APPENDIX Technical Presentation of Energy in GEM
Burstein, A., J. Neves, and S. Rebelo, 2000, “Distribution Costs and Real Exchange Rate Dynamics during Exchange Rate Based Stabilizations,” NBER Working Paper No. 7862 (Cambridge, Massachusetts: National Bureau of Economic Research).
Corsetti, G., and L. Dedola, 2002 “Macroeconomics of International Price Discrimination,” Working Paper, University of Rome III and Bank of Italy, January.
Hunt, B., P. Isard, and D. Laxton, 2002, “The Macroeconomic Effect of Higher Oil Prices,” National Institute Economic Review, No. 179 (January), pp. 87–103.
Hunt, B., and A. Rebucci, 2005, “The U.S. Dollar and Trade Deficit: What Accounts for the Late 1990s?” International Finance Vol. 8, No. 3.
Laxton, D., and P. Pesenti, 2003, “Monetary Policy Rules for Small, Open, Emerging Economies,” Journal of Monetary Economics, Vol. 50, No. 3, pp. 1109–46.
Orphanides, A., 2000, “Activist Stabilization Policy and Inflation: The Taylor Rule in the 1970s,” Finance and Economics Discussion Paper Series No. 2000–13 (Washington: Federal Reserve Board).
Taylor, J., 1993, “Discretion Versus Policy Rules in Practice,” Carnegie-Rochester Conference Series on Public Policy, Vol. 39, (December), pp. 195–220.
Prepared by Ben Hunt.
A more detailed discussion of the calibration of the energy structure in GEM can be found in Hunt (2005).
Cobb Douglas technology is assumed in energy production in the foreign sector.
A rapid increase in energy demand by emerging Asian economies is cited as key driver of the current rise in energy prices. This increase in energy demand by Asian economies reflects several factors and has an impact on the major industrial countries that is not captured in these simulations. Some preliminary work with GEM generating energy price increases from a variety of factors illustrates that positive spillovers can offset some of the negative impact of higher energy prices. The stronger are the industrial countries’ trading links with emerging Asia, the larger are the offsets.
GEM’s representative agent structure combined with the assumption that domestic households own all the capital stock has some important implications under energy price shocks that must be considered carefully. Households in energy producing countries receive a positive wealth shock from the increased returns in energy production when real energy prices rise. The structure of the model is such that households consume out of that wealth with their standard propensities. However, the increased returns in the energy sector are probably not widely spread and the propensity to consume out of the increase in wealth is likely much lower than average. To more accurately portray the likely impact on U.K. GDP, an additional temporary shock to household preferences is include so that in the near-term, U.K. consumption behaves similarly to consumption in the Euro Area. Although this is likely a factor in Canada as well, (and could be a factor for the U.S. because of the level of energy production there) no additional shock has been included. Consequently, the near-term positive impact on GDP in Canada is likely to be more subdued than these results suggest. This is an area that will be addressed more carefully in future work.
For the fourth quarter of 2005, the price and expectations path is matched to that available as of end-October 2005.
Because of the model’s complete choice theoretic framework, there is no scope for making ad hoc changes to the dynamic adjustment properties to more closely match the pass-through properties in the data.
Initially the policymaker’s estimate of potential output is generated putting a weight of 0.95 on the pre-shock level of output and a weight of 0.05 on the post-shock long-run level of output that is achieved once all adjustment has occurred. As the policymaker moves through time the weight on the old level of output gradually declines to zero and the weight on the new long-run level of output gradually increases to unity.
The convention throughout the model is that variables which are not explicitly indexed (to firms or households) are expressed in per-capita (average) terms. For instance,