7. Testing for a New Economy in the 1990s
The title of this chapter is the same as the title of a paper that can be read or downloaded from this site: Testing for a New Economy in the 1990s. You should read this paper before reading this chapter.

The no-stock-market-boom experiment in Section 4 of this paper uses the MC3 model. The following are the steps necessary to duplicate this experiment, which is setting CG to 542 (annual rate) for each quarter of 1995:1-2000:4.

  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 2000.
  3. Click "Use historical errors" and set the option to use the historical errors.
  4. Click "Drop or add equations" and drop the CG equation for the United States (equation 25).
  5. Click "Take equations to begin after the beginning of the prediction period" and add back in (i.e., change -1 to 0 in the relevant boxes) the equations explaining: UKH, DEH, NOH, SWH, GERSEMU (for EU), and GEEEMU (for EU)
  6. Click "Change exogenous variables" and ask to change CG for the United States. Then put 542 in the box labeled "Replace all existing values with" and hit enter. Be sure to save the changes once you are done.
  7. Click "Solve the model and examine the results".

Once the model is solved you can examine the results. If you have done the experiment correctly, your comparisons (between your dataset and MC3BASE) will match the comparisons in the paper. You can, of course, examine many more variables and periods than are presented in the paper. Remember that the flow variables are presented in the output at annual rates. For example, divide CG by 4 to put it at a quarterly rate. This experiment is useful for seeing the size of the wealth effects in the model.

The use of the historical errors is important. 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.

If you want to run the version of the experiment in which the Fed immediately lowers the interest rate to 1.5 percent in 1995:1 and leaves it there, the additional steps are:

  1. Click "Drop or add equations" and drop the RS equation for the United States (equation 30).
  2. Click "Change exogenous variables" and ask to change RS for the United States. Then put 1.5 in the box labeled "Replace all existing values with" and hit enter. Be sure to save the changes once you are done.

Note from this experiment that there is still an increase in the unemployment rate for the United States. Even the very aggressive Fed policy in this case is not enough to offset all of the negative effect of the lower equity prices.