RDP 2019-07: MARTIN Has Its Place: A Macroeconometric Model of the Australian Economy 1. Introduction

This paper presents a model of the Australian economy. The model, called MAcroeconomic Relationships for Targeting INflation (MARTIN), is a macroeconometric model built to capture the key economic relationships relevant for the conduct of monetary policy in Australia. It consists of a series of estimated equations that closely match the forecasting approach used at the Reserve Bank of Australia (RBA). RBA staff use the model to interpret recent economic developments, analyse the implications of alternative risks and scenarios and generate forecasts of the economy's likely future evolution.

The impetus for developing MARTIN came from an external review of the RBA's forecasting tools and procedures (Pagan and Wilcox 2016). The review recommended expanding the RBA's analytical toolkit to include an economy-wide model that could draw together the vast array of single-equation forecasting models that RBA staff maintain. The aim was to build a model that would closely correspond to the way analysts and policymakers at the RBA think about how the economy evolves. This objective drove the development of MARTIN, from its modelling framework, scope, choice of variables and causal mechanisms.

MARTIN captures many features of the Australian economy and monetary policy transmission mechanism. Most equations are modelled in an error correction framework, which allows us to impose a theoretically coherent structure on the long-run properties of the model while retaining the flexibility to account for the short-run empirical relationships observed in the data. The key elements of the model are the expenditure components of GDP, the labour market, the determinants of inflation and some financial market variables. The key mechanisms in the model trace through the relationships between these variables. The level of economic activity depends on decisions by domestic firms and households, along with international trade. Households' decisions are influenced by their income and balance sheet position, business investment is largely demand-determined and trade flows depend on Australian and overseas demand as well as relative prices. Economic activity affects the demand for labour and so the degree of spare capacity in the labour market. Labour market spare capacity affects inflation directly as well as through its effect on wages which, along with other input costs, also influence prices.

Cusbert and Kendall (2018) explain the rationale and goals of MARTIN, and provide an outline of the model's structure. This paper covers some of the same ground, but includes a more detailed treatment of MARTIN's individual equations, as well as an illustration of the model's dynamic properties. The paper is structured as follows. Section 2 describes the principles underpinning the modelling framework and how it fits in to the RBA's approach to analysing economic developments. Section 3 provides an overview of the model. And Section 4 delves into MARTIN's equations. Readers who wish to avoid the technical details of the model may safely skip these two sections. Section 5 describes some of the key dynamic properties of the model and Section 6 concludes.