Multi-Country Model (MCM)

The New Multi-Country Model is a large-scale estimated model covering the five largest euro area countries. It has firm micro-economic foundations and can be characterised as a micro-founded New Keynesian model. Expectation formation is treated explicitly so that the model can be simulated under rational model consistent expectations or under learning expectations. Under learning agents adapt their expectations more gradually in response to economic shocks according to a learning rule, which in the NMCM is consistent with the model's long-run solution and has stable properties.

The theoretic core of the model contains one exportable domestic good and one imported good and all central behavioural relations are based on the optimisation behaviour of three private sector decision making agents (i.e. households, labour unions and firms) and the reaction functions of the government sector and the central bank.

The model was developed at the European Central Bank with the aim for it to be used to produce forecasts, in particular in the context of the Eurosystem and ECB staff Macroeconomic Projection exercises, and to aid policy analysis. Its country-blocks can be used either on a single country basis (mainly for forecasting purposes) or as a linked euro area multi-country model (especially for policy analysis).

Key features of the model

1. The theoretical core of the model consists of three optimising private sector decision making representative agents, i.e. utility maximising households, profit maximising firms and trade unions, which minimise the quadratic loss function under the staggered wage adjustment assumption. Monopolistically competing firms set prices, and choose inventories and factor demands under the assumption of indivisible labour. Output is in the short run demand-determined. Monopoly unions set wages and overlapping generation households make consumption/saving decisions.
2. The production technology is described by a normalised Constant Elasticity of Substitution (CES) function, allowing for non-unitary elasticity of substitution between labour and capital, non-constant augmenting technical progress and heterogeneous sectors with differentiated price and income elasticities of demand.
3. Under learning expectations, agents optimise their behaviour under uncertainty concerning the process driving future developments in fundamentals but without uncertainty concerning the model's deep parameters.
4. The behavioural equations and the production function are estimated on the basis of quarterly national historical data from the 1980s onwards.
5. In the linked version of the model the cross-country linkages occur through four channels: trade volumes; trade prices; common monetary policy and a common exchange rate.

For more information on the model, please refer ECB Working Paper No. 1315 and 1316 (both published in Economic Modelling Volume 29, Issue 6, November 2012, Pages 2597-2614) to the contact person below.

Contact persons:
Allistair Dieppe, Senior Economist, Monetary Policy Division