra-area trade. These issues are further elaborated through simulation analyses using the ECB’s area-wide model (AWM). The simulations illustrate the impact of external and domestic shocks to trade in the euro area, in particular on intra- and extra-area trade. The richer dynamics from this disaggregated perspective provide additional insights and elucidate transmission channels of shocks that are not detectable from an aggregate (i.e. total trade) perspective. For instance, one interesting finding is that an appreciation of the euro has a significant downward impact on intra euro area trade. JEL Classification: E31, F17, C5competitiveness and trade substitution, euro area, exchange-rate pass-through, Intra-/ extra-area trade, pricing-to-market

The ECB's New Multi-Country Model for the euro area: NMCM - with boundedly rational learning expectations

Rational expectations has been the dominant way to model expectations, but the literature has quickly moved to a more realistic assumption of boundedly rational learning where agents are assumed to use only a limited set of information to form their expectations. A standard assumption is that agents form expectations by using the correctly specified reduced form model of the economy, the minimal state variable solution (MSV), but they do not know the parameters. However, with medium-sized and large models the closed-form MSV solutions are difficult to attain given the large number of variables that could be included. Therefore, agents base expectations on a misspecified MSV solution. In contrast, we assume agents know the deep parameters of their own optimising frameworks. However, they are not assumed to know the structure nor the parameterisation of the rest of the economy, nor do they know the stochastic processes generating shocks hitting the economy. In addition, agents are assumed to know that the changes (or the growth rates) of fundament variables can be modelled as stationary ARMA (p,q) processes, the exact form of which is not, however, known by agents. This approach avoids the complexities of dealing with a potential vast multitude of alternative mis-specified MSVs. Using a new Multi-country Euro area Model with Boundedly Estimated Rationality we show this approach is compatible with the same limited information assumption that was used in deriving and estimating the behavioral equations of different optimizing agents. We find that there are strong differences in the adjustment path to the shocks to the economy when agent form expectations using our learning approach compared to expectations formed under the assumption of strong rationality. Furthermore, we find that some variation in expansionary fiscal policy in periods of downturns compared to boom periods. JEL Classification: C51, D83, D84, E17, E32bounded rationality, Expectation, heterogeneity, imperfect information, Learning, macro modelling, open-economy macroeconomics

Modelling intra- and extra-area trade substitution and exchange rate pass-through in the euro area

The paper proposes a modelling approach for euro area goods and services trade volumes and prices on the basis of a break-down of trade data into their intra- and extra-area components. Using the evidence from the newly estimated trade equations, the paper gives new insights into two important issues. The first issue concerns the exchange-rate pass-through (ERPT) to euro area import prices. The second issue relates to substitution effects between intra- and extra-area trade. These issues are further elaborated through simulation analyses using the ECB’s area-wide model (AWM). The simulations illustrate the impact of external and domestic shocks to trade in the euro area, in particular on intra- and extra-area trade. The richer dynamics from this disaggregated perspective provide additional insights and elucidate transmission channels of shocks that are not detectable from an aggregate (i.e. total trade) perspective. For instance, one interesting finding is that an appreciation of the euro has a significant downward impact on intra euro area trade

Public debt, population ageing and medium-term growth

This paper analyses the challenges that high public debt and ageing populations pose to medium-term growth. First, macroeconometric model simulations suggest that medium-term growth can benefit from credible fiscal consolidation, partly through reductions in sovereign risk premia. Second, a disaggregated growth accounting exercise suggests that the impact of population ageing on medium-term growth can be mitigated by structural reforms boosting labour force participation. Finally, general equilibrium models suggest that pay-as-you-go public pension systems will require reforms combining lower benefits, a later retirement age and higher social contributions. These findings suggest several policy recommendations: (a) “fiscal space” should be preserved to counter adverse shocks, (b) credible fiscal plans can benefit growth through the sovereign risk channel, (c) the demographic transition increases the need for improved fiscal policy coordination and more flexible labour migration policies, and (d) fiscal consolidation should avoid perverse incentive effects that could lower labour supply and medium-term growth

Optimal monetary policy rules for the euro area: an analysis using the area wide model

In this paper, we analyze optimal monetary policy rules in a model of the euro area, namely the ECB’s Area Wide Model, which embodies a high degree of intrinsic persistence and a limited role for forward-looking expectations. These features allow us, in large measure, to differentiate our results from many of those prevailing in New Keynesian paradigm models. Speci?cally, our exercises involve analyzing the performance of various generalized Taylor rules both from the literature and optimized to the reference model. Given the features of our modelling framework, we ?nd that optimal policy smoothing need only be relatively mild. Furthermore, there is substantial gain from implementing forecast-based as opposed to outcome-based policies with the optimal forecast horizon for in?ation ranging between two and three years. Benchmarking against fully optimal policies, we further highlight that the gain of additional states in the rule may compensate for a reduction of communicability. Thus, the paper contributes to the debate on optimal monetary policy in the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism. JEL Classification: E4, E5euro area, monetary policy rule, optimization

Prevalence and risk factors for joint pain among men and women in the West of Scotland Twenty-07 study

Objective: To examine the association between three modifiable risk factors (obesity, smoking, and alcohol consumption) and reported joint pain. Methods: Cross sectional data were collected on 858 people aged 58 years living in the West of Scotland and on the same individuals four years later, aged 62 years. Results: There was a positive relation between obesity and reported pain in the hips, knees, ankles, and feet. The strongest relation was with knee pain (odds ratio = 2.42 (95% confidence interval, 1.65 to 3.56)). There were no strong consistent associations between smoking habits and pain in any joint after adjusting for sex, alcohol consumption, body mass index, social class, and occupational exposures. Similarly, alcohol was not consistently related to pain in any joint in the fully adjusted models. Conclusions: Obesity had consistent and readily explained associations with lower limb joint pain. The data suggest that smoking behaviour and alcohol consumption are not consistently associated with joint pain across the body

Is healing an option to aid sustainable healthcare futures?

It is becoming ever more apparent that the current model of healthcare delivery within developed countries is not sustainable. There are at least two major problems: the continuing development of expensive, high-technology approaches to diagnosis and treatment, which are putting an unsustainable economic burden on healthcare organisations (1); and the rapidly increasing carbon footprint of modern healthcare delivery systems, resulting in an unsustainable burden on the planet (2). Many possible answers to these problems are being considered by medical bodies including the British Medical Association (3). In addition, politicians are turning their attention to prevention, and are trying to move the responsibility for maintaining good health away from healthcare workers, and back to individuals and communities. For example, Public Health England is developing work on ‘salutogenesis’ (the generation of health) in addition to working on the prevention of disease (4,5). Over the last few years there has also been a burgeoning interest in what might be called ‘low-tech/high talk’ interventions such as the ‘walk and talk for mental health’ movement (6) and arts for healthcare (7). This has been accompanied by an increasing appetite amongst the public for complementary and alternative approaches to medicine (CAM)

Thousands of models, one story: current account imbalances in the global economy

The global financial crisis has led to a revival of the empirical literature on current account imbalances. This paper contributes to that literature by investigating the importance of evaluating model and parameter uncertainty prior to reaching any firm conclusion. We explore three alternative econometric strategies: examining all models, selecting a few, and combining them all. Out of thousands (or indeed millions) of models a story emerges. The chance that current accounts were aligned with fundamentals prior to the financial crisis appears to be minimal.Macroeconomics - Econometric models