RDP 8403: Modelling Recent Developments in Australian Asset Markets: Some Preliminary Results 6. Conclusion

This paper has attempted to show how a macroeconometric model can be adapted to handle changes of policy regime, such as the floating of the exchange rate, the introduction of a tender system for government bonds and interest rate deregulation. In doing so, the approach has recognised the interdependence of the current and capital accounts of the balance of payments under a floating exchange rate.

It has also been assumed:

• that because bonds are not supplied continuously, but at discrete intervals (through the periodic tenders), the Walrasian tatonnement process may not apply and thus that a partial adjustment mechanism may be appropriate for the determination of the bond rate;
• that interest rate expectations are consistent with market-clearing in the bond market and are fulfilled asymptotically;
• that the government's decision to sell a given quantity of bonds can allow for the need to fund the budget deficit while simultaneously achieving a targeted rate of growth for the money supply.

Attention has also been paid to some of the structural changes that might occur under these changes of policy regime, both to the model's parameters generally and to the specification of particular shocks.

Some of the properties of the model have been illustrated with counterfactual policy simulations. The results of these simulations suggest that fiscal and monetary policy, by themselves, cannot sustain an economic recovery with stable prices unless they induce (through expectations) changes in private agents' behaviour not captured in the structure of the model.

Comparison of these results with those of earlier versions of RBII (which use the estimated policy reaction functions) suggests that the structural modifications introduced in this paper facilitate the pursuit of monetary objectives in the short run. However, they have not much altered the real government spending multipliers (for output and employment) as might be expected in a model where nominal wages are assumed to adjust fully to movements in prices.

These results must, of course, be interpreted with caution. They are produced with an econometric simulation model in which some relationships are assumed rather than estimated. Moreover, the model assumes a simple specification for policy reactions. However, in attempting to apply existing econometric evidence to questions of the behaviour of “fix price” rather than “fix price” asset markets and their interaction with the “real” economy, it is hoped the paper makes some contribution to the understanding of the workings of these markets.