The international transmission of shocks - Some selected simulations with the NIME model [ Working Paper 09-03 - 01/09/2003]

The nime model is a macro-econometric world model developed at the Belgian Federal Planning Bureau. Although the most important features of the nime model will be discussed in the next section, we want to highlight here several channels through which shocks are transmitted across the different country blocks of the model. First, there is international trade in goods and services, whereby exports and imports are determined by relative prices and by the effective foreign and domestic output level, respectively. However, the impact of changes in exports and imports on overall domestic activity should be limited, as, for example, exports constitute about 15 percent of gross domestic product in the euro area, 25 percent in the non-euro eu countries, and 9 percent in the us. Second, there are financial flows which respond to the expected asset returns in the different country blocks. If the exchange rates are fixed at a predetermined rate, interest rates adjust in order to equalise expected returns, adjusted for a risk premium, across country blocks. If exchange rates are flexible and interest rates are set to accommodate domestic objectives, the exchange rates adjust to induce capital gains in order to equalise expected returns across country blocks. Given the importance of the changes in the exchange rate and interest rates on the (composition of) economic activity, the subsequent analysis will consider shocks under a flexible and fixed exchange rate regime. Third, in the productivity shock variant, the technological innovations in the leading country, i.e., the us, are diffused with a one year lag to the other country blocks. Moreover, economic agents in the other country blocks anticipate these future spill-over effects, and they adjust their expenditure plans in line with their expectations.

The structure of this paper is as follows. The second section describes briefly the nime model. The third section shows the simulation results for a temporary increase in public expenditures in the us. There the public expenditures of the us are increased by about 3.5 percent, inducing, ex ante, a 1 percentage point increase in the deficit to gdp ratio. The fourth section illustrates the case of a permanent productivity shock in the us. There the shock is not only transmitted via the traditional trade and financial flows, but also via (expected) changes in trend productivity. In the fifth section, we discuss a permanent increase in the risk premium in the us stock market, while the sixth section shows the simulation results for a temporary increase in the us interest rate. The last section draws some conclusions.

The simulations illustrate that the international transmission of shocks via international trade is rather limited, because most of the country blocks constitute large, relatively closed economies. The spill-over effects through financial flows can be very important, especially under a fixed exchange rate regime where there is a direct link between the interest rates of the country blocks. The simulations show also that expectations can be an important channel that speeds up international adjustment.

Before we proceed, we want to make the following three remarks. First, in the following sections we focus mainly on the spill-over effects on the euro area, because this is the main trading partner of Belgium. The simulation results for the other country blocks can be found in Appendix B of this working paper. Second, we want to emphasise that the simulations of this paper are of an illustrative and technical nature, and they should not be considered as predictions. Third, interpreting the simulations of this paper, it should be remembered that the nime model is a Keynesian model with classical long run properties. In the long run, the economy is at its natural equilibrium, whereby the relative prices clear the markets and the nominal variables do not affect equilibrium in the real sector. However, in the medium run, the model has typical Keynesian features, whereby prices adjust sluggishly to their equilibrium value, supply is determined by demand, and expectations have some backward looking features.