New-Area-Wide Model (NAWM)

The New-Area-Wide Model (NAWM) is a micro-founded open-economy model of the euro area, which is designed for use in the (Broad) Macroeconomic Projection Exercises regularly undertaken by ECB/Eurosystem staff and for policy analysis. It was recently developed by staff in the Econometric Modelling Division.

The NAWM succeeds the AWM which is a traditional macroeconomic model of the euro area that has been extensively used at the ECB over the past ten years. There are notable differences between the two models. The NAWM is neo-classical in nature and centred around intertemporal decisions of households and firms which are maximising expected life-time utility and the expected stream of profits, respectively. As a result, forward-looking expectations play a key role in influencing the adjustment dynamics of both quantities and prices, and changes in supply-side factors have a pronounced impact already in the short run. At the same time, the NAWM includes a number of nominal and real frictions that have been identified as empirically important, such as sticky prices and wages (so that some Keynesian features prevail in the short run), habit persistence in consumption and adjustment costs in investment. Moreover, it incorporates analogous frictions relevant in an open-economy setting, including local-currency pricing (giving rise to imperfect exchange-rate pass-through in the short run), and costs of adjusting trade flows. In contrast, the AWM features predominantly Keynesian behaviour in the short run, even though it has a basic neo-classical steady state.

The development of the estimated version of the NAWM has been guided by two important considerations, namely to provide a comprehensive set of core projection variables, and to allow conditioning on monetary, fiscal and external developments which, in the form of technical assumptions, are an important element of the ECB/Eurosystem staff projections.

Therefore the key features of the model are:

1. Its scale - compared with a typical DSGE model - is relatively large.
2. Employing Bayesian methods, it estimates 18 key macroeconomic variables, including real GDP, private consumption, total investment, government consumption, exports and imports, a number of deflators, employment and wages, and the short-term nominal interest rate.
3. Data on the nominal effective exchange rate, euro area foreign demand, euro area competitors' export prices as well as oil prices are utilised, which are deemed important variables in the projections capturing the influence of external developments.
4. As a novel element, the recently compiled extra-euro area trade data (both volumes and prices) are used, which appears economically more compelling than the use of total trade data.
5. Conformable with the number of variables, 18 structural shocks are considered in the estimation. These shocks are latent factors with an economic interpretation that help in typifying the sources of the observed fluctuations in the data.

For details on the development of this model, see the ECB Working Paper No 944