The economics underlying NiGEM


The NiGEM model allows forward-looking expectations in wages, consumption, exchange rates, bond and equity prices and in monetary policy making. We assume forward-looking behaviour by default in most cases, except in the case of consumption where the evidence of forward-looking behaviour is less clear.

Bond prices affect wealth and depend on long-term interest rates, which are the forward convolution of short-term interest rates, and equity prices, which depend on expected future profits, also affect wealth. A solution method is, therefore, needed that allows us to solve for their current and future values.

We use the Extended Path Method of Fair and Taylor to obtain values for the future and current expectations and iterate along solution paths. Expectations are repeatedly recalculated until convergence is achieved. The model is solved far enough into the future so that the results are not affected by the terminal date. Terminal conditions are standard, and embed steady state properties where appropriate.

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