A MACROECONOMETRIC MODEL FOR THE EURO ECONOMY

Christian DREGER (Halle Institute for Economic Research)

In this paper a macroeconometric model for the Euro economy is presented, where the Euro area is treated as a single economy. It is used for short term forecasts and simulation of external shocks.

The theoretical framework refers to an open economy with competitive markets. Agents have been aggregated into households, firms, government and foreign countries. Within each sector individuals are homogeneous. The model includes the goods, labor and financial markets. Private households and firms maximize individual utilities or profits. Government and foreign countries are exogeneous. Due to sluggish prices, output is demand driven in the short run, and determined by the supply side in the long run.

Because of the nonstationarity of most variables, equations are estimated in an error correction form. The long run is uncovered jointly with the short run dynamics to avoid the small sample bias arising from static regressions. Consistent estimation requires 2SLS, where stage 1 is needed to construct instruments for the endogeneous right hand side variables. Instruments are 1 period ahead forecasts derived from the whole system.

The model beats time series alternatives, such as ARIMA, VAR and factor models in an out of sample exercise for most variables and horizons. The approach is also justified by the means of standard simulation exercises.