Copvrig-llI © IFAC Dmalllic Mod e lling- al1(1 Control of 1'\;tlional Et:onnmies. l' K, 1'189 SHORT AND LONG RUN PROPERTIES OF THE BANK OF ITALY QUARTERLY ECONOMETRIC MODEL G. Galli, D. Terlizzese and I. Visco R ('S(,{lrr h Dl'po rt/l/('I/t , BOII{(J d'/ta/ia. RO/l/e . Italy Abstract. This paper analyzes the long-run equilibrium properties and the short-run dynamics of the Bank of Italy quarterly econometric model. A demand-determined frameyork is shoyn to prevail in the short run, yhereas supply behaviour and the dynamics of stocks (capital and yealth) are progressively more important in the medium and long run. The stationary state version of the model shares some, though not all, of the properties of a neoclassical groyth model. The stability of the stationary state is also taken up, shoying the issue to be sensitive to the dynamic specification of the Phillips curve. 1. INTRODUCTION Large scale econometric models are often criticized because of their lack of transparency. It is almost impossible, so the critique runs, to trace the essential causal links among variables due to the maze of feed-back relationship implicitly established by the model specification. As a result, the dynamics of the economic system portrayed by the model appears as the outcome of a black box rather than the well understood consequence of a theory agreed upon. To answer these critiques a recent line of research has been developed, trying to "extract" the core of large scale using both analytical and numerical tools . One possible approach is to couple the original, dynamic model yith its steady state, static version (the steady state which is considered is usually a balanced growth path; in the present paper ye shall consider a stationary state, i.e. a zero-growth path). The idea is that the underlying theory, yhich is most often just an equilibrium theory, comes out most clearly in the long-run equilibrium, i.e. when the adjustment processes built into the origin21 specification of the model have come to an end. The comparative static properties of a long - run equilibrium version of the model, however, are in general quite different from its short-term response. Because prices and yages are constrained to follow a relatively slow adjustment path, neither the goods nor the labour market need be in continuous Yalrasian equilibrium. The response of quantities to exogenous shocks or changes in policy variables will be magnified by the slow speed of adjustment of nominal variables and relative prices. A good understanding of the dynamic properties of the 1. See, for example, (1984), Malgrange (1988). Deleau -Ma lgrange-Muet 2. Related to this is the important finding that the elasticity matrix evaluated around a steady- state growth path is time invariant and therefore is best suited for the global analysis of the stability properties of the model . A research project currently underway in the Research Department of the Bank seeks to exploit this finding to gain a better understanding on the dynamics of the model. 379 model thus requires simulation exercises of a more traditional sort, performed over a relatively short horizon. In the present paper we shall pursue this line of research, presenting both an analysis of the stationary state version and of the short run properties of the quarterly model of the Bank of Italy . The Bank of Italy model consists of more than 700 equations, of which about 120 are stochastic, estimated on quarterly data over the period 1970-1984. A detailed analysis of the model specification and the estimation results is presented in Banca d'Italia (1986). Focusing on the scaffolding, we remember here that in the model the usual IS-LM scheme is enriched by dynamic mechanisms derived both from the neoclassical growth theory of the sixties and from the developments of the macro theory of the seventies. In the short run the output is demand determined, and the economy operates in a Keynesian underemployment regime, yith excess supply both in the labour market (unemployment) and in the goods market (excess capacity) . The output time path, however, is driven by capital accumulation - deriving from investment decisions by firms - by the response of prices and yages to disequilibrium and by the evolution of private yealth, together with the dynamics of the public debt . The behaviour of the supply sector is theoretically conceivable as the result of optimizing behaviour of monopolistically competitive firms, which choose their factor demand taking into account the expected quantity constraint on the market for their output. Price decisions are mark- up over costs and the actual price adjusts sloyly to the desired price . Yage dynamics is modeled by an expectation-a ugmented Phillips curve yhich embodies a non-accelerating rate of unemployment. Consumption decisions are consistent yith life cycle theory. The model includes a detailed specification of the public sector expenditures and revenues; public debt is part of private wealth. Financial decisions are modeled in a portfolio frameyork, extended to alloy for some choices to be considered as prior claims (consumption, money) . The flow-of-funds matrix involving the most important sectors and financial instruments is reconstructed . The paper is organized as follows. In the first section a very simplified, perhaps even simplistic, version of the model will be