RDP 8403: Modelling Recent Developments in Australian Asset Markets: Some Preliminary Results 1. Introduction

A central feature of the RBII model of the Australian economy has been its use of policy reaction functions to endogenise the exchange rate and interest rate management through which the authorities attempted to implement economic policy. Furthermore, the estimated structure of RBII reflects the regulation of deposit-taking by banks and the effect of this regulation on, in particular, the own rate of interest on money. This structure requires revision after the adoption in 1982 of the system for selling government securities (hereafter “bonds”) by tender, the floating in 1983 of the Australian dollar, and the removal of banking controls in August 1984.

In particular, changes need to be made to the policy reactions estimated on the basis of past relationships and to some of the private reactions based on the historical experience, including the determination of the own rate of interest on money.^[1]

This respecified model cannot be estimated until there is a sufficient run of data generated by the current system. This paper, therefore, presents a simulation version of the RBII model designed to represent a first attempt to model the present structure of the financial system. Sections 2, 3 and 4 deal with the modelling of the money market, bond market and foreign exchange market respectively. Section 5 examines some basic properties of the modified model, and Section 6 concludes with some final remarks on research strategy.

Footnote

Previous studies have used the RBII model to investigate alternative monetary policies (as in Jonson and Trevor (1981)) and exchange rate policies (as in Jonson, McKibbin and Trevor (1982)). While these studies retained interest rates and exchange rates as the instruments of the respective policies, their modifications to the policy reaction functions represented a first step in the direction explored more fully in this paper. [1]