Academic journal article National Institute Economic Review

Comparative Properties of Models of the UK Economy

Academic journal article National Institute Economic Review

Comparative Properties of Models of the UK Economy

Article excerpt

it is the interest rate effect which dominates the increase in government expenditure. The exchange rate appreciates giving a large increase in the real rate, so the increase in GDP and reductions in unemployment are completely crowded out by the end of the simulation. When interest rates rise to target the money supply in the OEF model, the effects are still dominated by the results from the government expenditure shock, so in contrast with the HMT model a depreciation in the exchange rate occurs. The growth in the interest rate is gradual, and the large initial fall in the exchange rate following the increase in demand is partially reversed as interest rates increase. Although the initial GDP response is in line with that seen in 1. Introduction

The sustainability of government budget deficits has become a policy issue of importance for the governments of many OECD countries. In the United Kingdom there is particular concern at the present time at the high level of the PSBR/GDP ratio. How much of the required reduction will be achieved automatically as the economy recovers from recession, or how much government action will be required, and whether such action should be on the expenditure or the tax side all feature in the policy debate (see, for example, the two reports produced to date by HM Treasury's Panel of Independent Forecasters). The determination of the exchange rate under a floating exchange rate regime has re-emerged as a key question since the departure of sterling from the exchange rate mechanism (ERM), and the speed of transmission of exchange rate shocks through wages and prices is of particular relevance. Floating exchange rates are heavily influenced by the future expectations of participants in the markets for foreign exchange. Understanding how these expectations are formed is of great importance for the operation of open economies such as that of the United Kingdom.

In order to analyse the impact of the various fiscal policy instruments it is essential to consider both direct and indirect effects. For example the direct effects of tax changes on government finances can be quantified through an assessment of the size of the tax base to which the tax change is to be applied, and such calculations may measure the short-run impact on government revenue quite well. However, over a period beyond the first few months following the tax change, the indirect effects through the operation of the economy as a whole come to dominate. Simulations of models of the macroeconomy are the only method of quantifying the size and time profile of these indirect effects. This article provides an analysis of the effects of tax and expenditure changes on the UK economy, through a comparative study of the overall properties of six leading macroeconometric models. It emphasises the importance of the assessment of both direct and indirect effects on government finances in particular and macroeconomic performance more generally.

The long-run impact of government fiscal policy on the economy remains an important point of theoretical discussion. The government must choose a mixture of expenditure and taxation plans which ensures that government debt does not grow without bound over the longer term. Members of the European Community are required under the Maastricht Treaty to control both the size of the general government financial deficit and the volume of government debt as a proportion of national output. These conditions can be thought of as providing a form of budget constraint or closure on government finances over time, although none of the models considered here has any formal mechanism by which the debt/GDP ratio is controlled. Some multi-country models have adopted a feedback rule which ensures that the government raises the income tax rate to offset the effect of an increase in expenditure on the PSBR and, consequently, growing public debt. In this article the issue of sustainability is addressed through the analysis of simulations of a government expenditure increase under a variety of financing assumptions. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.