Chapter

I Introduction

Author(s):
International Monetary Fund
Published Date:
July 1990
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Purpose of Model

MULTIMOD (MULTI-region econometric MODel) was designed to analyze the effects of industrial country policies on major macroeconomic variables, both in the developed and developing worlds. The focus of the model is on the transmission of policy effects, and in this respect it accords well with the Fund’s surveillance over the policies of major countries. More generally, the model can be used to trace the effects of changes in the external environment on the economies of developed and developing countries. To a limited extent, it can also be used to evaluate policies of developing countries, for instance, a policy of shifting demand away from consumption and toward investment. However, the monetary and fiscal policy instruments of the developing countries are not at present explicit in the model. The model has not been designed to make unconditional or “baseline” forecasts. Instead, it is intended to be used with a judgmental baseline forecast that incorporates the detailed knowledge of country economists. MULTIMOD itself is designed to examine the effects on that baseline of scenarios that involve changes in policies in major countries and other exogenous changes in the economic environment.1

Given the focus on comparative scenarios, the model can exclude some of the special factors that are often present in forecasting models. Simplicity is important; it makes the economics behind the model’s results easier to understand; and it allows faster solution of the model, particularly of computer-intensive simulations, such as those that impose consistency between the model’s solution and model-generated expectations. MULTIMOD is an annual model; the parameters are for the most part estimated.

The original version of the model published in Staff Studies for the World Economic Outlook2 included three separate industrial countries—the United States, Japan, and the Federal Republic of Germany—and grouped the remaining industrial economies into two blocs, one for the other Group of Seven countries (the larger industrial bloc—consisting of France, the United Kingdom, Italy, and Canada), and one for the smaller industrial countries. The rest of the world was divided into high-income oil exporters and developing countries. The Mark II version described here disaggregates the larger industrial bloc into its component countries, and, as a result, comprises eight industrial countries/ regions and two developing country regions. In addition, some of the equations have been respecified and re-estimated, as described below. The documentation that follows repeats much of the description of the model contained in the earlier paper, since much of the basic structure is similar. The major changes in structure relative to the earlier model relate to the modeling of consumption, investment, and trade flows, and the treatment of monetary policy. In addition, by including separate models for several of the European economies, it was possible to take account of the exchange rate mechanism (ERM) of the European Monetary System. A final section describes some of the problems to which MULTIMOD has been applied.

As before, the capital importing developing countries make up one aggregate region, with industrial production disaggregated into manufactures, oil, and primary commodities. The region is assumed to face an endogenous supply schedule for foreign loans that depends on a forward-looking assessment of developing countries’ debt-servicing capacity. Given the level of export earnings for the region, imports are assumed to depend on the level of financing available less interest payments.

The capital exporting countries, primarily high-income oil exporters, are treated separately in simplified form: they are the residual suppliers of oil, whose price is exogenous in real terms, and their exports of other goods are exogenous. In addition, they are assumed to have explicit import demand equations, instead of determining imports from the balance of payments identity as for the capital importing developing countries. Their holdings of reserves are the residual in the balance of payments.

Financing Flows to Developing Countries

An important linkage between industrial and developing countries is the level of capital flows and the interest rate on outstanding debt. Flows of financing between industrial and developing countries are assumed to depend on the ability of developing countries to service debt. The measure of servicing ability used is the ratio of interest payments on debt, corrected for inflation, to exports. Expectations are assumed to be formed for that ratio: if it exceeds a threshold level imposed on the model, additional financing will not be supplied. If it is less than the threshold, the amount of financing available will depend on the difference between the expected and the threshold levels.

Developments in industrial countries influence the expected value of that ratio, since the level of interest rates on developing countries’ debt appears in the numerator, and demand for the developing countries’ exports affects both prices and volumes in the denominator. Higher exports from developing countries will lead to greater financing flows from industrial to developing countries. This greater financing will stimulate larger imports by developing countries from the industrial countries; some of these imports will be associated with increased consumption, but the remainder, by increasing investment, will raise the capital stock in the developing world and future growth prospects. Increased demand by industrial countries for manufactures produced by developing countries will lead to increases in the volume of the latter’s exports, which will put upward pressure on the price of those exports, while an increase in demand by industrial countries for primary commodities will lead first to an increase in their price, and only later to an increase in output.

Commodity Disaggregation

Trade is disaggregated into three different types of goods: oil, primary commodities, and manufactures. Trade in oil is assumed to be at the unique world price, which is exogenous in real terms. All industrial countries and regions have variables for oil production and domestic consumption, and for exports and imports of oil; production is exogenous for the individual producer, while a domestic demand equation determines oil consumption; oil imports are the residual. For both the high-income oil exporters and the other developing countries, exports of oil are endogenous and equate world demand and supply; increases in demand are shared between the two groups of countries in a fixed proportion. Production of oil in these two regions is assumed to respond passively to demand at the given price. Inventories of oil are not explicit in the model; changes in inventories are implicitly included in consumption.

Primary commodities produced by developing countries are assumed to have a price that is perfectly flexible and clears the market. An increase in the relative price (and implicitly, in the profitability of production) of primary commodities will induce a shift of resources into this sector, increasing the quantity produced and eventually raising capacity and supply.

The composite manufactured good is assumed to be produced by all regions, and manufactured imports and exports of all regions (except the high-income oil exporters) are endogenous to the model. Each region’s (or country’s) manufactured output is assumed to be an imperfect substitute for other regions’ manufactures, and relative prices of the different manufactured goods help determine imports and exports. Base-period trade shares are used as weights for calculating relative prices. The price of domestic output in each region is determined by a Phillips-curve mechanism, which leads to some degree of stickiness in the price level.

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