RDP 2005-11: A Small Model of the Australian Macroeconomy: An Update 5. Summary

This paper provides an update on the current structure of the model of the Australian macroeconomy presented in Beechey et al (2000). Over the past five years quite a number of changes have been made to the model. However, it remains small, highly aggregated and non-monetary in nature. It also remains empirically based, so as to be consistent with the behaviour of key variables in the Australian economy over recent decades.

The most significant changes to the model since Beechey et al have been made either in response to changes in the behaviour of certain variables (such as the decision to model the output gap rather than the level of output), or in an attempt to better capture the underlying behaviour of a particular series (such as the decision to model a smoothed version of the unit labour cost series). The model now includes six behavioural equations, all of which are estimated econometrically. Each of the equations is specified so as to generate suitable long-run behaviour in the model, as well as appropriate short-run dynamics.

The model remains a convenient tool with which to analyse past developments in the economy and generate forecasts – while remaining simple enough to ‘carry around in one's head’. Its dynamic properties are illustrated by simulations which show the response of key variables to a variety of different shocks (including a shift in monetary policy). As these simulations highlight, the model continues to provide a useful framework for analysing and quantifying the main macroeconomic inter-relationships in the Australian economy.