Modern economies are considerably complex, with many variables and different sectors being interlinked. A macro-econometric model is a simplified description of this complex reality. It captures the key economic relationships underpinning an economy, usually based on both theory and historical data, and thus serves to assist economists and policymakers in understanding the inner workings of the underlying economy.
In 2012-2013, the Bank built and published a new macro-econometric model of the Maltese economy which, since then, has been reviewed regularly and developed further. The model serves as a tool for conducting simulations to assess the potential impact of various economic shocks, generating macroeconomic forecasts, examining the impact of policy actions and deepening our understanding of how the domestic economy functions. Although this is the Bank's core model, it is just one of the tools employed to analyse and forecast economic developments.
The model, named STREAM (Structural and TRaditional Econometric model for Malta), is a traditional model built around the neo-classical synthesis. The latter asserts that output is driven by supply in the long run. However, in the short term, as a result of the sluggish adjustment of quantities and prices, there are deviations from this long-run equilibrium and output is determined by the components of aggregate demand. Departures from long-run output set in motion a sequence of price and wage adjustments that gradually bring the model back to its long-run equilibrium. Behavioural equations are mostly estimated, rather than calibrated, in error-correction form on the basis of quarterly data starting from 2000Q1. Economic agents are assumed to have adaptive expectations. The novelty of STREAM is that it contains fully fledged fiscal and financial blocks, which is uncommon in such traditional models. Given both the strong links these sectors share with the broader economy, as well as the substantial influence they have on each other, it is ideal to model them within the same framework.
Economic modelling is a continuous process. Models should be reviewed regularly to ensure they remain a faithful representation of how the underlying economy functions and can be developed further to capture more of the inter-linkages within the economy. With this in mind, the model has been reviewed and enhanced on a regular basis. Below one can find the documentation of the third version of the model - the latest version - along with that relating to all previous versions. The development of the model has now reached an advanced stage and therefore no major changes to its structure are envisaged in the short term. That said, further refinements are possible, such as an enhanced integration of the supply side, particularly with regard to the labour market. Moreover, the model will continue to be evaluated regularly to ensure that it is able to fulfil its ultimate purpose: serving as a reliable simplification of how the Maltese economy functions. Updated versions of the model will be placed on the Bank's website as they become available.
The third version of the model includes two key upgrades when compared to the previous version: (i) it has been extended to include an even richer financial block, and (ii) has been re-estimated using ESA 2010, chain-linked data that span an additional year.
In comparison to the previous version, the second version of the model includes five main enhancements: (i) a detailed fiscal block, (ii) a richer financial block, (iii) enhanced macro-financial linkages, (iv) a price block that is more responsive to domestic economic activity, and (v) re-estimation using an additional year of data.