Danish Rational Economic
Agents Model, DREAM
Poul Schou
March 2, 2006
Outline of presentation
• Purpose & short history of CGE models
• How to build and use a large-scale CGE
model: Danish Rational Economic Agents
Model (DREAM)
Computable General Equilibrium
models
• A child of economic theory
• Main purpose: Quantify magnitudes of
theoretical results (important for policy)
Definition of a CGE model
• ”Equilibrium”: supply and demand
behaviour determined by optimizing
agents. Flexible prices of (at least) some
goods and factors of production → market
equilibria
• ”General”: several optimizing agents and
markets
• ”Computable”: use data from real
economies, solved on a computer
History of CGE models
• Leif Johansen (1960)
• 1960’es:structure of (theoretical) general
equilibrium models developed and refined,
cf. Arrow & Hahn, 1971
• Development of large-scale macroeconometric models
• Scarf (1967) designs algorithm for
numerically specified G.E. models
History: 1970’es
• New economic regime: Rising energy
prices, break-down of international
monetary system, stagflation
• Better hardware, software and data
bases→ increasing interest for CGE
models, also among decision-makers
Advantages of CGE models
• Quantify magnitudes
• Identify net results of counter-acting
effects
• Able to cope with complex problems
• Solid micro-economic foundation
• Able to analyze welfare effects
• Able to analyze policy fundamentally
different from initial position
Drawbacks of CGE models
• Specification of functional forms
• Calibration
• Economic theory not sufficiently welldeveloped in all fields
• May become rather complex
Static CGE models
•
•
•
•
•
”Big and simple”
Very disaggregated input-output system
Perfect competition in all markets
Only distortion: taxes/duties/subsidies
Main uses: Trade agreements & trade
policy, environmental policy
Dynamic CGE models
• Explicit periodization
• Rich theoretical structure
• Rational (forward-looking) expectations →
simultaneous models → huge
computational power requirements
• Aggregate production structure
Danish CGE models
•
•
•
•
GESMEC (1993, Economic Council)
Mobi-DK
EPRU model
Various ad hoc models
Motivation for DREAM
• Wish to create comprehensive model for
long-term simulations of Danish economy
• Utilize state-of-the-art economic theory
• Analyze demographic changes
• Evaluate structural reforms with respect to
welfare, intergenerational distribution,
macroeconomic performance and fiscal
sustainability
Institutional setting
• Research project initiated in January 1997
• Originally located in Statistics Denmark,
from 2002 an independent research unit
affiliated with the Danish Ministry of
Finance
• Independent board
• 8 full-time economists and 3 students
Challenge of building DREAM
• Choose level of details, theoretical setting
and data use
• Demographics important → focus on
population projections and generations
• Independent population projections
Main principles
• Optimizing households and firms
• Other institutions: Pension funds,
government, foreign sector
• Important markets: Labour market, goods
markets, financial markets
• Base-line projection is a sequence of
temporary equilibria leading to a steady
state (Dynamic calibration)
Households I
• OLG model: 85 overlapping generations
• Representative household in each
generation
• Consumption-saving choice (intertemporal
optimization)
• Labour supply and consumption mix
choice (intratemporal optimization)
Households II
• Specification of functional form important
• In principle: Should be based on empirical
investigation of elasticities, etc.
• In practice: A few functional forms typically
used (C-D, CES, nested CES)
• DREAM typically uses nested CES
functions
Firms
• Two private production sectors:
• Construction
• Other private goods
• Representative firms maximize value of
shares
Market structure
• Imperfect competition in goods market
• Union-like behaviour in labour market
• → positive profits and unemployment
Government sector
•
•
•
•
Produces goods
Collects taxes
Supplies government services
Pays out transfers and subsidies
• Behaves rather mechanically
• Very detailed modelling of taxes and
transfers
Calibration and data
• ”Calibration”: Process which determines
parameters to make data fit the theoretical
model
• Data come from national accounts, labour
force statistics, Law Model and various
other sources
• How are parameters in DREAM
determined?
How do you execute DREAM?
• DREAM runs on a powerful PC
• System of premodels, main model and
modules for reporting
• Execution takes about 1 hour
• Main programming language: GAMS
• Presentation is Excel-based
Results
• Projection 100 years ahead
• Calculates NA measures, utility levels of
all generations, age-distributed income
and wealth levels, etc.
Results
Table 1: Macroeconom ic developm ent in base-line projection
2003
Level, billion DKK
Private consumption
2003
2010
2020
2040
2060
2100
Index in fixed prices, 2003 = 100, not growth-corrected
552.6
100
116.9
141.2
197.8
281.9
617.2
1,210.6
100
113.8
133.7
180.8
255.4
551.2
6.2
6.2
4.8
5.0
5.0
5.2
5.2
800.0
100
113.7
133.3
180.4
254.7
553.0
58.8
100
137.1
155.8
207.7
298.3
671.1
Private non-construction sector
497.1
100
115.7
134.3
174.8
242.8
513.6
Public sector
244.1
100
104.1
125.8
185.1
268.4
604.9
10.2
100
123.4
142.1
192.8
279.3
628.5
248.2
100
115.1
134.9
178.0
249.1
526.3
25.8
100
93.8
113.4
167.2
242.8
545.9
-178.0
-12.7
19.9
51.9
70.1
63.5
31.3
Real GDP
Unemployment*
Employment
Construction sector
Capital stock
Construction sector
Private non-construction sector
Public sector
Net foreign assets**
* Level in per cent
** Index is assets in per cent of GDP
Alternative: tax rise
Table 2: Macroeconom ic developm ent in alternative projection
2003
2010
2020
2040
2060
2100
Index in fixed prices, base-line = 100, not growth-corrected
Private consumption
100.0
94.0
93.3
92.9
92.8
92.8
Real GDP
100.0
98.2
97.8
97.7
97.6
97.6
Unemployment
100.0
104.8
104.8
104.8
104.6
104.7
Employment
100.0
98.7
98.7
98.7
98.7
98.7
Construction sector
100.0
92.0
96.2
96.1
96.1
96.1
Private non-construction sector
100.0
95.7
95.0
94.9
94.8
94.7
Public sector
100.0
107.7
107.4
106.7
106.4
106.2
Construction sector
100.0
93.0
96.7
96.7
96.7
96.7
Private non-construction sector
100.0
96.9
95.5
95.3
95.3
95.2
Public sector
100.0
108.8
108.5
107.8
107.6
107.3
-12.7
30.1
60.8
76.2
67.8
33.3
Capital stock
Net foreign assets*
* Index is assets in per cent of GDP
Endogenous developments
•
•
•
•
•
Terms-of-trade gain
Unemployment changes
Capital-labour ratio changes
”Free” savings of households disappear
Endogenous policy adjustment
Main uses of DREAM
• Is fiscal policy sustainable?
• Macroeconomic and welfare
consequences of tax, labour market and
other reforms
• Consequences of changes in mean lifetime, fertility, immigration and integration
• Used for some masters’ theses