Elsevier

Economic Modelling

Volume 21, Issue 6, December 2004, Pages 991-998
Economic Modelling

An empirical, small scale ‘Traded–Nontraded Goods’ model for New Zealand

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Abstract

In this paper, an empirical model of the traded–nontraded goods model was built in order to examine the effect of various policy variables on the real exchange rate and resulting impacts on the variation in industrial supply, demand and employment levels. This framework was also built to search and simulate alternative policy settings to 1984 economic reforms of New Zealand, that would possibly decrease the short-term adjustment costs of 1984 reforms. It was found that, particularly the output contraction and employment loss in exportable industries, would have been lower if the liberalization in the exportable and importable industries had followed similar timing.

Introduction

The New Zealand economy performed poorly on many measures in the years immediately following the reforms, 1984–1990. Much of the literature on the New Zealand economic reforms criticized the sequencing and timing of policies followed during the policy changes. In particular, the impact the chosen policy sequence had on the real exchange rate was criticized. The studies, however, did not go so far as to demonstrate how a different sequence of policy changes might have led to higher levels of output and employment (lower short-term adjustment costs) during the reforms.

An empirical model of the traded–nontraded goods model was built in this study in order to examine the effect of various policy variables on the real exchange rate and resulting impacts on the variation in industrial supply, demand and employment levels. The theoretical background of the traded–nontraded goods model is based upon the Swan (1960) and Salter (1959) two-sector ‘real’ model. Dornbusch (1974) extends the Swan–Salter model into a three-sector model and later Mussa (1986) extends it to incorporate money and asset markets. The theoretical background of the model also draws on the policy analysis and theoretical discussions by Edwards (1989). In New Zealand the exportable sector is mainly comprised of livestock-based production. Based on this, the Jarvis (1974) supply response model is used to explain the relationship between the real exchange rate and agricultural supply response. Finally, the Wren-Lewis (1983) employment model is used in order to specify the relationship between industrial output and employment levels (see www (web archive) for theoretical discussions).

The empirical model also provided the basis to carry out counter factual analyses that would provide answers to the question: “What would have been the outcomes of the economic reforms if policy changes had been applied with a different sequencing and timing?”.

Section snippets

Specifics of the model

The empirical model consisted of four equation blocks—real exchange rate, real output, real demand and employment—which includes a 13-equation system. In this system, there are 13 endogenous variables that are estimated using 19 predetermined variables of which 12 are exogenous and 7 are lagged endogenous variables. The system has a block-recursive structure.

Before estimation, time series properties of the variables and co-integrating relationships in the behavioral relationships were checked.

A counter factual to trade liberalization in New Zealand

In this section a counter factual analysis1 was carried out to evaluate the impact of an alternative trade

Outcomes and concluding remarks

The simulation outcomes for real exchange rates, trade balance and unemployment rate are provided in Table 3. The new policy setting have produced lower rerx and rerm values during the period of 1984–1996. The main effect is observed to be on the rerx which may be caused because of the gradual liberalization in export subsidies. By 1990, the simulated rers appear to increase compared to pre-1990. This may be the result of the effect of relatively high rates of import tariffs compared to export

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There are more references available in the full text version of this article.

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