Annex 4 analytical methods

QUEST III belongs to the class of New-Keynesian Dynamic Stochastic General Equilibrium (DSGE) models that are now widely used by international institutions and central banks. These models have rigorous microeconomic foundations derived from utility and profit optimisation and include frictions in goods, labour and financial markets. With empirically plausible estimation and calibration they are able to fit the main features of the macroeconomic time series. Calibrated model versions are used for most policy applications, but the  QUEST III model has also been estimated on Euro Area, US and specific Euro Area countries (ES, DE) data using Bayesian estimation methods. 

In order to deal with the wide range of policy issues in DG ECFIN, different model versions of the QUEST III model have been constructed, each with a specific focus and regional and sectoral disaggregation. Many of the main applications deal with fiscal and monetary policy interactions and either use a one-sector model or models that explicitly distinguish tradable and nontradable sectors, and include trade in intermediates. Other  model variants also include housing and collateral constraints.

QUEST III has also been used for the analysis of structural reforms and another version has been employed for the analysis of energy and climate change policies. All these models are employed using different country disaggregations, focusing on the euro area or EU as a whole, and other global regions, or on individual member states.

The models are developed by the modelling unit in DG ECFIN. The Joint Research Centre of the European Commission supports QUEST development providing econometric, computational and methodological expertise in estimation and calibration, maintaining dedicated IT resources.

An update of some new developments of the QUEST III models was described in ECFIN Research Letter Vol.3.Issue 1/2009 (pp 10-13).  For further references on the QUEST model, see the model homepage.

Key inputs for the estimated model versions are coming from national accounts and other macroeconomic data source. The main ones are:

• National account data (GDP and its components, current and constant prices)
• Labour market data (wages, employment)
• Financial variables (interest rates)
• Trade data
• Monetary data (interest rates)

Key outputs produced by the model:

• Model parameter estimates to be used for simulation (time evolution of all macro-variables of interest in response to a shock in the economy or changes in policy) and model-based policy analysis;
• Among the macroeconomic variables of interest, the model allows to study dynamics and economic drivers of:
  • GDP and its components
  • Price deflators
  • Fiscal variables
  • Employment, wages
  • Interest rates
  • Trade

QUEST III is a tool suitable for policy preparation and implementation. It is designed to analyze economic issues like the occurrence boom-bust cycles, the study of structural reforms (Lisbon process), fiscal policy, country debt stabilization and sustainability. Main policy areas requiring QUEST based analysis concern MIP (Macroeconomic Imbalance Procedure) assessments, EDP (Excess Deficit) procedures and debt sustainability analysis.

DG ECFIN uses QUEST III for macroeconomic policy analysis and research. Results of the studies feed into ECFIN policy repots. JRC supports DG ECFIN for the development of QUEST III, focusing on the estimation. JRC provides estimated versions of QUEST models for individual member states, used to support policy studies for macro-economic surveillance by DG ECFIN

• Economy, finance and the euro 
• Taxation 
• Employment and social affairs 
• Trade