4. Fed Policy and the Effects of a Stock Market Crash on the Economy
The title of this chapter is the same as the title of a paper that can be read or downloaded from this site: Fed Policy and the Effects of a Stock Market Crash on the Economy. If you are interested in this subject, you should read this paper before reading this chapter. The paper uses the MC2 model to analyze Asia-type crises. The two experiments in this paper ("No Boom" and "Crash") can be duplicated on this site. The following are the steps necessary to duplicate the first experiment, the "No Boom" experiment.
  1. Click "MC2 Model" in the left menu and type in M2ABASE with a password of MCBASE to be copied to a dataset you have named. (Do not use the default MC2BASE as the base dataset.)
  2. Click "Set prediction period" and set the period to be 1995 through 2004.
  3. Click "Drop or add equations" and for Japan add the I and RS equations and for Australia add the L2 equation. (These three equations are dropped for the forecast, which is the default case, and so they need to be added back in for this experiment.) Also, for the United States drop the LM, CG, and RS equations (equations 8, 25, and 30). (The CG and RS equations are dropped because of the nature of the experiment; the LM equation is dropped because it appears to be seriously misspecified.)
  4. Click "Use historical errors" and set the option to use the historical errors.
  5. Click "Change exogenous variables" and ask to change RS for the United States. Then enter the bill rate values under "No Boom" in Table 3 of the paper. Then ask to change CG for the United States, and ask to replace each existing value with 521.28 (this is a quarterly rate of 130.32, which is used in the paper). Be sure to save the changes once you are done.
  6. Click "Solve the model and examine the results".

Once the model is solved you can examine the results. If you have set the experiment up correctly, the comparisons between your dataset and M2ABASE of GDPR, real GDP for the United States at an annual rate, will match the results in Table 4 of the paper, subject to some rounding error. (The rounding error primarily affects the predictions for 2003 and 2004.) You can, of course, examine many more variables than are presented in the paper.

The following are the steps necessary to run the second experiment, the "Crash" experiment.

  1. Click "MC2 Model" in the left menu and type in M2ABASE with a password of MCBASE to be copied to a dataset you have named. (Do not use the default MC2BASE as the base dataset.)
  2. Click "Set prediction period" and set the period to be 1999 through 2004.
  3. Click "Drop or add equations" and for Japan add the I and RS equations and for Australia add the L2 equation. (These three equations are dropped for the forecast, which is the default case, and so they need to be added back in for this experiment.) Also, for the United States drop the LM, CG, and RS equations (equations 8, 25, and 30). (The CG and RS equations are dropped because of the nature of the experiment; the LM equation is dropped because it appears to be seriously misspecified.)
  4. Click "Use historical errors" and set the option to use the historical errors.
  5. Click "Change exogenous variables" and ask to change RS for the United States. Then for the 1999:3-2004:4 period enter 3.0 for the bill rate values. Leave the base values for 1999:1 and 1999:2 unchanged. Then ask to change CG for the United States, and enter -33598.8 for 1999:3 (this is a quarterly rate of -8399.7, which is used in the paper). Leave the other values unchanged. Be sure to save the changes once you are done.
  6. Click "Solve the model and examine the results".