QUEST II. A Multi-Country Business Cycle and Growth Model

QUEST was designed to analyse the economies in the Member States of the European Union and their interaction with the rest of the world. The paper presents a new version of the QUEST model which is now considerably modified with respect to its theoretical structure. It first presents a model description for the following sectors: household behaviour, firm behaviour and government. Then, it proposes the markets and prices equations. The second section contains standard simulations. It first considers monetary policy and fiscal policy shocks, then an example of a productivity shock.II/511/97-ENQUEST was designed to analyse the economies in the member states of the European Union and their interactions with the rest of the world, especially with the United States and Japan. The focus of the model is on the transmission of the effects of economic policy both on the domestic and the international economy. The model was primarily constructed to serve as a tool for policy simulation; less emphasis was put on its ability to serve as a forecasting tool. Given the wide coverage of the model it must necessarily be highly aggregated. A high degree of aggregation and foundation of the specification in current macroeconomic theory also helps in interpreting and understanding the results of the simulations. Finally simplicity also facilitates the solution of the model and reduces the time and memory requirements of the computer-simulations. The new model contains structural models for the EU member states, the US and Japan and distinguishes 10 additional countries/regions in trade feedback models in order to model trade interactions with the rest of the world.Compared to the former version of the QUEST model, which was presented in European Economy No. 47 (1991), the new model is now considerably modified with respect to its theoretical structure. The previous version of QUEST was deeply rooted in the Keynesian tradition of econometric model building, strongly stressing the demand side of the economy and modelling consumer and investment behaviour in a backward looking fashion. In the new version an attempt was made to base the behavioural equations more strongly on principles of dynamic optimisation of private households and firms. That makes the model substantially more forward looking. Also the supply side is now more explicitly modelled. The present model is also closed with respect to stock-flow interactions. Those stock variables which can be identified on a macroeconomic level such as physical capital, net foreign assets, money and government debt are endogenously determined and wealth effects are allowed to influence savings, production and investment decisions of private households, firms and the government. Moreover, financial linkages between national economies are now more explicitly modelled. In the current version it is assumed that assets determined in different currencies are perfect substitutes - up to an exogenous risk premium. Consistent modelling of international trade and financial linkages also require that at each instant two adding-up constraints hold: trade balances and net foreign asset positions sum to zero. Also the long run properties of the model are now systematically explored.Apart from simulations related to the Commission's short and medium term projections, the model has been intensively used to analyse the impact of the Maastricht criteria on growth and employment and the long run effects of fiscal consolidation and structural reforms in Europe (e.g. Bayar et al., 1997a). Related to this, the model was used to study the impact of monetary policy on the success of government expenditure cuts (Roeger and in 't Veld, 1997a), and the macroeconomic effects of various tax reforms (Roeger and in 't Veld, 1997b) and VAT harmonisation (Bayar, Roeger and in 't Veld, 1997). The model has also been used to assess the employment and growth effects of the Trans European Transport Networks (European Commission, 1996), while the models for Greece, Ireland, Portugal and Spain have been used to look at the macroeconomic effects of the Structural Funds (Roeger, 1996b).