Models

Independent Extended Computable General Equilibrium (CGE) model: for industry and tax policy analysis

Independent Macro-econometric model: for economic forecasts and macro policy analysis

Independent HFE model: for analysing options for Horizontal Fiscal Equalisation (GST revenue sharing) between the states and territories

Independent Short-term Forecasting model: for timely, short-term economic forecasts

Independent Extended CGE model (updated August 2015)

As a Computable General Equilibrium (CGE) model, the Independent Extended CGE model analyses the economic impacts of changes to the economic environment. These impacts cover economic activity, employment, trade and investment at the level of individual industries, impacts on households and impacts on the Australian economy as a whole. Compared to other CGE models, our model has a special focus on tax policy, industry detail and regional sub-economies.

History

The first edition of the model, known simply as the Independent CGE model, was developed by us as a completely new model early in 2012. Later in 2012 we further developed the modelling of business tax, with input from Treasury, to meet the modelling needs of the Australian Government’s Business Tax Working Group (BTWG). The first edition of the model has been used by Treasury under licence to us on three occasions.

  • In 2012 modelling of a cut in the rate of company tax was included in the Final Report of the BTWG.
  • In 2014 Treasury officers published a more detailed analysis of a cut in company tax in the Treasury Economic Roundup.
  • In 2015 Treasury officers published an analysis of the efficiency of major taxes in a Treasury Discussion Paper prepared to support the deevlopment of the Tax White Paper.

In 2014 and 2015, Independent Economics developed the second edition of the model, known as the Independent Extended CGE model. Compared to the first edition of the model, the major enhancements are as follows.

  • The number of industries distinguished was extended from 120 to 288.
  • The model's database was updated, including by using the latest input-output tables from the ABS.
  • A regional module was added to extend the modelling of economic impacts from the national level to 50 regions of Australia.
  • The model's capabilities for modelling the economic impacts of tax reform were upgraded, as discussed below.

Independent Economics is presently the only entity licenced to use the second edition of the model.

Modelling Tax Reform

The first edition of the model was designed to analyse tax reform and this tax reform modelling capability has been developed much further in the second edition. Special tax-related features in the first edition include the following.

  • sophisticated modelling of production in each industry, distinguishing nine types of produced capital, three fixed factors to capture economic rents, and eight occupations for labour. This allows more precise modelling of the impact and incidence of taxes on different inputs into production such as company income tax.
  • builds in highly-developed modelling of the business tax system and its economic impacts. It takes into account factors such as: the different tax treatments of debt and equity financing; the complex system of depreciation allowances and tax concessions; franking credits; and the potential for international profit shifting.
  • provides a rigorous measure of changes in consumer welfare or living standards, so that policy changes can be correctly evaluated in terms of the public interest.

The second edition added the following important tax-related features.

  • the model now distinguishes 24 different taxes, up from six taxes in the first edition.
  • a 2-tier approach to modelling consumer demand was introduced. This takes into account that households often have more scope to substitute within 19 broad categories of spending than between those broad categories. This is important in robustly modelling the effects of changes to the scope of taxes on consumer spending such as the GST.
  • the extension from 120 to 288 industries adds to the robustness of modelling specific taxes such as those on different forms of alcohol and gambling. It makes it possible to model the distortions from applying different rates of tax to the different forms.
  • A tax-adjusted Capital Asset Pricing Model (CAPM) that optimally allocates wealth across asset classes has been added. This captures the economic distortions from applying personal income tax at non-uniform effective rates across asset classes.
  • The model now allows for progressivity in the tax-transfer system. It does this taking into account both the payment of government cash benefits and the tax-free threshold under personal income tax. This progressivity adds to the excess burden of personal income tax.

Download the Information Paper

Download the information paper on "The Independent Extended CGE model" (updated April 2015).

Independent Macro-econometric model (updated August 2015)

As a macro-econometric model, the Independent macro model is designed for economic forecasting and for analysis of fiscal, monetary and labour market poicies. It aims to balance economic principles and evidence from historical data in capturing the broad workings of the Australian economy. This balanced approach is in contrast to: (i) calibrated macro models that place most weight on economic theory and are mainly designed for policy analysis; and (ii) vector autoregressive (VAR) models that place most weight on the historical data and are mainly designed for short-term forecasting.

History

The Independent macro model is the latest in a series of macro-econometric models developed by Chris Murphy since 1988. It shares common design features with earlier models in the series as follows.

  • It uses quarterly data, and the parameters are estimated econometrically.
  • Stickiness in wages and prices means it is demand-driven or Keynesian over short time horizons.
  • Market clearing means it is supply-driven or neoclassical over long time horizons.
  • A representative business in each industry maximises profits in the long run.
  • Financial markets are forward-looking, with model-consistent expectations, while other markets are generally backward looking.

The original model was based on one industry (Murphy, 1988) but this was extended to 12 and then 18 industries in Murphy Model 2 (Powell and Murphy, 1997). The current macro model has six industries: Agriculture, Mining, Manufacturing, Government Services, Other Services and Housing Services. This broad industry detail is designed to provide a stronger base for macro policy analysis and forecasting.

The first edition of the Independent macro model was developed by us as a completely new model from 2012 to 2014. In 2015 the second edition of the macro model was developed by making economic growth semi-endogenous. The first edition of the model incorporated the following new design features.

  • There is a short-term interest rate rule based on the Reserve Bank's inflation targeting approach.
  • Land and mining resources are introduced as fixed factors of production.
  • The GFC is taken into account in modelling consumer and investment behaviour.
  • THere is a new approach to modelling household consumption that uses a target for asset holdings based on labour income.
  • THere is a new approach to modelling household consumption that uses a target for asset holdings based on labour income.

The second edition of the model retains all of the new design fetures of first edition, and also makes economic growth semi-endogenous. This follows similar work with the Quest III model at the European Commission (Varga and Veld, 2011). Drivers of economic growth are modelled as follows.

  • Demography: the population by age and gender is projected using the cohort-component method from assumptions about fertility, mortality and migration.
  • Education: the link from government eduction funding to education attainment (school, VET, university) is modelled.
  • Skill: the link from education attainment to occupational skill level (high, mid, low) is also modelled. Different skill levels have different productivity, labour fore participation and sustainable unemployment rates.
  • Migration: the model captures the different labour force experiences (in terms of labour force status and occupation) of five permanent and four temporary visa categories.
  • Infrastructure: the model allows for economies of scale in the provision of government infrastructure as a productive input for the business sector.
  • R and D: high-skilled labour is used to produce patents that raise productivity.

Download the Information Paper on the macro model

Download the information paper on "The Independent macro model" (updated August 2015).

Independent HFE model

In Australia, state fiscal capacities are equalised through the Horizontal Fiscal Equalisation (HFE) system used in distributing GST revenue between the states. The Independent HFE model is a multi-regional Computable General Equilibrium (CGE) model. It is the leading tool for analysing the economic impacts of any proposed changes to Australia's HFE arrangements.

The Independent HFE model shows how HFE policy options can lead to interstate migration that changes living standards. It has already been used in a major HFE modelling report submitted by the South Australian Government to the GST Distribution Review.

Independent Short-term Forecasting model

The Independent Short-term Forecasting model is a structural Vector Autoregression (SVAR) model of Australia designed for a post-GFC world. Hence, it focusses on the linkages from the world financial markets to the world economy, and from the world to Australian financial markets and the Australian economy.

For Australia, this model provides forecasts of economic growth, unemployment and inflation, and their financial market drivers of the stock market, interest rates and the exchange rate.

For more information on our models, email our office.

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