Short-term Structural Macroeconometric Model: India

For an effective macroeconomic policy making, understanding of overall economic behavior through a macroeconomic model is necessary. Macroeconomic models provide an understanding of structural relationships among various macroeconomic variables. It also provides cause and effect relationship between the policy and target variables and also helps forecasting, which are essential for effective policy formulations.

Two important limitations of these models are:
1.based on annual data, it requires long time series data, which, given the sharp changes in the economic behaviors, might be irrelevant for forecast purpose;
2. difficult to capture the impact of intermittent policy changes.

To overcome these limitations, we have attempted to estimate a short term quarterly macroeconometric model. There are data limations for this exercise as the real sector data is available only from the Q2/1996.

Structure of the model
Like any models, this model also has broad disaggregations with strong interlinkages between each block. The model has five blocks namely real sector, price, monetary, fiscal and trade sector. Within each block, based on the availability of data, we have further disaggregated. Unlike in the annual models, this quarterly model lacks disaggregated investment equations as the data on private and public investments are not available at the quarterly level. Hence, the gross fixed capital formation has been used as a proxy for the investments. Similarly, in the trade block, the disaggregation is limited only upto oil and non-oil and in fiscal block the disaggregation is limited at tax and non-tax revenues and total expenditure.

The model follows an eclectic approach with a mix of theoretical underpinnings, but largely Keynesian and neo-classical. The demand side behavior is expected to follow the Keynesian approach while the supply side it is the neo-classical approach. As we know that the economic behavior is dynamic, to capture of this model is to capture the current macreconomic behavior, the model sufficiently incorporates open-economy macrtoeconomic relations. This will also helps in understanding the international tyranmission mechanism and also the impact of current global economic developments on the Indian economy. Further, the model is capable of capturing exogenous shocks (both domestic and external) such as world oil prices and rainfall.
Real sector
1 Real agriculture output=F(Rainfall,food credit, agriculture deflator, Agriexports, International Food prices,GFCF)
2 Real industrial output- F(non-industrial output, non-food credit, total exports,price variable)
3 Real services output=F(non-services output,GFCF,World demand,BSE sensex,exchange rate)
4 Real GFCF=F(total outpu, lending rate, FII Flows, net domestic credit to government and commercial sector)
Price block
5 Agriculture deflator=F(Money Supply,price of imports, agriculture output, world oil prices)
6 Industrial deflator=F(money supply,price of imports, industrial output)
7 Services deflator=F(Money supply, price of imports, service output)
8 GDP deflator=F(weighted average of Sectoral indices
9 Consumer price index=F(WPI)
10 Price of exports= f(GDP deflator, price of imports)
11 Price of imports=f(GDP deflator, world prices, Exchange rate)
Fiscal block
12 Tax revenue=F(Non-agriculture output)
13 Non-tax revenue=f(Non-agriculture output)
14 Total public expenditure=(total revenue,Grants,Banking sector credit to government)
Monetary Block
15 Money supply=F(Net foreign exchange with banking sector, credit to both government and commercial sector,Fiscal balance)
16 Net foreign exchange assets=F(exchange rate, World Output, current account balance)
17 Net domestic credit government=F(real GDP,fiscal balance)
18 Net domestic credit commercial sector=F(real GDP,lending rate,fiscal variable)
19 Lending rte=F(Domestic inflation,repo rate, foreign interest rate)
Trade Block
20 Non-oil exports=F(World output, Exchange rate, relative prices, Non-oil imports)
21 Oil exports=F(Exchange rate, WPI fuel in India, WPI fuel in the world)
22 Oil imports=F(World oil prices, real GDP,Exchange rate)
23 Non-oil imports=f(Exchange rate, real GDP,Foreign exchange reserves)