Refining Policy Tools: The Impact of a New DSGE Model on North Macedonia's Economy

The IMF's new DSGE model for North Macedonia is designed to enhance policy analysis by reflecting the unique characteristics of the economy, including its fixed exchange rate and structural changes, offering a more micro-founded approach to understanding economic dynamics. This model complements existing tools, providing deeper insights into long-term policy impacts.

Research by IMF delves into the creation and application of a new Dynamic Stochastic General Equilibrium (DSGE) model specifically designed for North Macedonia. This model was developed by the National Bank of the Republic of North Macedonia (NBRNM) in collaboration with the International Monetary Fund (IMF) and the Czech National Bank (CNB). The model reflects the unique characteristics of North Macedonia, a small open economy with a fixed exchange rate regime that has undergone significant structural changes over the years. The fixed exchange rate system, pegged to the Euro since 1995, has been a cornerstone of maintaining price stability in the country, successfully keeping inflation rates low and stable. This economic environment, characterized by moderate but consistent GDP growth, underpins the model's structure and calibration.

Enhancing Analytical Tools for Policy Analysis

The DSGE model presented in the paper is designed to enhance the analytical tools available to the NBRNM, particularly for policy analysis and understanding the underlying drivers of the business cycle in the Macedonian economy. Unlike traditional models, the DSGE model is rooted in microeconomic foundations, accounting for the interdependent behavior of consumers, firms, and the institutional framework within the economy. This allows for a detailed examination of how various shocks such as changes in foreign demand, risk premiums, or domestic inflation affect the economy and influence monetary policy decisions. The model incorporates a range of economic agents, including households, firms, and the government, each with specific roles and behaviors that align with the broader macroeconomic environment.

Calibration Over Estimation: A Strategic Choice

One of the key features of this DSGE model is its focus on calibration rather than formal estimation. This approach was chosen due to the relatively short time series available for North Macedonia and the significant structural changes the economy has experienced. Calibration involved an iterative process of testing and refining the model’s parameters to ensure it accurately reflects the dynamics of the Macedonian economy. This included reviewing the model's impulse response functions, which describe how key macroeconomic variables respond to shocks over time, and historical simulations that compare the model’s predictions with actual economic data.

Complementing Existing Forecasting Tools

The paper emphasizes that the DSGE model is not intended to replace the NBRNM’s existing quarterly projection model, MAKPAM, which remains the primary tool for economic forecasting. Instead, the DSGE model serves as a complementary tool, offering a more coherent and theoretically grounded framework for analyzing structural issues and policy impacts. For instance, while MAKPAM is primarily a gap model focusing on deviations from potential output, the DSGE model provides insights into the underlying causes of these deviations by analyzing the behavior of economic agents in response to various shocks. This makes the DSGE model particularly useful for understanding the long-term effects of policy decisions and external factors on the economy.

Capturing the Unique Dynamics of North Macedonia

The model also includes specific technological trends and wedges, which are necessary to capture the non-stationary nature of key economic variables in North Macedonia, such as the shares of investment, export, and import in GDP. These trends are crucial for ensuring that the model aligns with the actual data and accurately reflects the economy's evolving structure. For example, the model accounts for the Balassa-Samuelson effect, which drives a wedge between GDP deflator growth and export deflator growth, leading to long-term real exchange rate appreciation. This is particularly important in an economy like North Macedonia's, where external factors play a significant role in shaping domestic economic outcomes.

Overall, the new DSGE model represents a significant advancement in the NBRNM's analytical capabilities, providing a robust tool for policy analysis and decision-making. It allows the central bank to better understand the complex interactions within the economy and to anticipate the effects of various shocks on key macroeconomic variables. While the model is not designed for short-term forecasting, it plays a crucial role in informing the NBRNM's long-term policy strategy and improving its ability to respond to economic challenges. The paper concludes by noting the ongoing efforts to refine the model’s calibration and expand its application to a broader range of policy issues, ensuring that it remains a valuable resource for the NBRNM in the years to come.