Using the Model - A Health Warning

A macroeconomic model is simply a set of equations describing how the model builder believes the economy to work. Outcomes from the model are obtained in the same way as with any system of equations. Values are inserted for the known variables and the solution calculated for the unknown quantities. As a consequence in certain circumstances a mathematical solution can be found that has no economic interpretation. For example in the case of the Virtual Economy model it is possible to achieve negative unemployment and interest rates.

Generally the model describes the structure of the economy over the period its equations were estimated. Results from simulation experiments are only valid if the shocks to the model are small enough not to influence the overall way in which the economy behaves. Formulating a policy package to drive inflation below zero is fairly easy and although deflation is a real prospect in some countries in 2002, it is unlikely that the UK economy would continue to behave as before in these circumstances. This situation and any other large shock lying outside recent historical experience requires a new model describing the changed economic climate.

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