Economics in Theory and Practice: An Eclectic Approach: Essays in Honor of F. G. Adams

273 Pages·1990·18.27 MB·English

by  L. R. Klein

ECONOMICS IN THEORY AND PRACTICE:
AN ECLECTIC APPROACH
Advanced Studies in Theoretical and Applied Econometrics
Volume 17
Managing Editors:
J.P. Ancot, Netherlands Economic Institute, Rotterdam, The Netherlands
A.J. Hughes Hallet, University of Strathclyde, Glasgow, Scotland
Editorial Board:
F.G. Adams, University of Pennsylvania, Philadelphia, U.S.A.
P. Balestra, University of Geneva, Switzerland
M.G. Dagenais, University of Montreal, Canada
D. Kendrick, University of Texas, Austin, U.S.A.
J.H.P. Paelinck, Netherlands Economic Institute, Rotterdam, The Netherlands
R.S. Pindyck, Sloane School of Management, M.I. T, U.S.A.
H. Theil, University of Florida, Gainesville, U.S.A.
W. Welte, University of Lodz, Poland
For a list of volumes in this series see final page.
Economics in
Theory and Practice:
An Eclectic Approach
Essays in Honor of F. G. Adams
edited by
Lawrence R. Klein
Department of Economics,
University of Pennsylvania, U.S.A
and
Jaime Marquez
Division of International Finance,
Federal Reserve Board, U.S.A
KLUWER ACADEMIC PUBLISHERS
DORDRECHT / BOSTON / LONDON
Library of Congress Cataloging in Publication Data
Economics in theory and practice an ecletic approach I edlted by
Lawrence Klein, ~aime Marquez.
p. cm. -- (Advanced studies in theoretlcal and applied
econometrlcs ; 17)
"Essays in honour of F.G. Adams."
1. Econometric models. 2. Economics. 3. Adams, F. G. I. Adams,
F. Gerard (Francis Gerard), 1929- II. Klein, Lawrence Robert.
III. Marquez, ~alme R. IV. Series Advances studles ln theoretica~
and applled econometrics; v. 17.
HB141.E256 1989
330--dc20 89-15588
ISBN-13: 978-94-010-6693-8 e-ISBN-13: 978-94-009-0463-7
001: 10.1007/978-94-009-0463-7
Published by Kluwer Academic Publishers,
P.O. Box 17, 3300 AA Dordrecht, The Netherlands.
Kluwer Academic Publishers incorporates
the publishing programmes of
D. Reidel, Martinus Nijhoff, Dr W. Junk and MTP Press.
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Printed on acid-free paper
All Rights Reserved
© 1989 by Kluwer Academic Publishers
Softcover reprint of the hardcover 1s t edition 1989
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TABLE OF CONTENTS
Preface vii
L.R. f{[ein and J. Marquez
P ART I: FRONTIERS IN FORECASTING AND ECONOMETRIC
MODELLING
1. Combinations of High and Low Frequency Data in Macroeconometric 3
l\Iodels
L.R. Klein and E. Sojo
2. Stochastic Simulation, Prediction and Validation of Nonlinear Models 17
R. S. Mariano and B. W. Brown
3. An Integrated Exhaustible Resource Model of Copper Market Dynamics 37
We. Labys
PART II: TRADE, DEBT, AND DEVELOPMENT
11. The Impact of Commodity Price Instability: Experiments with a 59
General Equilibrium Model for Indonesia
J.R. Behrman and J.D. Lewis
5. Commodity Price Contractions, Debt and Economic Growth lOl
in Developing Countries: The Venezuelan Case
P.A. Palma
G. Income and Price Elasticities of Foreign Trade Flows: 129
Econometric Estimation and Analysis of the US Trade Deficit
J. Marquez
VI
PART III: INDUSTRIAL ORGANISATION AND GOVERNMENT POLICY
7. Previous Cartel Experience: Any Lessons for OPEC? 179
J. M. Griffin
8. The Implications for Future Contingency Planning of the 207
1979 Gasoline Shortage
L.E. Grayson and R.M. Morris
9. International Trade, Investment, and American Cities and Regions 227
N. J. Glickman
Index 249
PREFACE
Lawrence Klein, University of Pennsylvania
Jaime Marquez, Federal Reserve BoarrI*
All examination of the economics literature over the last twenty years reveals a
marked tendency towards polarisation. On the one hand, there has been a
propensity to develop theoretical models which have little connection with either
empirical verification or problems requiring immediate attention. On the other
iland, empirical analyses are generally typified by testing for its own sake, with
limited examination of the implications of the results. As a result, the number of
papers confronting theory with facts towards the solution of economic problems
has been on the decline for years.
To fill this growing gap in the literature, we have invited a number of
authors to write papers using both theoretical and empirical techniques to
address current issues of interest to the profession at large: the US trade deficit
and the global implications of policies that attempt to reduce it, the international
ramifications of the debt crisis, the international oil market and its implications
for the US oil industry, and the development of new econometric techniques. In
addressing these issues, each author has approached the subject matter from an
eclectic standpoint - that is, avoiding strict adherence to a given doctrine.
These essays are grouped in three sections according to issue they address. In
section I we include papers dealing with the development of new techniques for
forecasting, model evaluation, and econometric modelling. Section II contains
three papers examining the international debt crisis and its relation with
international trade. Finally, section III is devoted to studying the issue of
industrial organisation and its relation to changes in both the regulatory
environment and the international oil market.
vii
viii
I. FRONTIERS IN FORECASTING AND ECONOMETRIC MODELLING
For an econometric model to be useful in decision making, it must be accurate. In
this regard, much has been written about the forecasting records of both time
series models and structural models. However, until recently, the approaches
available forced practitioners to choose one type of model or the other. Lawrence
J({ein and Eduardo Sojo develop a single forecasting model that integrates time
series modelling with structural modelling. As they show, the chief advantage of
this integration is the reduction in the risk associated with forecasting. This task
is accomplished by combining forecasts from models that rely on data with
different frequencies. For example, the forecasts of a structural quarterly model
can be combined with the forecasts of a supplementary time series model that
relies on monthly information.
Several advantages arise from their approach to forecasting. First, it is
possible to exploit the most recent information, which is generally available ill
high frequencies. Second, it is possible to integrate time series and structural
modelling, with the former being more accurate in the short run and the latter
being more accurate in the long run. Finally, the paper by Klein and Sojo is of
interest to policymakers, who often have access to a low frequency model and the
high frequency data.
A particular forecast is not very useful if there is no information about its
standard error. With this error, it is possible to evaluate the relative risk of the
forecast, which is particularly important for making economic decisions.
However, the complexity of existing econometric models precludes the
computation of such standard errors in all but the simplest of models. Roberto
Ma1'iano and Bryan Brown develop a methodology to compute forecast standard
errors for large scale models in a computationally simple way. They accomplish
this task by examining the large sample properties of alternative forecasting
procedures for the class of dynamic nonlinear models. Because the vast majority
of econometrically estimated models fall into this class, their analysis has
immediate applicability to private and public institutions for which economic
forecasts are an integral part of the decision making process. Mariano and Brown
recognise that the historical residuals of an econometric model can be treated as
estimates of the original disturbances. These estimated residuals form the basis to
generate stochastic dynamic simulations that would enable researchers to
compute the standard errors associated with both model forecasts and model
multipliers.
IX
Finally, the econometric estimation of parameters of interest requires
variation in the data. There are circumstances, however, in which model
predictions would be improved by incorporating relations which, by their own
nature, do not tend to produce data with the needed variability. An important
issue is, then, whether it is possible to combine models using different
methodologies for parameter estimation, and if so, what interpretation can be
given to the model results.
Walter Labys studies these questions in the context of the world copper
market. Specifically, he uses engineering parameter estimates along with
II II
econometric parameter estimates in a single model. The former are used to gauge
technical relations which ultimately determine productive capacity and thus, long
run supply. However, it is not possible to obtain data on long-run relations, and
even if it were, the data would not exhibit enough variation to permit
('conometric estimation of the associated parameters.
By integrating two strands of commodity market modelling, Labys is able to
['oeus on the transition from a short-run disequilibrium to a long-run
equilibrium. Short-run disequilibrium is modelled in a standard commodity
(econometric) model (e.g., the work of Adams, Behrman, and Labys) which is
well suited for explaining supply side considerations, such as capacity formation.
The model is validated and in this process, Labys is able to identify the effects of
both supply and demand factors on fluctuations in copper prices.
II. TRADE, DEBT, AND DEVELOPMENT
One of the oldest questions in economics is whether international trade is
conducive to development. Although theoretical arguments lead one to believe
that it does, it has been argued that international trade has increased the
exposure of developing countries to price fluctuations which in turn have
hampered their development process.
To address this question, Je1'e Behrman, Jeffrey Lewis, and Sherif Lotfi use a
Computable General Equilibrium model to examine the extent to which
fluctuations in commodity prices have affected the development process of
Indonesia. As it stands, the existing literature, much of which has been written
by Behrman himself, focuses on the macroeconomic consequences of lower
commodity prices. However, as the paper argues, the question is not whether
lower export prices affect adversely growth prospects, but whether a greater
variability in these prices is responsible for lower growth rates. Furthermore, very
x
little attention has been given to the microeconomic implications of greater price
variability. Microeconomic considerations are important because they explain the
degree to which the supply of both labour and goods are affected by
unpredictable price paths. Finally, the effects of price increases have received less
attention than the effects of price decreases. This asymmetry in price effects
interacts with policy responses from both domestic and international institutions
potentially obscuring the ultimate effect.
A more recent, and related issue is the degree to which many debtor
countries are able to support both a sustained growth path and service their debt
obligations. Pedro Palma studies the policy responses of debtor countries to
commodity price changes, an issue of interest given that most debtor countries
are currently engaged in debt rescheduling agreements the viability of which are
also dependent on commodity prices. A second important issue addressed by
Palma is the effect of alternative debt rescheduling agreements on the
macroeconomy. Knowledge of these macro effects is of interest because it helps to
determine the rescheduling package a country should adopt and the policy
responses that would be required to support a given rescheduling plan if
commodity prices change.
To address these questions, Palma relies on dynamic simulations of a
medium size econometric model for the Venezuelan economy. Venezuela is an
ideal case for addressing these questions because of the recent volatility in oil
prices, the heavy reliance on oil exports as a source of export revenues, and the
existence of a debt rescheduling agreement with banks. Thus fluctuations in oil
prices affect not only Venezuela's growth prospects but also the country's ability
to service its external obligations. The result of this analysis, besides being
relevant to policy making in other debtor nations (e.g., Mexico), might shed light
on questions regarding the difference between liquidity and solvency as well as
the conduct of stabilisation policy in developing countries.
Jaime Marquez studies the design of policy responses to address international
trade imbalances and the associated consequences for international trade flows.
To address these issues, Marquez develops a trade model explaining bilateral
trade flows in an eight region world economy (Canada, Germany, Japan, the
United Kingdom, the United States, Other OECD, non-OPEC developing
countries, and OPEC). A key feature of this model is that international trade
imbalances add up to zero. The analysis estimates income and price elasticities
for bilateral import equations, tests for the properties of the error term, for