IS-LM-BP model of Ireland, as a country receiving financial assistance

Viliam Páleník

No 4485, EcoMod2012 from EcoMod

Abstract: Ireland is (together with Greece and Portugal) a euro-zone country, which is receiving financial assistance. It is conditional on acceptance of recommendations of common experts groups of European commission, European central bank and International monetary fund. Macroeconomic stabilization including fiscal restrictions is a part of these recommendations. This recommendation is usually criticized by necessity of expansive fiscal policy during the time of crisis. The goal of this paper is to take part of this discussion by constructing a macroeconomic model of Ireland, which would be a compromise between simplicity and transparency on one hand, and containing of all necessary connections on the other hand. The principal of decreasing abstraction was used in construction of IS-LM, Mundell-Fleming and IS-LM-BP models. Several possible alternatives of suitable parameters on real exchange rate in euro-zone were used. By least squares method we estimated individual equations of behavior on time series of Ireland before and including crisis. We took into account statistical significance of elasticities. Qualitative analysis of the model was done by method of derivation of implicit function. For the small and open economy of Ireland, by applying of IS-LM-BP model we received very similar results than when applying Mundell-Fleming model. These results confirmed validity of basic macroeconomic connections but also led to some non-trivial macroeconomic connections. In the investment function during the pre-crisis period, the effect of interest rate was not significant, what show problems of Irish investment boom. When applying the crisis period, the effect of interest rate started to be significant, this could imply success of Irish stabilization policy. From the IS-LM-BP model analysis, we can draw that restrictive fiscal policy has negative effect on GDP, decrease of public spending by 1 bil Euro decreases GDP by 0.72 bil Euro, increase of taxes by 1 bil Euro decreases GDP by 0.46 bil Euro. Restrictive fiscal policy also increases interest rates. Increase of risk premium decreases GDP. The non-trivial results are that direct debt from abroad decreases in the volume of 1 bil Euro decreases GDP by 0.7 bil euro. On the other hand, sterilized direct investments of 1 bil euro cause increase of GDP by 0,92 bil Euro.

Keywords: Ireland; Macroeconometric modeling; Business cycles (search for similar items in EconPapers)
Date: 2012-07-01
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