Reconstruction of a macroeconometric model for bangladesh : a dynamic behavior of policy simulation

Abstract

The study describes a medium-sized macroeconometric model of Bangladesh economy over the period 1981 to 2000 aiming to account for a number of macro linkages that facilitates forecasting with some major policy shocks on various exogenous variables including total government expenditures (TGE), interest rate, and exchange rate to measure the effectiveness of monetary, fiscal and exchange rate policy respectively. For the sake of better specification, the model in this research has developed based on 6 building blocks, which covers aggregate production, consumption, international trade, money supply, price, and government revenue and expenditure that can be used to examine the effects of both domestic and external shocks to the economy. Based on simultaneous equation approach, the model used in this thesis has attempted to utilize Super-structural Macroeconometric technique by avoiding cross-equation-correlation of the residuals in the system. That is, all behavioral equations have been estimated individually by selecting Two Stage Least Squares (TSLS) method with the inclusion of all exogenous and lag variables of the model as instrument lists. After that, to check stationarity, the methodology employed in this study uses unit root tests by considering Augmented-Dickey Fuller (ADF) tests under Akaike Info Criterion followed by ARIMA/ ARMA (as appropriate) model for forecasting exogenous variables. As Bangladesh economy is becoming increasingly market-driven, most of the equations used in the model are formulated from the viewpoint of demand-side analyses. After giving the expansionary fiscal shock by 18.97% to TGE, all production sectors including primary, secondary, and tertiary sectors are worse off. It worsens the government budget deficit, but expands government revenue. Likewise, having an expansionary monetary policy shock, both real GDP and Gross Domestic Expenditures (GDE) have dampened slightly. However, an exchange rate policy shock has given a positive push to total volume of exports. It is because the domestic goods and services for the foreigners became cheaper due to depreciation of Taka against USD. Precisely, total volume of exports expansion leads to fall foreign trade deficit that ultimately directs to increase real GDP. The effect has made a synergy by increasing total investment in future that supported the government to expend more for consumption purposes. Consequently, by running policy mix simulations, it reveals that the hypothesis formulated in this dissertation- “monetary policy along with exchange rate policy is more effective than fiscal policy for economic development of Bangladesh”- is testified as a valid result empirically. Thence, based on the macroeconometric model restructured in this thesis, a blending of monetary and exchange rate policy is one of the best alternative options to uplift the aggregate economy of Bangladesh.