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The Canadian Economic and Fiscal Model - 1996 Version: Part 1 - Model Structure

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  • Benoît Robidoux
  • Bing-Sun Wong

Abstract

The first version of the Canadian Economic and Fiscal Model (CEFM) was completed in 1986. Since then, CEFM has been used by the Department of Finance for macroeconomic forecasting and policy analysis. The model has gone through many rounds of revision since its original version. This report documents the theoretical structure of the 1996 version of the model, CEFM96. Companion papers contain up-to-date descriptions of the empirical specification, the forecast performance, and dynamic simulation properties of this version of the model. The design of the model is constrained by the fact that it must serve two purposes: forecasting and policy analysis. This is not a trivial constraint: it is well known that a trade-off often exists between having a model that performs well in a forecast mode and having one with theoretically desirable simulation properties. In addition, one main objective of the forecasting process in the Department of Finance is to predict at a fairly detailed level the outlook for federal government revenues and expenditures. As a result, CEFM96 has quite a detailed government sector. Despite these constraints, however, the 1996 version of CEFM has properties that closely approximate those of a tight theoretical model. We adopted a strategy in which we treated the determination of the equilibrium long-run value for key economic variables separately from the dynamic adjustment or determination in the short run. As a result, we modelled key choice decision variables within an error-correction structure, since such a framework appears ideally suited for that purpose. This framework allows the testing and/or imposition of long-run relationships between economic variables, often suggested by economic theory, without imposing such relationships on short-term dynamics. Building a model that embodies sound economic theory and appropriate econometric foundations would not have been possible without reducing the size of the core model. We thus reduced the size of the model significantly in many sectors, while choosing a top-down approach in other sectors. This means a simpler, more transparent model with properties that can be more easily interpreted in relation to its theoretical specification. Overall, this approach improves the theoretical consistency of the model as well as its ability to forecast. La première version du Modèle économique et fiscal canadien (MEFC) a été complétée en 1986. Depuis lors, le MEFC a été utilisé par le Ministère des Finances à des fins de prévisions macro-économiques et d'analyse de politiques. La version originale du MEFC a été révisée à maintes reprises. Ce rapport documente la structure théorique de la version la plus récente du modèle, la version MEFC 96. Une description à jour de la spécification empirique, de la capacité à prévoir et des propriétés en simulation dynamique de cette version du modèle, se retrouve dans deux autres documents. La structure du modèle est contrainte par le fait qu'il doit remplir un double emploi : la prévision et l'analyse de politiques. Ceci n'est pas une contrainte mineure puisqu'il est bien connu qu'il existe souvent un dilemme entre avoir un modèle qui se comporte bien en mode de prévision et un modèle qui possède les propriétés théoriques souhaitées en simulation dynamique. De plus, un des principaux objectifs du processus de prévision au Ministère des Finances est de prévoir à un niveau détaillé les perspectives de revenus et de dépenses du gouvernement fédéral. Par conséquent, la version MEFC 96 a un secteur gouvernemental assez détaillé. Ces contraintes rendent plus difficile le développement d'un modèle purement théorique. Nous avons adopté une approche où la détermination de l'équilibre des variables économiques clés est traitée séparément de l'ajustement dynamique ou de la détermination à court terme. Par conséquent, les variables de choix clés sont modélisées à partir d'une structure de correction des erreurs puisqu'un tel cadre permet d'incorporer une telle approche explicitement. La structure de correction des erreurs permet de tester ou d'imposer des relations entre des variables économiques, souvent suggérées par la théorie économique, sans imposer ces relations sur la dynamique de court terme. La mise sur pied d'un modèle incorporant des éléments valables de théorie économique et des fondations économétriques appropriées n'aurait pas été possible sans une diminution de la taille du coeur du modèle. La taille du modèle a donc été réduite substantiellement dans plusieurs secteurs alors qu'une approche, partant de l'agrégat macro-économique plutôt que de ces composantes, a été adoptée dans d'autres secteurs. De cette approche découle un modèle davantage simple et transparent qui a des propriétés qui peuvent être interprétées plus facilement par rapport à sa structure théorique. Globalement, cette approche améliore à la fois la cohérence théorique interne du modèle et sa capacité à prévoir.

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Paper provided by Department of Finance Canada in its series Working Papers-Department of Finance Canada with number 1998-05.

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Handle: RePEc:fca:wpfnca:1998-05

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