Balance of resources

 

The balance of resources is described by the basic income identity:

 

 

where SEC is household consumption expenditure, SEGC is government consumption expenditure, SEGI is government investment expenditure, SEBI is private business investments, SEHI is housing investments, SEXG is exports of goods, SEXS is exports of services, SEMG is imports of goods, SEMS is imports of services and SEDS is changes in inventories. The consumption functions is

 

 

where SEYD is real private disposable income and SEU is the unemployment rate. The unemployment rate is included to capture income uncertainty[1]. Real private disposable income is defined by

 

 

where SEWHB is the gross hourly wage rate, SEHOURS is the mean number of hours worked and SEE is the number of employed. SEOPI is other personal income, SETRAN is transfers and SETAX is direct taxes. Personal income is defined as

 

 

where total compensation SECOMP is defined by

 

 

where SEWTR is the wage tax rate and SECOLLR the payroll tax rate.

 

This consumption function is one out of three basic alternatives and uses current and lagged values only. The second alternative uses a forward-looking income variable, SEYDFORW, which is the present value of incomes four year ahead. A third alternative is a disaggregated model in which household consumption is divided into six components[2]. This model can partly be traced to Bernanke (1985) who derives Euler equations for components of private consumption, in which expenditure on one component depends on expenditure on other components. (See the web site for details.)

 

Government consumption and investments are simple random walks with drift. Private business investments is based on a paper by Assarsson, Berg and Jansson (2004)

 

 

where a model is used in which both an accelerator and Tobin’s Q determines investment. According to the basic theory Tobin’s marginal Q should be a sufficient determinant of investments. That model can be extended and a possibility opened for output to influence investments if firms are rationed in the home market. In the paper we also show that the measure SETQ above is a good approximation to a more sophisticated but less transparent measure of Q. From this we also note that an increase in interest rates lowers equity prices and Tobin’s Q and hence lowers business investments.

 

Housing investments is determined by

 

 

where SERR is the real rate of interest and SEHS is the number of housing starts. The number of housing starts is determined by

 

 

Housing starts is used since there is a time delay between the decision to build a new house and until the house is finished, due to administrative factors.

 

Export and import equations for goods and services, respectively, are demand equations and as such it is important to find the most appropriate approximations of relative prices and income[3]. There are several alternatives in each case and I have tried numerous specifications. As relative prices there are relative export and import prices, relative unit labour costs, real effective exchange rates, consumer or producer prices, etc. The income variables are more straightforward and I have used Swedish export markets – SES – for exports and SETFE = SEY + SEMG+SEMS, total demand, for imports. Swedish export markets are defined as the export share weighted imports from other countries. The real effective exchange rate is also defined where relative consumer prices (consumption deflators) across countries are weighted with export shares. The nominal index is SEEFEX and the relative index is SEREFEX. These indexes are broader than the Swedish TCW-indexes but the correlation between them still is close to unity. Other measures that are possible and are included in the BASMOD data base and therefore easily can be tried out by anyone interested are SERULT=trend in relative unit labour cost, SERPX=relative export price index or SERPM=relative import price index. The final functions are

 

                         exports of goods

                     exports of services

              imports of goods

                   imports of services

 

Finally, the investments in inventories – changes in inventories – is determined by

 

 

where SEDS is changes in inventories and SESL is the stock of inventories. This completes the description of the demand side of the model apart from economic policy which in the model works via demand.