Alternative Models of the Irish Supply Side

This paper is a product of the ongoing re-estimation of the Irish macro model. This is part of the EMI Multicountry Model. The paper is concerned with the estimation of a system of equations, which seek to capture the salient features of the supply-side of the Irish economy. Expressions are required for the marginal cost of production, long-run labour and capital demand. The estimated parameters from the system are then used to simulate the underlying production function thereby permitting the generation of key macroeconomic indicators such as the output gap and total factor productivity. A Cobb-Douglas approach is used initially to approximate the underlying technology within the economy. The associated factor demands with the Cobb-Douglas are easily derived and the functional form has the advantage of relative computational ease. Initial results from this approach yield very large measures of the output gap. Therefore, these results are then compared with the use of more flexible functional forms as a control or check. In particular, a translog production function approach is adopted and the consequent output gap is calculated. This output gap is then used as a benchmark for comparison. As a result, the Cobb-Douglas approach is re-visited and adjustments are made to the initial specification. The structural change witnessed by the Irish economy throughout the 1990’s is proxied for by the use of a number of different methods. It is found that by adopting a non-linear improvement in technology through time, the output gap achieved with the Cobb-Douglas approach correlates quite strongly with that from the more flexible translog form. This approach is then advocated for the macro model.