Modelling Industry-Specific Policy Using Treasury’s Industry Model (TIM): A Dynamic General Equilibrium Model of the Australian Economy

In this paper, we build a small open economy neoclassical growth model of Australia with rich industry detail (114 industries producing 114 commodities and 11 margin goods). This model is intended to be used by the Australian Treasury to analyse the likely effects of a change to industry policy. We add to existing rich industry models by including households and firms that have rational expectations. This approach overcomes many of the inherent limitations of existing reduced form models such as replacing rule of thumb investment and savings decisions with those derived from well-defined intertemporal optimisation decisions. We show that incorporating forward looking households and firms has a significant effect on the activity and budgetary responses (both in terms of timing and level) to industry specific policies. An important feature of the intertemporal optimisation approach, over reduced form models, is that it provides a well-defined welfare metric to evaluate the costs/benefits of policy change.