Macro Modelling During Transactions
Ashok V Desai's Writing on the Wall (August 1) has described the macroeconomic model of National Council for Applied Economic Research (NCAER) as outdated. As far back as in 1992 when he was in the finance ministry, the model had little use for the ministry. Macroeconomic models in general and the present model in particular are often criticised on these grounds, both with respect to aspects of the underlying theoretical structures, data and estimation techniques. It is not a unique position that Dr Desai can claim.
NCAER's macro model that Dr Desai apparently is referring to has been in operation since the early 1980s in its various versions. It has been in use for forecasting and simulation purposes every year since the early 1980s. While it was updated for all the available data every year, in 1993-95, major re-specification, estimation and evaluation were carried out. In fact this was the only model at the time that was capable of endogenising the exchange rate based on international trade equations for specified levels of current account deficit. Even today the richness in the specification of price formation in terms of administered prices, prices of tradables and non-tradables is a unique strength of the model.
Any model has its purposes and consequent limitations. The current model is a short-term model and by its very nature, it cannot be used to see the impact of policy changes that take time to have an impact: for example, trade policy changes that have an impact on the re-allocation of resources including the ones that lead to additional capacities in sectors that become more competitive than before. Another CGE (computable general equilibrium) model that NCAER's macro division has developed addresses precisely these issues. The model, however, has its uses: for short-term forecasting and evaluation of policies from a short-term perspective.
It is precisely in recognition of the current model's limitations that we have been attempting to develop new models, new research of a complementary nature: Business Expectations Surveys, leading indicators, and work in the financial sector. Today we indeed have funding for a project that specifically aims to develop a macroeconometric model that looks at short and longer term issues. But of course, even the unborn child may be 'outdated' since it takes about nine months to be born. If the research work has fallen behind times, it is not only because of the capabilities of the researchers but also because of the relevance of the advances. There would have been no point in building a liberalised version of financial markets in the early 1990s. There would not have been much point in developing a model that forecast FDI inflows in the 1980s. Our attempt is to develop capabilities that are seen as relevant by the users.
We have begun our work on incorporating financial markets into our models, and we are attempting to find financial support for our work on assessing state-level performance. It should also be remembered that the period of 1990s has also seen a great deal of changes in the policy environment. By the very nature of empirical tools in economics, prediction and forecasting in such transition period involves larger errors. Data revisions are also taking place in terms of new series of National Accounts, new series of prices and IIP. There may be a point in continuing with the available models, adapt them in the best possible manner and in the mean time develop methodologies that can improve model performance over time.
Writing in 1989, Professors, Krishna, Krishnamurthy, Pandit and Sharma from Delhi School of Economics and IEG remarked: "While this (official institutions like RBI, Planning Commission and MoF have shown interest in the area of macroeconomic modelling) is encouraging in itself, a really positive stimulus will come only when these institutions begin to use this work as an input in policy formulation. This is still awaited". Perhaps there is some progress, but significant progress can come only when those who do not find much use for the models would interact with the researchers and put forth their requirements of policy analysis.
Macro modelling is an applied economic research activity. Model building requires considerable developmental work in terms of specification testing and estimation of inter-relationships and of course updating the estimates every now and then to keep them from becoming 'outdated'. The model does not have rational expectations nor inter-temporal optimisation. But it does incorporate some of the important structural features of the Indian economy. There is a need to invest in such tasks to contribute to policy debates in a meaningful manner. Regrettably, one has to look to 'foreign assistance' even for such research activity. NCAER's macro model does manage to fund its own operating costs by providing analysis and forecasts to its Industry Package subscribers, besides the work that is disseminated through the quarterly publication, Macro Track, which has drawn Dr Desai's grudging complements. The 'outdated' macro model has been a workhorse, which has ensured with its track record that a worthy successor would take on the job. We earnestly hope that the public funding for macroeconomic research, particularly relating to macroeconomic modelling would keep the developmental work alive. Private funding will ensure application of the model.