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In this section simulation results are presented of standard demand and supply shocks to
illustrate the most important transmission mechanisms in the model as well as the spillovers
between countries. First we consider monetary policy and fiscal policy shocks, then an
example of a productivity shock follows. Monetary shocks are not only interesting in their
own right for policy analysis, they are also a good way of testing whether price homogeneity
holds in the model. As far as fiscal policy shocks are concerned, the discussion here is
limited to increases in government spending ( more specifically government purchases of
goods and services). Various other shocks on earlier versions of the model have been
discussed elsewhere 5.
The results below are presented either as percentage or percentage point deviations from the
baseline. This base scenario incorporates the most recent projections of the Commission
services. These projections were imposed on the model and residuals were calculated so that
the model reproduced this forecast. As stock-flow adjustments can be very prolonged, a
much longer baseline is required for the model to settle down in a simulation after a shock.
Therefore, the base was further extrapolated to the steady state solution of the model, so that
the model can be simulated over a time span of at least 70 years. This allows for enough time
for dynamic adjustment mechanisms to work through and for the stock-flow adjustments to
take place. All simulations are performed in fully linked mode, i.e. all foreign variables are
endogenously determined and the impact a shock has on other countries is fully taken into
account.
The simultaneous solution to the equations of the model is calculated using a Newton-
Raphson solution algorithm6. As various endogenous variables in the model have leads,
representing expectations of these variables in future time periods, an assumption has to be
made on the formation of expectations. It is assumed that expectations are model-consistent,
LH each period’s future expectations coincide with the model’s solution for the future. In
simulations this means that the leads in the model equations are equal to the solution values
from future periods. This is done by applying a stacked-time algorithm that solves for
multiple time periods simultaneously, Lh stacks the time periods into one multiple system of
equations and solves them simultaneously. The appendix to this paper contains more details
on the model solution method.
5 Roeger and in ’t Veld (1997b) discuss the short and long term effects of government expenditure cuts
accompanied by various tax reductions. Roeger (1996a) discusses the long term effects of fiscal
consolidation and compares the long run effects of changes to tax rates, benefits and increased
competition on the steady state solution of the model. Leppa (1996) reports on a wide variety of
temporary shocks using an earlier preliminary version of the Finnish country model of QUEST.
6 The model is simulated using the TROLL software system (see Hollinger and Spivakovsky (1996).)
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