The new g3 structural model

The Czech National Bank has added a new model to its range of analytical tools: a "g3" dynamic structural model reflecting the basic characteristics of the Czech economy. The model has been used for shadow forecasting since January 2007 and is presented in this Inflation Report in the form of an alternative forecast scenario. This model framework will be used to construct the baseline scenario of the forecast starting from the next Inflation Report.

The model captures the basic characteristics of the Czech economy as described by the levels and dynamics of variables such as prices, wages and GDP components in both nominal and real terms. Given the openness of the Czech economy, emphasis is placed on foreign trade and the exchange rate and its effects. The structural linkages within the model provide a relatively detailed view of the relationships between nominal variables and the real economy and of the supply side of the economy in an analytically consistent framework.

From the viewpoint of economic theory, this is a dynamic, stochastic general equilibrium model inspired by the new neo-classical synthesis, which links the theory of the real business cycle with the nominal rigidities of the new Keynesian theory. Forward-looking expectations and their interaction with monetary policy and structural economic shocks are an important feature of the model. The main difference from the previously applied QPM model is that the new model is more strongly anchored by microeconomic assumptions.

In the g3 model, the economy is divided into a corporate sector, a household sector, a state sector and an external sector. Corporations produce intermediate goods using the production factors of labour and capital owned by households. These intermediate goods, along with imported goods, are used to produce final consumption, investment and export goods and government consumption goods. Households maximise their expected future utility of consumption and leisure subject to their budget constraints, offer labour and capital to the production sector, invest abroad, pay taxes and receive government transfers. They are also recipients of the profits of firms in the economy. The fiscal sector collects taxes, distributes transfers and consumes goods. The government is allowed to generate public debt. The external sector is captured by external demand, prices of imported goods and foreign interest rates. Monetary policy in the model applies an inflation targeting regime.

As an analytical instrument, the g3 model is used mainly to interpret present developments in the economy and to forecast future developments and analyse the risks of the forecast. The main forecasting inputs are an assessment of the current state of the economy (current structural shocks and the economic story they imply − the starting conditions), projected developments abroad and the outlook for administered prices and government consumption. Based on this input information and an expert view, the forecast is then compiled for the economy. The new model framework, like the previous one, allows alternative scenarios − capturing the main risks of the forecast - to be drawn up in addition to the baseline scenario.