Large-scale macroeconometric model
Encyclopedia
Following the development of Keynesian economics
, applied economics
began developing forecasting models based on economic data including national income and product accounting
data. In contrast with typical textbook models, these large-scale macroeconometric models used large amounts of data and based forecasts on past correlations instead of theoretical relations. These models estimated the relations between different macroeconomic variables using time series analysis. These models grew to include hundreds or thousands of equations describing the evolution of hundreds or thousands of prices and quantities over time, making computers
essential for their solution. While the choice of which variables to include in each equation was partly guided by economic theory
(for example, including past income as a determinant of consumption, as suggested by the theory of adaptive expectations
), variable inclusion was mostly determined on purely empirical
grounds. Large-scale macroeconometric model consists of systems of dynamic equations of the economy with the estimation of parameters using time-series data on a quarterly to yearly basis. Macroeconometric models have a supply and a demand side for estimation of these parameters. Authors Kydland and Prescott (1991) call it the system of equations approach. Large-scale macroeconometric model can be defined as a set of stochastic equations with definitional and institutional relationships denoting the behaviour of economic agents. The supply side determines the steady state properties of the macroeconometric model. The macroeconometric model designed by the model builder is significantly influenced by his interests, information, purpose behind its construction, time and financial constraints in the research. The size and nature of the model will change because of the above considerations while building the same. According to Pesaran and Smith (1985) the macroeconometric model must have three basic characteristics viz. relevance, adequacy and consistency. Relevance means the model must be according to the requirements of the desired output. Consistency will expect the model to be inline with the existing theory and inner working of the described system. Adequacy explains the model to be better in terms of its predictive performance. The main objective of the model decides its size. In the current scenario there is an increasing interest in the use of these large-scale macroeonometric models for theory evaluation, impact analysis, policy simulation and forecasting purposes.
Large-scale macroeconometric models were criticized by Robert Lucas
in his critique
. Lucas argued that models should be based on theory, not on empirical correlations. He said that empirical correlations were sensitive to policy changes, and only a model based on theory could account for shifting policy environments. Lucas and other new classical economists
were especially critical of the use of large-scale macroeconometric models to evaluate policy impacts when they were purportedly sensitive to policy changes.
Dutch
economist
Jan Tinbergen
developed the first comprehensive national model, which he first built for the Netherlands
and later applied to the United States
and the United Kingdom
after World War II
. The first global macroeconomic model, Wharton Econometric Forecasting Associates
' LINK project, was initiated by Lawrence Klein
. The model was cited in 1980 when Klein, like Tinbergen before him, won the Nobel Prize in Economics. Large-scale empirical models of this type, including the Wharton model, are still in use , especially for forecasting purposes.
Keynesian economics
Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the...
, applied economics
Applied economics
Applied economics is a term that refers to the application of economic theory and analysis. While not a field of economics, it is typically characterized by the application of economic theory and econometrics to address practical issues in a range of fields including labour economics, industrial...
began developing forecasting models based on economic data including national income and product accounting
National Income and Product Accounts
The National Income and Product Accounts are part of the national accounts of the United States. They are produced by the Bureau of Economic Analysis of the Department of Commerce...
data. In contrast with typical textbook models, these large-scale macroeconometric models used large amounts of data and based forecasts on past correlations instead of theoretical relations. These models estimated the relations between different macroeconomic variables using time series analysis. These models grew to include hundreds or thousands of equations describing the evolution of hundreds or thousands of prices and quantities over time, making computers
Computational economics
Computational economics is a research discipline at the interface between computer science and economic and management science. Areas encompassed include agent-based computational modeling, computational modeling of dynamic macroeconomic systems and transaction costs, other applications in...
essential for their solution. While the choice of which variables to include in each equation was partly guided by economic theory
Theory
The English word theory was derived from a technical term in Ancient Greek philosophy. The word theoria, , meant "a looking at, viewing, beholding", and referring to contemplation or speculation, as opposed to action...
(for example, including past income as a determinant of consumption, as suggested by the theory of adaptive expectations
Adaptive expectations
In economics, adaptive expectations means that people form their expectations about what will happen in the future based on what has happened in the past...
), variable inclusion was mostly determined on purely empirical
Empirical
The word empirical denotes information gained by means of observation or experimentation. Empirical data are data produced by an experiment or observation....
grounds. Large-scale macroeconometric model consists of systems of dynamic equations of the economy with the estimation of parameters using time-series data on a quarterly to yearly basis. Macroeconometric models have a supply and a demand side for estimation of these parameters. Authors Kydland and Prescott (1991) call it the system of equations approach. Large-scale macroeconometric model can be defined as a set of stochastic equations with definitional and institutional relationships denoting the behaviour of economic agents. The supply side determines the steady state properties of the macroeconometric model. The macroeconometric model designed by the model builder is significantly influenced by his interests, information, purpose behind its construction, time and financial constraints in the research. The size and nature of the model will change because of the above considerations while building the same. According to Pesaran and Smith (1985) the macroeconometric model must have three basic characteristics viz. relevance, adequacy and consistency. Relevance means the model must be according to the requirements of the desired output. Consistency will expect the model to be inline with the existing theory and inner working of the described system. Adequacy explains the model to be better in terms of its predictive performance. The main objective of the model decides its size. In the current scenario there is an increasing interest in the use of these large-scale macroeonometric models for theory evaluation, impact analysis, policy simulation and forecasting purposes.
Large-scale macroeconometric models were criticized by Robert Lucas
Robert Lucas, Jr.
Robert Emerson Lucas, Jr. is an American economist at the University of Chicago. He received the Nobel Prize in Economics in 1995 and is consistently indexed among the top 10 economists in the Research Papers in Economics rankings. He is married to economist Nancy Stokey.He received his B.A. in...
in his critique
Lucas critique
The Lucas critique, named for Robert Lucas′ work on macroeconomic policymaking, argues that it is naïve to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data.The basic idea...
. Lucas argued that models should be based on theory, not on empirical correlations. He said that empirical correlations were sensitive to policy changes, and only a model based on theory could account for shifting policy environments. Lucas and other new classical economists
New classical macroeconomics
New classical macroeconomics, sometimes simply called new classical economics, is a school of thought in macroeconomics that builds its analysis entirely on a neoclassical framework. Specifically, it emphasizes the importance of rigorous foundations based on microeconomics...
were especially critical of the use of large-scale macroeconometric models to evaluate policy impacts when they were purportedly sensitive to policy changes.
Dutch
Netherlands
The Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...
economist
Economist
An economist is a professional in the social science discipline of economics. The individual may also study, develop, and apply theories and concepts from economics and write about economic policy...
Jan Tinbergen
Jan Tinbergen
Jan Tinbergen , was a Dutch economist. He was awarded the first Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 1969, which he shared with Ragnar Frisch for having developed and applied dynamic models for the analysis of economic processes...
developed the first comprehensive national model, which he first built for the Netherlands
Netherlands
The Netherlands is a constituent country of the Kingdom of the Netherlands, located mainly in North-West Europe and with several islands in the Caribbean. Mainland Netherlands borders the North Sea to the north and west, Belgium to the south, and Germany to the east, and shares maritime borders...
and later applied to the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
and the United Kingdom
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...
after World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...
. The first global macroeconomic model, Wharton Econometric Forecasting Associates
Wharton Econometric Forecasting Associates
Wharton Econometric Forecasting Associates, Inc was a world-leading economics forecasting and consulting organisation founded by Nobel Prize winner Dr. Lawrence R. Klein....
' LINK project, was initiated by Lawrence Klein
Lawrence Klein
Lawrence Robert Klein is an American economist. For his work in creating computer models to forecast economic trends in the field of econometrics at the Wharton School of the University of Pennsylvania, he was awarded the Nobel Memorial Prize in Economic Sciences in 1980...
. The model was cited in 1980 when Klein, like Tinbergen before him, won the Nobel Prize in Economics. Large-scale empirical models of this type, including the Wharton model, are still in use , especially for forecasting purposes.
List of large-scale macroeconometric models
- Project LINK at Wharton
- MIT-Penn-Social Science Research Council
See also
- Macroeconomic model
- Time seriesTime seriesIn statistics, signal processing, econometrics and mathematical finance, a time series is a sequence of data points, measured typically at successive times spaced at uniform time intervals. Examples of time series are the daily closing value of the Dow Jones index or the annual flow volume of the...
- Lucas critiqueLucas critiqueThe Lucas critique, named for Robert Lucas′ work on macroeconomic policymaking, argues that it is naïve to try to predict the effects of a change in economic policy entirely on the basis of relationships observed in historical data, especially highly aggregated historical data.The basic idea...
- Dynamic stochastic general equilibriumDynamic stochastic general equilibriumDynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics...