A macro-economic model of Jamaica, 1959-1966

This paper is prepared f'or the BankOs internal use and is not for publication. The views are those of the author and not nec:essarily those of the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATICN Economics Department Working Paper No. 65 A MACRO-ECONOMIC MODEL OF JAMAICA, 1959-1966 February 4, 1970 Nicholas G. Carter Assisted by: Steven Kohlhagen and W.L. van der Valk Quantitative Techniques and Analysis Division  1. This paper consists of a descriptive account of an econometric model of the Jamaican economy over the period 1959-66. As such, it belongs to a well-known, class of models, the members of which have the common characteristic that they provxide a macro-economic structural description of an economy, with statistically-estimated quantitative parameters. These models, the development of which is particularly associated with the name of Professor LaTwrence R. Klein, typically contain about thirty equations, anu provide a description of the macro-economic behavior of the economy over an observed period of time. As such they are often used in order to project the future path of an economy, or to show the likely effect of possible economic policies. 2. Originally such models were constructed for the economies of developed countries such as the United States. With the observations and predictions relating to quarterly periods, they have had some measure of success in connection with attempts to assess the impact of government fiscal and monetary policies, and to make conditionial predictions of the values of the main macro-economic aggregates.L This success has been limited, however, to periods for which the underlying structure was 1/ See for example, Kelin, L.R. and Goldberger, A.S., An Econometric Model of the United States, 1929-1952, New York, 1955, Humanities Press. 2/ See for example: National Bureau of Economic Research, Models of Income Determination, Princeton, 1964, pp. '1-57 (the Wfharton Model). Also see, Duesenberry, J.S., Eckstein, 0. and Fromm, G., A Simulation of the U.S. Economy in Recession, Econometrica 28 (1960), pp. 7 1. For a larger attempt at the same thing see Duesenberry, J.S., Fromm, G., Ilein, L.R. and Kuh, E., eds. The Brookings Quarterly Econometric Model of the U.S. Economy, Chicago, Rand-McNally, 1965  -2- correctly specified. Recently, and in particular since the latter part of 1968, the predictive value of such models of the American economy has not been good. This suggests that the underlying structure of the economy has changed. 3. Very similar models have in many cases been constructed also for developing countries. In such cases the limitations of the data have made it necessary to proceed on an annual rather than a quarterly basis; while a further problem is that the structural relations which the models attempt to determine statistically may be more subject to change than in more complex economic systems. Thus in developing countries the models necessarily rest on much less secure foundations. Despite this, however, they have sometimes been used as a basis for longer term forecasts, for periods of five or ten years ahead, and also as a guide to the choice of economic policies. Thus for example the UNCTAD Secretariat,, first in estimating the prospective "resource gap" of the developing world and subsequently in making projections in relation to the Second Development Decade, has made extensive use of this kind of econometric model. 4. In our view, such extensions and applications of the model are of questionable value. An explanatory system which works reasonably well on a quarterly basis, and for short-term predictions in a developed economy which has good sources of data and is not subject to drastic change, cannot legitimately be used for forecasting several years ahead in a situation where typically the data are extremely bad and rapid structural changes are 1/ See for example: Trade Projectiorns and Capital INeeds of Developing Countries, UNCTAD, New York, 1967  -3- both expected and desired. There are a number of reasons why this is so, a1/ of hich the following are perhaps the most significant: a. The process of growth in developing countries is often characterized by major structural changes, while a statistically estimated macro-economic model of the kind that we are concerned wihr, here is related only to the structure of a past period. b. The forecasting error inherent in such models is so large that over the typical planning horizon, which is usually five years but, may sometimes be ten or more, the dispersion of probable outcomes is too wide to allow the forecast to be of any practical use. Educated guesses are in general more reliable, as well as less costly and laborious to make. c. Data limitations are often very serious, and of'ten dictate the form of the model that can be used. In so doing, however, one runs the risk of creating serious spoeci.fication errors. d. Even with better data, the problerm of spacific,ai'.Qon may still be a serious one. In particalarM the cac&:al relation- ships that will be inmportant in the futu re may not have been so in the past. e. The constructiorn and manipulation of such models is, and will continue to be, demandinig in terms both of skilled labor and 1/ For an extended discussion of t