Area-wide Model Research Articles

The EAGLE: A Model for Policy Analysis of Macroeconomic Interdependence in the Euro Area

Building on the New Area Wide Model, we develop a 4-region macroeconomic model of the euro area and the world economy. The model (EAGLE, Euro Area and Global Economy model) is microfounded and designed for conducting quantitative policy analysis of macroeconomic interdependence across regions belonging to the euro area and between euro area regions and the world economy. Simulation analysis shows the transmission mechanism of region-specific or common shocks, originating in the euro area and abroad. JEL Classification: C53, E32, E52, F47

Forecasting with DSGE Models

In this paper we review the methodology of forecasting with log-linearised DSGE models using Bayesian methods. We focus on the estimation of their predictive distributions, with special attention being paid to the mean and the covariance matrix of h-step ahead forecasts. In the empirical analysis, we examine the forecasting performance of the New Area-Wide Model (NAWM) that has been designed for use in the macroeconomic projections at the European Central Bank. The forecast sample covers the period following the introduction of the euro and the out-of-sample performance of the NAWM is compared to nonstructural benchmarks, such as Bayesian vector autoregressions (BVARs). Overall, the empirical evidence indicates that the NAWM compares quite well with the reduced-form models and the results are therefore in line with previous studies. Yet there is scope for improving the NAWM’s forecasting performance. For example, the model is not able to explain the moderation in wage growth over the forecast evaluation period and, therefore, it tends to overestimate nominal wages. As a consequence, both the multivariate point and density forecasts using the log determinant and the log predictive score, respectively, suggest that a large BVAR can outperform the NAWM. JEL Classification: C11, C32, E32, E37

Building rehabilitation capacity in rural New South Wales

The aim of this article is to report on a study of the expansion of specialist rehabilitation services in central New South Wales, Australia, through the introduction of rehabilitation as a new service type at 2 small rural multi-casemix hospitals, within an integrated area-wide model of rehabilitation service delivery. Mixed methods were used. Information about bed occupancy and patient participation in rehabilitative activities were collected from hospital data bases and patient observation by staff over a 10 month period, and analysed quantitatively using descriptive statistics. During the same time period 10 staff from each hospital participated in a series of 3 audio-taped interviews each. These semi-structured interviews were conversational in nature and asked about the staff member's experiences and perceptions of the introduction of rehabilitation. Inductive qualitative analysis of the interview transcripts captured the enablers and threats to rehabilitation at each site. The introduction of rehabilitation as a new service type at 2 small rural hospitals was facilitated by an integrated area-wide model of rehabilitation service delivery, and the support of a regional specialty rehabilitation service provider. The formal introduction of rehabilitation at the 2 small hospitals was delayed while processes to ensure that patients were transferred to the appropriate hospital were developed, equipment purchased and building modifications undertaken. Despite this, staff came to appreciate the benefits of rehabilitation for their patients and to see rehabilitation potential in their usual patient population. Some staff took longer than others to embrace the changes; however, staff generally appreciated that the introduction of rehabilitation was not hurried. When linked to a specialty rehabilitation provider, small multi-casemix rural hospitals appear to have the potential to support the rehabilitation of patients in their local communities whose rehabilitation needs are uncomplicated. To fully realise the potential of small rural hospitals, and because these hospitals are primarily staffed by nurses, nursing staff working in these facilities need to be supported to develop their rehabilitative potential. This support should come from the collective wisdom of specialist rehabilitation nurses, medical rehabilitation specialists and allied health staff, and must be provided at the broader structural level. Through cross-disciplinary sharing of knowledge and skills, residents of rural communities could spend less time hospitalised at long distances from their homes.

Evaluating macro-economic models in the frequency domain: A note

We present a novel approach to the evaluation of macro-econometric models. Using the European Central Bank's “Area Wide Model”, we implement a Cholesky bootstrap whereby the model is stochastically-simulated using historically-consistent covariances. Using this generated data, and the standardized spectral density, we derive its implied frequency characteristics in terms of persistence, periodicity and spectral fit. We benchmark that against that of the historical data. The testing procedure is applicable to a large class of macro models and thus of general interest.

Fiscal consolidation in the euro area: Long-run benefits and short-run costs

In this paper, we examine the macroeconomic effects of alternative fiscal consolidation policies in the New Area-Wide Model (NAWM), a two-country open-economy model of the euro area developed at the European Central Bank (cf. [Coenen, G., McAdam, P., Straub, R., in press. Tax reform and labour-market performance in the euro area: a simulation-based analysis using the New Area-Wide Model. Forthcoming in the Journal of Economic Dynamics and Control]). We model fiscal consolidation as a permanent reduction in the targeted government debt-to-output ratio and analyse both expenditure and revenue-based policies that are implemented by means of simple fiscal feedback rules. We find that fiscal consolidation has positive long-run effects on key macroeconomic aggregates such as output and consumption, notably when the resulting improvement in the budgetary position is used to lower distortionary taxes. At the same time, fiscal consolidation gives rise to noticeable short-run adjustment costs in contrast to what the literature on expansionary fiscal consolidations suggests. Moreover, depending on the fiscal instrument used, fiscal consolidation may have pronounced distributional effects.

An area-wide model approach for the management of a disease vector planthopper in an extensive agricultural system

The “Mal de Río Cuarto” disease in maize is a viral disease caused by a reovirus (MRCV) and transmitted by the delphacid planthopper Delphacodes kuscheli Fennah in a persistent manner. Although the disease is endemic in only one provincial department, when regional outbreaks occur the losses in maize production are very significant. Actively dispersing D. kuscheli individuals were collected from 15 sampling sites during the 1999 and 2000 spring seasons using sticky traps placed at 6 m above ground level, designed to detect flying individuals. Insect host patches were surveyed using Landsat 5 TM images for the periods studied. Two critical landscape metrics, total class area and mean proximity index, were calculated using FRAGSTATS 3.3 on the winter pasture satellite images. A multiple regression model showed the relationship between host patch area, mean proximity index and D. kuscheli abundance to be highly significant ( R 2 = 0.96, r = 0.98, P < 0.0001). Spatial simulations of different host areas and different interpatch separations were created in order to test the effect of these metrics on the abundance of the dispersing individuals. The estimate of the insect's abundance showed that, although patch size is very important in determining mean insect abundance in an area, the separation of these patches is crucial to establish the effect of host patch area on the abundance of dispersing individuals. Until now, disease management consisted in modifying sowing dates in order to avoid maximum D. kuscheli abundances and thus minimize risk of Mal de Río Cuarto Disease. Our results show that a rational area-wide management of host patches can keep populations of the vector at a very low level, diminishing the risk of a regional outbreak.

Globalisation and the Euro Area: Simulation Based Analysis Using the New Area Wide Model

Globalisation and the Euro Area: Simulation Based Analysis Using the New Area Wide Model

International Transmission and Monetary Policy Cooperation

We use a version of the New Area-Wide Model (NAWM) developed at the ECB in order to quantify the gains from monetary policy cooperation. The model is calibrated in order to match a set of empirical moments. We then derive the cooperative and (open-loop) Nash monetary policies, assuming that the central banks' objectives is to maximize the welfare of the households. Our results show that given the current degree of openness of the US and euro area economies, the gains from monetary policy coordination are small, amounting to 0.03 percent of steady-state consumption. Nevertheless, the gains appear to be sensitive to the degree of openness and further economic integration between the two regions could generate sizable gains from cooperation. For example, increasing the trade shares to 32 percent of GDP in both regions, the gains from cooperation rise to about 1 percent of steady-state consumption. By decomposing the sources of the gains from cooperation with respect to the various shocks, we show that mark-up shocks are the most important source for gains from international monetary policy cooperation.

The New Area-Wide Model of the Euro Area: A Micro-Founded Open-Economy Model for Forecasting and Policy Analysis

In this paper, we outline a version of the New Area-Wide Model (NAWM) of the euro area designed for use in the (Broad) Macroeconomic Projection Exercises regularly undertaken by ECB/Eurosystem staff. We present estimation results for the NAWM that are obtained by employing Bayesian inference methods and document the properties of the estimated model by reporting its impulse-response functions and forecast-error-variance decompositions, by inspecting the model-based sample moments, and by examining the model's forecasting performance relative to a number of benchmarks, including a Bayesian VAR. We finally consider several applications to illustrate the potential contributions the NAWM can make to forecasting and policy analysis.

On the use of area-wide models in the Euro-zone

This paper investigates the legitimacy of using area-wide models in predicting aggregate variables in the Euro-area. We aim to compare the performance of area-wide versus national specific models for modeling money demand when using different aggregation schemes. A generalized Grunfeld and Griliches criterion and the Vuong test are used to discriminate between competitive models. Results show that the use of different aggregation methods is not irrelevant. In fact, due to the volatility of the exchange rates, the aggregate models fit better than the disaggregate whenever we employ ECU exchange rates. However, for fixed exchange rates expressed in Euro, the disaggregate models outperform the aggregate ones.

Tax reform and labour-market performance in the euro area: A simulation-based analysis using the New Area-Wide Model

In this paper, we employ a calibrated two-country version of the New Area-Wide Model (NAWM) developed at the European Central Bank to examine the potential benefits and spillovers of reducing labour-market distortions caused by euro area tax structures. Our analysis shows that lowering tax distortions to levels prevailing in the United States would result in an increase in hours worked and output by more than 10%. At the same time, tax reductions would have positive spillovers to the euro area's trade partners, bolstering the case for tax reforms from a global perspective. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the impact of tax reforms.

Tax Reform and Labour-Market Performance in the Euro Area: A Simulation-Based Analysis Using the New Area-Wide Model

In this paper, we employ a calibrated two-country version of the New Area-wide Model (NAWM) currently under development at the European Central Bank to examine the potential benefits and spillovers of reducing labour-market distortions caused by euro area tax structures. Our analysis shows that lowering tax distortions to levels prevailing in the United States would result in an increase in hours worked and output by more than 10 percent. At the same time, tax reductions would have positive spillovers to the euro area's trade partners, bolstering the case for tax reforms from a global perspective. Finally, we illustrate that, in the presence of heterogeneous households, distributional effects may be of importance when gauging the impact of tax reforms.

Monetary policy under a liquidity trap: Simulation evidence for the euro area

In this paper, we analyze the conduct of monetary policy under a zero nominal interest-rate bound (hereafter ZIB) in a model economy of the euro area, namely that of the Area Wide Model. The aggregate euro-area economy is modeled to have relatively sluggish adjustment properties and a private sector with mainly backward-looking expectations. For a given ZIB benchmark, we consider variations in the monetary-policy reaction function to minimize the macro-economic consequences of such a deflationary regime. We rank the effectiveness of these remedial policies using a number of metrics and relate our results to features and properties of the model economy. J. Japanese Int. Economies 20 (3) (2006) 338–363.

Modelling Intra- and Extra-Area Trade Substitution and Exchange Rate Pass-Through in the Euro Area

The paper proposes a modelling approach for euro area goods and services trade volumes and prices on the basis of a break-down of trade data into their intra- and extra-area components. Using the evidence from the newly estimated trade equations, the paper gives new insights into two important issues. The first issue concerns the exchange-rate pass-through (ERPT) to euro area import prices. The second issue relates to substitution effects between intra- and extra-area trade. These issues are further elaborated through simulation analyses using the ECB's area-wide model (AWM). The simulations illustrate the impact of external and domestic shocks to trade in the euro area, in particular on intra- and extra-area trade. The richer dynamics from this disaggregated perspective provide additional insights and elucidate transmission channels of shocks that are not detectable from an aggregate (i.e. total trade) perspective. For instance, one interesting finding is that an appreciation of the euro has a significant downward impact on intra euro area trade.

Areawide Models Comparing Synchronous Versus Asynchronous Treatments for Control of Dispersing Insect Pests

Integrated pest management (IPM) has the goal of combining several control methods that reduce populations of pest insects and their damage to tolerable levels and thereby reduce the use of costly pesticides that may harm the environment. Insect populations can be monitored during the season to determine when the densities exceed an economic threshold that requires treatment, often as an insecticide application. We developed a simulation model where insect populations varied in exponential growth in fields and dispersed to adjacent fields each day of a season. The first model monitored populations of individual fields in a grid of fields and treated any field with insecticide if it exceeded a threshold population (asynchronous model) as done in traditional IPM. The second model treated the entire grid of fields with insecticide when the average population of all fields exceeded the threshold (synchronous model). We found that the synchronous model at all growth and dispersal rates tested had average field populations during a season that were significantly lower and required fewer treatments than the asynchronous method. Parameters such as percentage of fallow fields, number of fields, and treatment threshold had little affect on relative differences between the two models. The simulations indicate that cooperation among growers in areawide monitoring of fields to obtain an average population estimate for use in treatment thresholds would result in significantly less insect damage and fewer insecticide treatments. The synchronous method is more efficient because population refugia are precluded from which dispersal could reintroduce insects.

Areawide Models Comparing Synchronous Versus Asynchronous Treatments for Control of Dispersing Insect Pests

Integrated pest management (IPM) has the goal of combining several control methods that reduce populations of pest insects and their damage to tolerable levels and thereby reduce the use of costly pesticides that may harm the environment. Insect populations can be monitored during the season to determine when the densities exceed an economic threshold that requires treatment, often as an insecticide application. We developed a simulation model where insect populations varied in exponential growth in fields and dispersed to adjacent fields each day of a season. The first model monitored populations of individual fields in a grid of fields and treated any field with insecticide if it exceeded a threshold population (asynchronous model) as done in traditional IPM. The second model treated the entire grid of fields with insecticide when the average population of all fields exceeded the threshold (synchronous model). We found that the synchronous model at all growth and dispersal rates tested had average field populations during a season that were significantly lower and required fewer treatments than the asynchronous method. Parameters such as percentage of fallow fields, number of fields, and treatment threshold had little affect on relative differences between the two models. The simulations indicate that cooperation among growers in areawide monitoring of fields to obtain an average population estimate for use in treatment thresholds would result in significantly less insect damage and fewer insecticide treatments. The synchronous method is more efficient because population refugia are precluded from which dispersal could reintroduce insects.

How Domestic is the Fama and French Three-Factor Model? An Application to the Euro Area

The euro area has faced a high number of monetary and policy changes in the recent past as a consequence of the European integration process and, naturally, these developments have important implications for portfolio diversification and asset pricing. Therefore, this paper concentrates on the performance of a specific asset pricing model: the Fama and French three-factor model. Griffin (2002) shows that the Fama and French factors are country specific for the U.S., the U.K, Canada, and Japan. We apply the same methodology to the euro area countries and find that even in this very integrated area the domestic three-factor model outperforms the euro area three-factor model. However, the relative performance of the euro area wide model is increasing, especially for countries with a high number of listed stocks. This could be interpreted as evidence of a higher level of equity market integration caused by lower investment barriers and a changing point of view of institutional investors. Furthermore, we extend the methodology and also test an industry-specific three-factor model. Our findings suggest that lower pricing can be acquired using an industry-specific model relative to the euro area three-factor model.

Optimal Monetary Policy Rules for the Euro Area: An Analysis Using the Area Wide Model*

In this article, we analyse the conduct of optimal monetary policy for the new euro area. The aggregate euro area economy is modelled to have relatively sluggish adjustment properties and a private sector with mainly backward-looking expectations. In this economy, we assume that the central bank searches for its best-performing monetary policy rule, e.g. for the optimal weight to give to inflation stabilization compared to that of output and for the optimal degree of forward-looking in the planning horizon. We first find that the optimal degree of gradualism in interest rate-setting needs only be relatively mild and that the central bank should incorporate new information quickly into policy-making. Second, there is substantial gain from implementing and communicating quite forward-looking policies. The optimal forecast horizon for inflation ranges around six quarters. In contrast to deliberately simple rule-based policy recommendations, fully optimal policy is a complicated response to many different economic indicators. With regard to this we find, third, that optimal policy should be based on a broad information set, even if the resulting policy framework is hard to communicate to the outside world. Thus, the article contributes to the debate on optimal monetary policy for the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism.

An area-wide model for the euro area

This paper presents a quarterly estimated structural macroeconomic model for the euro area, the AWM, which is a medium-sized model that treats the euro area as a single economy. The model is designed to have a long-run equilibrium consistent with neo-classical economic theory while the short-run dynamics are largely demand-driven. The current version of the AWM is mostly backward-looking and is largely estimated rather than calibrated. A general overview of the structure of the model and of its long-run and short-run properties is given, with particular emphasis on the steady state properties, and a review of key equations. Results from two illustrative simulations are provided: a fiscal expenditure shock and a change in interest rates, with and without policy responses, respectively.

Optimal Monetary Policy Rules for the Euro Area: An Analysis Using the Area Wide Model

In this article, we analyse the conduct of optimal monetary policy for the new euro area. The aggregate euro area economy is modelled to have relatively sluggish adjustment properties and a private sector with mainly backward-looking expectations. In this economy, we assume that the central bank searches for its best-performing monetary policy rule, e.g. for the optimal weight to give to inflation stabilization compared to that of output and for the optimal degree of forward-looking in the planning horizon. We first find that the optimal degree of gradualism in interest rate-setting needs only be relatively mild and that the central bank should incorporate new information quickly into policy-making. Second, there is substantial gain from implementing and communicating quite forward-looking policies. The optimal forecast horizon for inflation ranges around six quarters. In contrast to deliberately simple rule-based policy recommendations, fully optimal policy is a complicated response to many different economic indicators. With regard to this we find, third, that optimal policy should be based on a broad information set, even if the resulting policy framework is hard to communicate to the outside world. Thus, the article contributes to the debate on optimal monetary policy for the euro area, as well as to the conduct of monetary policy in face of substantial persistence in the transmission mechanism.