MEMO is a macroeconomic, dynamic stochastic general equilibrium model (DSGE). The model is calibrated to a single economic region, with external trade governed by an open-economy module and the multi-sector production structure set to replicate data from an input output matrix. The model can be used to examine the effect of policies on a variety of economic indicators such as unemployment, wages at sector level, GDP, sector composition, demand for energy etc. MEMO is particularly suitable for studying short and medium run dynamics of economic systems after the introduction of a policy. For example, since the model incorporates various labour market and technology frictions it takes into account that, upon change in sectoral composition, not all workers can smoothly move from heavy industry to services. Thus a policy which leads to changes in sectoral composition produces a temporary increase in the unemployment rate.
What does the model do?
The decision making process in the model is based on the solution to a series of optimisation problems. Companies chose quantities which maximize their profit subject to the specified production functions and factor costs. Household members make decisions regarding consumption, savings and labour input to maximise their utility. Each optimisation has an infinite horizon, e.g. agents take into account future consequences of their current actions. The solver of the model generates a set of equations which must be satisfied in equilibrium if companies takes optimal decision (the set of first order conditions). Solving this system gives equilibrium quantities and prices.
What kind of questions can the model address?
- What is the effect of carbon tax on unemployment and wages in different sectors?
- How does a reduction in the PV installation cost affect energy prices, energy demand and GDP?
- (When combined with a bottom up analysis) what is the effect of feed-in tariffs for PV on industrial output?
What kind of answers can the model provide?
- Upon introduction of carbon tax, in early quarters unemployment increases due to contraction in heavy industry. In the following quarters workers find employment in other sectors and unemployment gradually returns to its long-run level.
- Reduction in PV installation cost results in reductions in the electricity price and increases in energy demand. However, since in the short run firms have limited possibilities to adjust their production to lower energy prices, in early quarters an increase in energy demand is small. In the long run, firms have a possibility to increase their energy consumption, and thus energy demand grows more significantly.
- Manufacturing of PV increases the demand for output of the industrial sector. In the short run, the industrial sector cannot significantly increase output and thus the price of industrial good rises significantly. This leads to drop in investment in other sectors (crowding out of investment by the PV). However, in the long run, the industrial sector is capable of increasing employment and accumulating capital and thus, to increase its production capabilities. This reduces the price of industrial goods and brings the investment in other sectors back to their initial levels.