On Modeling the Economic Linkages among Countries

This chapter is concerned with modeling the economic linkages among countries. Although there are by now a number of multicountry macroeconometric models in existence, it seems safe to say with respect to the treatment of capital Rows and exchange rates that econometric work has not kept pace with theoretical developments. Since Mundell’s pioneering theoretical work (1968) in the 1960s. the potential empirical importance of capital flows among countries has been known, and yet in most multicountry econometric models capital Rows are either ignored completely or else taken to be exogenous. This usually means that exchange rates are also taken to be exogenous, which in the present regime of floating exchange rates is clearly an important limitation. Econometric model-builders are not, of course, unaware of these limitations. For a number of reasons, econometric work in this area is dificult, and these difficulties have undoubtedly impeded progress. One difficulty is the lack of good data for a number of countries. Another is the sheer size of the task of linking a number of single-country models together. Dealing with hundreds or thousands of equations is painstaking. and there is a natural tendency in this type of work to be less concerned with theoretical purity than with the practical issue of getting the model running. Theoretical work in this area has. on the other hand, ignored a number of important economic linkages among countries that are accounted for in multicountry econometric models. The two-country theoretical models af the type surveyed by Myhrman (1976) and Mussa (1978), for example,