RDP 2000-05: A Small Model of the Australian Macroeconomy 1. Introduction

This paper presents a small model of the Australian macroeconomy. The model provides a convenient way of summarising the main macroeconomic interrelationships in the Australian economy. It can be used as a simple framework with which to analyse developments in the economy and the effects of shocks, and to generate forecasts of the economy's likely future evolution.

The model is predominantly empirically based and designed to be consistent with the behaviour of the main macroeconomic aggregates in the Australian economy over the past fifteen years. It is primarily of interest for examining macroeconomic developments – including the effects of monetary policy on the economy – over the short to medium run; that is, for perhaps one to three years. Despite this main focus, however, the model also has a well-defined steady state to which it converges in the longer run, with properties that accord, in crucial respects, with our theoretical expectations.

The model consists of five estimated equations. Two of these equations explain real variables, non-farm output and the real exchange rate, while the remaining three explain nominal ‘price’ variables, import prices, unit labour costs, and consumer prices. The equations are specified to encompass both short-run dynamics and longer-run steady-state relationships. Restrictions are imposed on some of the coefficients in the three equations explaining price variables to generate appropriate steady-state behaviour.

The paper is structured as follows. Section 2 provides a broad overview of the model. Section 3 presents estimation results for the five equations in the model. Section 4 characterises the steady-state properties of the model and describes the calculation of potential output. Section 5 presents several illustrative simulations of the model, and Section 6 concludes.