Clopper Almon, The Craft of Economic Modeling, Part 2
Department of EconomicsUniversity of MarylandDraft of April 2004In Part 1, we developed a very simple model and suggested some directions …
Department of EconomicsUniversity of MarylandDraft of April 2004In Part 1, we developed a very simple model and suggested some directions in which it could beexpanded. In the present chapter, we will carry out some of the suggestions while trying tofollow the good advice of the last chapter of Part1. In particular, our model willrefine the consumption and employment functions presented previously.divide fixed investment into three major components, equipment, residences, and otherstructures, and develop appropriate equations for each.develop equations for exports and imports.complete the income side of the model with equations for capital consumption, profits,dividends, interest rates, interest payments and income, employee compensationand proprietor income.calculate revenues from various taxes, government expenditures in current prices (fromvariables exogenous in constant prices), interest payments, and budgetary deficitsor surpluses for the federal government and, separately, for the combination ofstate and local governments.The word structural in the name of the Quest model is noteworthy. Quest is a model intendedto embody and test an understanding of how the economy works. It is concerned with howaggregate demand affects employment, how employment affects unemployment, howunemployment affects prices, how prices and money supply affect interest rates and incomes,and how incomes, interest rates, and prices affect investment, consumption, imports, and exports,which make up aggregate. demand. The model embodies a view of how each link in this closedloopchain works. Satisfactory performance is not to judged by how well it works forecasting afew quarters ahead, but by how well it holds up over a much longer period. Can it keepemployment within a few percent of the labor force over decades? Can it keep inflation in linewith the increase in money supply though it does not use money supply in the inflation equation?Can it right itself if thrown off course for a few quarters? We will test it in 21-year historicalsimulation, time enough for it to go seriously astray if it is inclined to do so
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