CGE Model Closures in a Skeleton World Model

Abstract

This paper deals with closure issues that arise in the context of global multinational models, typically, trade models. We also explore a few related issues: model homogeneity, the role of exchange rates, calibration consistency, and testing for calibration consistency and model homogeneity. To examine and illustrate these issues, we develop a highly simplified skeleton model derived from the PEP-w-1 worldwide CGE model, which represents the essential structure of several world trade models. After the basic concepts have been defined, the first statement of the model explicits all theoretical relationships. The model is then simplified, and redundant equations are identified and deleted. Next, the role of exchange rates is clarified, and the model is re-written in terms of the international currency, without exchange rate variables. Closure rules are discussed. Finally, exchange rates are re-introduced, and closure rules are revisited, detailing the choice between fixed exchange rates (FE) or fixed regional price (FP) closures; and calibration consistency is discussed. The final version of the model is implemented in GAMS.

Keywords: Computable general equilibrium models (CGE); World models, CGE model closures, Current account balance, Exchange rate

JEL Classification: C68, D58, F47