National Institute Global

Econometric Model

NiGEM Overview

October 2017

National Institute of Economic and Social Research

 NiGEM Overview

• NiGEM is a large model of the • Models depend on both theory

and data
world economy and is used for
• There is a common (estimated
forecasting and scenario analysis
and calibrated) underlying
• Discrete models for most OECD structure across all economies
economies and there are regional
• Long-run structure relatively rigid
blocks for the remaining
• Contains both forward looking,
countries in Asia, America, Africa,
rational expectations and
the Middle East and Europe adaptive learning.
• Flexible policy environments

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 Structure of NiGEM
• The country models have
complete demand and supply
sides, also full asset structures
• Most behavioural equations
estimated in error-correction
format
• Rational expectations options
– Financial markets
– Labour markets.
– Consumption
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• Country Linkages
– trade and competitiveness
– interacting financial markets
– through international stocks
of assets
• Supply-side
– based on CES relationship
between capital (K) and
labour (L), embedded in a
Cobb-Douglas framework
with oil (M)
• Government
– direct and indirect taxes,
government spending and
interest payments.
– tax rule to ensure long run
solvency
 The structure of a model equation

• Long run - what factors drive economic variables

yt  a  b * xt  et
• Adjustment - how long does it take to reach equilibrium

yt  yt 1  a  b * xt 1   dynamics  error

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 The Structure
Consumption Interest Rates Exchange Rates

Based on real disposable income and wealth Short rates set by policy rule  rx   1  int t 
E  t 1     * 1  RPt 
ln C     ln RPDI  (1   ) lnRNFW  RTW  LRt   j 1,T SRt  j   tprem  rxt  1  usint t
T
Long rates: 

Fiscal
Investment Energy
Equilibrium Capital Stock
•Stock of Gov. debt with deficits as flow
•Range of taxes and rates Dynamic adjustment from actual to K  Demand error-corrects on real world oil
•LR solvency ensured by tax rate equation equilibrium capital stock ln  t     USERt price
I t  Kt  Kt 1  Yt    wdpot 1 * rxt 1 
 ln Ot     ln Ot 1  ln  
  ced t 1 

The Supply Side

The Demand Side

NiGEM  
  (1 ) 


 
Yt  Ct  Gt  I t  X t  M t 
  
YCAP   K    (1   ) Letechl    O

International Trade
X P XNCOM t 1 
 ln X t  1    t 1   2   St Capacity Utilisation/Output Gap
Marginal products give factor demands for labour,
 St 1 CPX t 1  capital and energy - FOC
Y
 P M t 1  CU 
 ln M t  1    M t 1   2   3TFEt 1  YCAP
 ced t 1  Forms core producer Labour Market
price equation
(unit total cost) Wage derived from MPL
less scaled unemployment
Domestic Prices
Import and Export Prices rate (bargaining power)
P X  P XCOM  1   P XNCOM Consumer prices are derived from unit total costs
and import prices
PXCOM & PMCOM : weighted average of 5 world
commodity prices  ln ced t 1  Unemployment Rate
PXNCOM : domestic price*RX  ln ced t     1 ln P M t 1  (1  1 ) ln UTCt 1 
1  0.5 * itrt 1 ( popt * prtt )  et
wa
PMNCOM : weighted average of trade partners’  Ut  wa
export prices   2  ln P M t   3  ln UTCt   popt * prtt

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 Modelling GDP
• In the short- to medium-term, GDP is driven by the demand side

Y  C  I  G  XVOL  MVOL

• In the longer term, GDP is driven by the supply side

YCAP   [K    (1   )( Letechl )   ](1 ) /  M 

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 Modelling GDP from the demand side - Consumption

• Consumption depends on (a dynamic adjustment path around) real

personal disposable income and wealth.

ln(C )     ln( RPDI )  (1   ) ln( RFN  RTW )

• By default consumers are assumed myopic

• Forward looking consumption is an option

– Permanent income is the flow off infinite forward recursion of total
human wealth

TWt  Yt  Tt  TWt 1 /((1  rrt )(1  myt ))

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 Modelling GDP from the demand side - Investment

• The equilibrium capital output ratio depends on the user cost of capital.
Derived from the marginal product condition from the production function

ln (Kt /Qt) = a1 - σ ln(usert)

• Linked to investment through the capital stock identity relationship

Kt = δKt-1 + It
• Dynamic adjustment path around long-run relationship

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 Modelling GDP from the demand side – Government
spending

• Government consumption (GC) and investment (GI) are essentially

exogenous policy variables, but are endogenously linked to capacity
output

dlog(gegc) = -0.125*(log(gegc(-1)) -log(geycap(+1)))

dlog(gegi) = -0.25*(log(gegi(-1)) -log(geycap(+1)))

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Modelling GDP from the demand side – External Trade

• Trade volumes and prices are linked by Armington matrices, based on 2010
trade patterns
• External market size (S) is weighted average of imports in other countries
• Relative export prices are domestic export prices relative to weighted
average of competitor prices
• Relative import prices are domestic consumer prices relative to weighted
average of export prices in import source countries

XVOL  b1  S  b2 RPX
MVOL  b1  1.24 *TFE  b2 RPM

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 Modelling GDP from the supply side – Factor
demands

• Production function governs factor demands (labour, capital, energy)

YCAP   [K    (1   )( Letechl )   ](1 ) /  M 

• Marginal product condition implies

ln (Lt /Qt) = a1 - σ ln(Wt/Pt)-(1- σ)TECHL

• This also forms firm side of wage bargain and core producer price
equation (UTC)

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 Modelling GDP from the supply side – Capacity
utilisation

• Capital utilisation is the ratio of output to potential output:

Y
Capacity Utilisatio n 
YCAP

• feeds into the price system to bring demand in line with supply
• a change in the real wage or real cost of capital affects the capital labour
ratio and a change in the oil price changes demand for K and L.

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 Prices

• Prices partly determined by marginal cost, derived from production

function (UTC)

• Consumer prices (CED) are a mark-up on unit total costs and import
prices, adjusted for the indirect tax rate

• Import price weights vary across countries

• Import prices modelled as weighted average of export prices from all

other countries/regions on the model

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 Forward looking financial markets

• Forward looking long rates should be related to expected future short term
rates
(1+LRt) = j=1, T (1+SRt+j)T + tprem

• Forward looking wages

Short-term wage dynamics depend on a weighted average of expected
and current inflation

• Equity Prices reflect the net present discounted value of expected profits,
including an equity risk premium
EQPt = EQPt+1 /Discounted + Profitst

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 Exchange rates

• Simulations are generally run with forward looking exchange rates for
consistency
– Backward-looking or fixed exchange rates are options
• Forecast baseline produced with fixed interest rates and backward looking
exchange rates
• UIP condition adjusted by risk premium
– If interest rates are above those in the US, exchange rate is expected
to depreciate (unless there is a positive risk premium)
t

 rxt 1   1  int t 
E     (1  rpt )
 rxt   1  usintt 

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 Monetary Frameworks

• Short-term interest rates set by a central bank

– Feedback rules depend on (+T for Target)
• Inflation (INFL), Output gap (Y/YCAP),
• Price level (PL), Nominal Aggregate (NOM)
• Taylor Rule
– Interest rate = a*(INFL-INFLT)+b*Y/YCAP
• Two Pillar Strategy
– Interest rate =c*(INFL-INFLT)+d*(NOM-NOMT)
• Price Level Targets
– Interest rate = e*(INFL-INFLT)+f*(PL-PLT)

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