Academic journal article IUP Journal of Applied Economics

Modeling the Financial Crisis with the Global, Econometric E3MG Model

Academic journal article IUP Journal of Applied Economics

Modeling the Financial Crisis with the Global, Econometric E3MG Model

Article excerpt

Recent developments in global finance and the world economy have demonstrated some of the shortcomings in the widely-applied equilibrium-based modeling approach. In this paper, the global E3MG model (www.e3mgmodel.com) has been applied to assess the impacts of the crisis that began in 2008 with the so-called credit crunch. E3MG is a sectoral input-output model (including the banking sector), based on the system of national accounts. The model includes 20 global regions and uses annual time series data. E3MG's parameters are estimated using error-correction methodology, making it an almost unique tool in being able to assess short-term sectoral impacts, as well as long-term trends. Using E3MG, an analysis of the crisis and current (January, 2009) policy measures has been build up through a series of carefully-defined scenarios, simulating aspects of behavioral changes within the banking sector and in the wider global economy. The results help to explain the mechanisms through which the real economy has been impacted by the crisis and give an indication of the effectiveness of current policy. Finally, the paper considers the effects of policy measures designed to restore confidence in the global financial system that are coordinated at the global level, following the 'seven-point plan' outlined in Barker (2009).

Introduction

In early 2009 it became clear that the effects of the global financial crisis have not been limited to the banking sector and we are now seeing major impacts on the wider economy. There are various economic mechanisms through which the problems in banks have been transmitted to other companies and households, such as lack of access to credit and volatility in asset prices. This has had knock-on effects on other sectors, for example, a reduction in investment has impact on industries that produce investment goods. Countries that have a high concentration of such industries are particularly affected by the crisis.

There remains much uncertainty over the extent of these impacts with a relatively wide range of forecasts, being updated when new information becomes available. Macro-econometric models are not well-suited for the current situation as they do not include an explicit treatment of the banking sector, where the crisis originates, while equilibrium-based modeling approaches tend to predict a quick return to normal without providing a clear explanation of why it should be so.

This paper builds on the more theoretical analysis presented in Barker (2009), which outlines some of the causes of the current crisis and suggests policy responses in the form of a 'seven-point plan'. The paper assesses this using an econometric model with detailed disaggregation by sector and region. Through a series of scenarios based on assumptions about some of the key behavioral aspects of the crisis and policy responses, a picture has been build up of the prevailing situation in early 2009. The final result is a detailed set of projections, disaggregated by world region and sector, incorporating both the direct and indirect effects of these assumptions.

The E3MG Model

The E3MG model (An Energy-Environment-Economy Model at the Global level) was constructed by international teams led by 4CMR (Department of Land Economy, University of Cambridge) and Cambridge Econometrics. It is an econometric model for the world, capable of addressing issues that link developments and policies in the areas of energy, environment and economy. The main purpose of the model is to provide a framework for forecasting and evaluating different policies, both in the short- and medium to long-terms.

E3MG is the latest in a succession of models developed for energy-economy and, for E3 (Energy-Economy-Environment) interactions at global level. It is very similar in structure to the E3ME model (www.e3me.com), which followed from EXPLOR, built in the 1970s, and then HERMES in the 1980s. Each model has acquired substantial resources from international teams and each model has learned from earlier problems and developed new techniques. …

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