4. Estimated Inflation Costs Had European Unemployment Been Reduced in the 1980s by Macro Policies
The title of this chapter is the same as the title of a paper that can be read or downloaded from this site: Estimated Inflation Costs Had European Unemployment Been Reduced in the 1980s by Macro Policies. You should read this paper before reading this chapter. The paper uses the MC1 model to estimate the consequences of an easier German monetary policy in the 1980s. It is easy to duplicate the experiment in the paper on this site. This is explained in Chapter 2 of the MC1 Model Workbook. This experiment can also be performed using the MC3 model. The steps are:
  1. Click "Solve" under "MC3 Model" in the left menu and copy MC3BASE to a dataset you have named.
  2. Click "Set prediction period" and set the period to be 1982 through 1990.
  3. Click "Use historical errors" and set the option to use the historical errors.
  4. Click "Drop or add equations" and drop the GERS equation for Germany (equation 7).
  5. Click "Change exogenous variables" and ask to change GERSOLD for Germany. (NOTE: This is GERSOLD, not GERS. See the discussion in Chapter 1, Section 1.9, of this workbook.) Then add -1.0 for 19821-19834, add -.75 for 19841-19854, add -.5 for 19861-19874, and add -.25 for 19881-19904. 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. You can then compare these results using the MC3 model with those in the paper using the MC1 model.

This is a nice example for learning some of the features of the MC3 model and for learning how to work with it. Once you have mastered this experiment, you may want to perform others to examine what else macro policies might have done in the 1980s to reduce European unemployment and at what price level and inflation costs.

Note that the use of the historical errors is important. As discussed in the paper, this allows the perfect tracking solution to be the base path, from which changes can then be made. If you did not use the historical errors, you would have to first create a base path of predicted values, which the new predicted path (after the interest rate changes) would be compared. See Section 2.6 of The US Model Workbook for more discussion of this.