RDP 8710: Transmission of External Shocks in the RBII Model 4. Conclusions

The paper has outlined a series of structural adjustments to the SBII model, designed to reflect recent developments in Australian financial markets and to improve the accuracy of RBII's treatment of debt. These changes represent a continuation of earlier model development work by Fahrer and Rankin (1984), by introducing continuous clearing into a second market (the cash market) in addition to the foreign exchange market. In keeping with the spirit of earlier versions of RBII, these clearing markets are embedded in a macroeconomic structure of general disequilibrium.

Our simulation results suggested a number of important properties of the revised modelt

• the introduction of greater interest rate flexibility tends to reduce the size of the fiscal multiplier, due to increased effects of interest rate movements on consumption and investment;
• public sector debt is not stable in the model unless it is controlled by a policy rule which responds to the debt to GDP ratio;
• when debt responses are incorporated into the model, the fiscal multiplier is much reduced and becomes negative after about 5 years.

These results come from a simulation model in which many of the parameters are imposed rather than estimated. We argued that this was unavoidable given the nature of the process of structural change in Australia's financial sector. Nonetheless, uncertainty about the appropriate values for the new parameters is such that results should be treated with caution. As more data accumulates for the post-deregulation environment, we would expect to be able to learn more about the currently unknown parameters through further empirical work.