Theoretical foundation for the macroeconomic model

Abstract

The Economic Commission for Africa (ECA) model has been developed to assist countries in implementing a sustainable development plan. It is characterized by a long run neoclassical supply side and a short run Keynesian demand side. In this model, behavioral equations are specified in a cointegration and error correction framework This is because there will be a model in a theoretically consistent manner while the short run can be modeled to fit the data, with the error correction mechanism ensuring that the system moves towards the long run in the absence of shocks. This approach will allow both policy analysis and forecasting to be encompassed in the same framework. The model has been built to give a solid description of the historic relationship between economic variables and to capture the key linkages between those variables. Although a lot of weight is given to the fit of the model, this is not at the expense of economic theory and intuitive properties under a wide range of scenarios. The logic underpinning the model is that Governments can temporarily shift the level of aggregate demand using fiscal policy, but the longer-term properties ensure that if output is driven up beyond the economy’s potential, then inflation will rise, which is not sustainable. Eventually, interest rates will rise, and the economy will return to a state of equilibrium that is defined by the working age population and the amount of capital they have to work with.