Output determination in an annual macro- econometric model-partial adjustments to demand and supply changes

Abstract

Abstract: In an annual macro-econometric model it can be argued that in the determination of real production both demand and supply play a significant role. Even if there is unutilized capacity, the adjustment of production as a respond to a change in demand could not be totally completed, as it is implied with the Keynesian equilibrium condition but only partly. On the other hand, productive capacity can change and this has a certain effect in the real production to the extent that this additional capital equipment will be used within the year. This work proposes the specification of a relation of output determination in which elements of both supply and demand are included. The extent of their effect on production is estimated statistically by a relation of partial adjustments of real production to changes in demand as well as in supply. Policy simulations of a simple model for the Greek economy, which incorporates an adjustment relation of output determination, are compared with those of a similar model in which the macroeconomic Keynesian relation of equilibrium is included. The proposed model gives more plausible results compared to the usual Keynesian model. More specifically, the increase of public expenditure does not appear to have as strong effect on production as in the Keynesian model where the adjustment of production to changes in demand are fully completed within a year. The reduction of interest rate, leads to a greater increase in production with the proposed model due to the increased effect of investments through both the demand and the supply while the short-run model does not incorporate the effect of supply on production.