6. 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. 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. This is explained in Chapter 4 of the MC2 Model Workbook. These experiments can also be performed using the MC3 model. The steps for the first experiment, the "No Boom" experiment, 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 1995 through 2004.
  3. Click "Drop or add equations" and for the United States drop the CG and RS equations (equations 25 and 30).
  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. You can then compare these results using the MC3 model with those in the paper using the MC2 model. The particular variable of interest is GDPR, real GDP.

The following are the steps for the second experiment, the "Crash" experiment.

  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 1999 through 2004.
  3. Click "Drop or add equations" and for the United States drop the CG and RS equations (equations 25 and 30).
  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".