Evaluating International Economic Policy with the Federal Reserve's Global Model

By Levin, Andrew; Rogers, John et al. | Federal Reserve Bulletin, October 1997 | Go to article overview
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Evaluating International Economic Policy with the Federal Reserve's Global Model


Levin, Andrew, Rogers, John, Tryon, Ralph, Federal Reserve Bulletin


FRB/Global is a large-scale macroeconomic model developed and maintained by the staff of the Board of Governors of the Federal Reserve System. The model contains the equations of the FRB/US model (discussed in the April 1997 issue of the Federal Reserve Bulletin) to represent the macroeconomic structure of the U.S. economy. In addition, FRB/Global contains eleven other blocks of equations to represent each of the foreign Group of Seven (G-7) industrial economies (Canada, France, Germany, Italy, Japan, and the United Kingdom), Mexico, and four other groups of industrial and developing economies.

Simulation experiments conducted with FRB/Global assist the Board in analyzing sudden changes in external macroeconomic variables and alternative policy responses in foreign economies. For example, experiments with FRB/Global provide useful information about the effects of exchange rate movements or oil price changes on U.S. unemployment and inflation. The alternative scenarios studied with FRB/Global also provide a valuable input to forecasts of foreign activity and the U.S. external sector.

Over the past several years, two important features have been added to the structure of FRB/Global. First, the equations have been reformulated to ensure long-run stability: In response to a macroeconomic disturbance, each economy represented in FRB/Global gradually converges to a balanced growth (or equilibrium) path, that is, a path in which actual output is equal to potential gross domestic product and in which every inflation-adjusted variable has a constant ratio to potential GDP. The inflation rate adjusts to a target level determined by monetary policy, and all relative prices reach constant values.

Fiscal solvency (a condition in which the stock of government debt grows no faster than nominal GDP) is maintained by assuming the gradual adjustment of a country's tax rate. Similarly, national solvency (a condition in which the stock of net external debt grows no faster than nominal GDP), is ensured by the assumption that the risk premium on a country's external liabilities rises when net external debt is high relative to nominal GDP.

The second feature added to FRB/Global is the explicit treatment of expectations. In the model, agents' expected values of future variables directly influence interest rates, consumption and investment expenditures, the aggregate wage rate, and the exchange rate. Thus, the way in which agents form expectations can have important implications for the simulation results. In FRB/Global, simulations can be performed under either of two assumptions about the nature of expectations: (1) limited-information expectations, under which agents have incomplete information about the structure of the global economy or (2) model-consistent expectations, under which agents possess all the information contained in the model.

This article provides a historical perspective on the development of FRB/Global and an overview of the model's blocks of equations for foreign countries. We use three simulation experiments to highlight the dynamic properties of FRB/Global: a reduction in U.S. government purchases, a depreciation of the U.S. dollar, and an increase in the price of oil exported by countries in OPEC (the Organization of Petroleum Exporting Countries). The article also illustrates other uses of FRB/Global by examining the spillover effects of fiscal and monetary policy under alternative European monetary policy regimes.

A HISTORICAL PERSPECTIVE ON FRB/GLOBAL

In the mid-1970s, a variety of factors--increased economic interaction among countries, the first (1973) shock to oil prices, and the floating of exchange rates--combined to raise interest in global macroeconomic modeling. Against this background, the Board's staff began the development of a large-scale macroeconometric model called the Multicountry Model (MCM) to provide an empirical framework for analyzing interactions among the major industrial countries.

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