Macroeconomic Models

Introduction to Basic Theory

Model
A Model describes the theoretical relationship between variables. Macroeconomic model would thus describe the relation between macroeconomic variables Models are estimated using Statistical Methods, Econometric Theory (Mathematical Modelling of Economic Theory and estimated using Statistical Data)

Example
We can model the relation between GDP and Investment following one of the most simple procedures. First take, GDP(y)=f(Investment(i)) as one of the basic and assumed model The mathematical function will then describe the expected model where we can find theory/literature which will help us define the nature of the model Is it a linear, non-linear? Hence the linear function will be y=a +b (i)

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.

Estimation
Estimation of the specified model is then the Mathematical procedures to determine the value of 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.

Contd.
Statistical data on GDP and Investment will be used for any country, for example Pakistan for more than 30 years or for 30 or more countries for a single year. The datasets are attached with the email/link you will receive for these documents. 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.

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 ycI Note the data points equal the number of years for which we have the data

Estimation Checking
How to see if the estimated model is the best We use tests which are used for the checking of OLS assumptions BLUE Also will check some other Econometric problems in the estimated models These include Autocorrelation, heteroscedasticity, Multi-collinearity and Normality of the error terms etc. Why?

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 in next week sessions when our main point of discussion will be Estimation and Selection of a Model among a list of Possible Models Why? Because we need to be sure that the model used for forecasting the best model used on grounds of Mathematical, Statistical and Econometric reasons.

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

Questions & Answers

Any Questions and Answers?

HomeWork
Now select a country of your choice, collect annual or quarterly data on GDP (y), Labour Force (L), Agriculture Production Values (ag), Industrial Values (il), Land (Arable Land, Area under Cultivation) (area) and estimate the following 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?