A Thai Interindustry Dynamic Model With Optimization

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2004-06-18

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Abstract

This study develops a long run forecasting model for Thailand, building a dynamic interindustry model that incorporates detailed sectoral inter-relationships in a consistent manner and that describe how the economy will evolve over a long time period. Policy options can be simulated with the model. An optimization technique allowing policymakers to set an optimal path for tax rates to affect inflation and unemployment is demonstrated.

The Thai Dynamic Interindustry model (TIDY) is constructed from the 'bottom up' and relies on a series of 26-sector input-output tables of Thailand describing all productive activity. Because the model uses a comprehensive and internally consistent representation of all sector interactions, the model provides a tool for studying policy effects at the sectoral level.

A special feature of TIDY is its use of loss functions to improve estimates of two critical macro variables: saving rate and prices. The loss function minimizing estimation errors on two variables, unemployment and inflation, yields estimates of the saving rate that are consistent with underlying economic theory and are an improvement over standard least squares estimates.

Forecasts of the Thai economy are presented for the period through 2020. The results demonstrate that the long run prospects for the economy, as reflected in growth in real consumption, price stability, and full employment, are quite good if stable policies for fiscal policy are followed and exchange rates remain stable. The economy is, however, not immune to major financial shocks such as occurred in the late 1990's.

The model also demonstrates the effects of alternative fiscal policies, by simulating outcomes when the time path of personal direct taxes are set to minimize the deviations of two critical macro variables inflation and unemployment rates from desired levels of 3.0 percent. A quadratic objective function, capturing substitution effects between inflation and unemployment, is specified. A time path for the inflation-averse policymaker of increasing tax rates yields slower real growth but relative price stability and a stable trade balance. The alternative of a continuous tax cut for the unemployment-adverse policymaker increases real consumption and inflation, and leads to a widening trade imbalance. These forecasts demonstrate the key role of international trade and capital markets to Thailand's long run future.

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