Cooking Up a Tasty Scenario Using Just Barebones

This paper describes the barebones macroeconomic model devised initially for pedagogical purposes by the author and Francesco Luna. The model is fitted with data from a former transition country. Despite being fairly stripped-down, the model gives rich answers to seemingly simple questions such as what is the government expenditure multiplier. In particular, the model’s properties are sensitive to assumptions about interest and exchange rates, as well as to the treatment of dollarization. In the practical world of policy analysis, the paper argues, it is often preferable to exogenize these variables. Because interest and exchange rates are hard to model and their responses depend on a host of initial conditions and other factors, relying on pre-programmed equations or links can lead the policymaker astray. In the end, there is no escape from bringing expertise and judgment to bear when using a model to cook up a meaningful economic scenario.