## 1. Calibration for Key Trading Relationships, 1997

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---

### Introduction
- Rapid growth in emerging Asia over the last decade has had a significant impact on the world economy.
- Growth skewed toward the export sector:
  - Import of competitively priced goods from emerging Asia has helped keep inflation in tradable goods prices low.
  - Increased demand for raw materials associated with this rapid growth has been a factor raising commodity prices.
- Australia is uniquely positioned to benefit from both channels:
  - Relatively small manufactured goods sector; reliance on imported manufactured goods.
  - Endowment of key commodities heavily demanded by emerging Asia has increased export volumes and export incomes.
- Model used: a version of the IMF’s Global Economy Model (GEM) with four regions (Australia, emerging Asia, the United States, remaining countries) and three goods (tradable commodity, tradable finished good, nontradable finished good).
- Two stylized facts underpin the simulations:
  - The gap in tradable sector productivity growth between emerging Asia and other countries driving differential real GDP growth over roughly the last decade.
  - The increase in the share of imports coming from emerging Asia evident in trade data.

### Simulation setup and calibration
- Historical replication elements:
  - A 10-year increase in emerging Asia’s real GDP of 50 percent driven by tradable sector productivity growth.
  - An increase in imports from emerging Asia in other countries’ import bundles replicating observed data increases.
- Model purpose:
  - Estimate impact of emerging Asia’s rapid growth on Australian GDP over the last decade and potential next decade.
  - Capture two main channels affecting Australia: commodity exports and import of competitively priced manufactured goods.
- Two model calibrations: one reflecting 1997 characteristics, one reflecting 2007 characteristics; focus on steady-state trading relationships among the four blocks.

### Key quantitative findings (historical-impact simulation)
- Aggregate effects (percent deviation from baseline after 10 years):
  - Australia: 11 percent
  - United States: just under 2 percent
  - Remaining Countries: roughly 4 percent
- Together the two factors (commodity channel and import competition) raise Australian real GDP by almost 11 percent, accounting for roughly 25 percent of Australia’s increase in real GDP over the period.
- Real U.S. dollar price for commodities rises by 20 percent (proxy noted in text).
- Emerging Asia REER appreciation after 10 years:
  - With commodities: just under 7 percent
  - Without commodities: over 9 percent
- Australia REER after 10 years:
  - With commodities: appreciates by just under 4 percent
  - Without commodities: small depreciation
- Sectoral and macro adjustments in Australia:
  - Consumption and investment both rise; consumption increases significantly.
  - Investment growth moderated by larger decline in relative price of investment goods (higher import content).
  - Capital reallocates toward nontradable and commodity sectors; capital in manufactured goods declines.
  - Commodity production increases less than factor inputs due to Land fixed factor.
  - GDP increase is driven primarily by factor accumulation (capital and labor) rather than domestic productivity growth.
- Inflation dynamics:
  - Initial tradable goods price declines push CPI inflation below baseline.
  - As agents learn persistence and wealth rises, nontradable inflation accelerates and eventually pushes CPI above baseline, but CPI does not rise much above baseline.

### Exchange rate and commodity price effects
- Balassa-Samuelson effect: productivity growth in tradable goods sector implies pressure for appreciation of emerging Asia’s real exchange rate.
- Commodities moderate appreciation:
  - Emerging Asia is a net importer of commodities; the relative price of commodities is highly sensitive to increases in demand because Land is a fixed factor in commodity production.
  - Import of increasingly expensive commodity goods helps balance emerging Asia’s current account, reducing the need for exchange rate adjustment.
- Future projections:
  - Rising commodity prices play an even larger role in moderating required appreciation in emerging Asia’s real exchange rate in larger future scenarios.
  - If emerging Asia’s growth becomes more balanced across tradable and nontradable sectors, a significant depreciation of emerging Asia’s real exchange rate would be required to maintain external balance.
  - More balanced growth could lower the underlying equilibrium exchange rate over time.

### GEM model: structure and calibration (model details)
- Regions: Australia, Emerging Asia, United States, Remaining Countries.
- Goods: nontradable; tradable noncommodity (manufactures); tradable non-energy commodity.
- Production functions:
  - Noncommodity tradable and nontradable: Y = f(A, K, L, Q_C, M_C) with constant elasticity of substitution; calibrated as Cobb-Douglas for noncommodities.
  - Commodities: Q_C = f(A, K, L, Land) with Land a fixed factor and low elasticity of substitution.
- Households: infinitely lived, monopolistic suppliers of differentiated labor, habit persistence in consumption, wage markups, capital and land ownership.
- Governments: consume nontradables, finance via nondistorting tax, set short-term nominal interest rate; nominal anchors:
  - Australia, United States, Remaining Countries: inflation targets.
  - Emerging Asia: stability in the nominal exchange rate versus the U.S. dollar.
- Exchange rates: adjust to desired current accounts and net foreign asset positions.
- Learning about persistence: agents form forecasts via a Kalman-filter-type signal extraction; learning calibrated so agents initially learn slowly, then faster as shock endures.

### Stylized facts (1997–2007) and calibration inputs
- Emerging Asia grew much faster than other regions:
  - "Between 1997 and 2007, emerging Asia’s real GDP grew by roughly 50 percent more than the average for the world."
- Table 3: Increase in Real GDP Between 1997 and 2007 (Percent)
  - Australia: 43.1
  - United States: 35.4
  - Emerging Asia: 97.3
  - Remaining Countries: 44.9
  - World: 47.2
- Table 4: Average Annual Labor Productivity Growth, 1995–2004 (Percent)
  - Tradables: Australia 2.9; Emerging Asia 6.5; United States 3.5; Remaining Countries 3.2
  - Nontradables: Australia 1.5; Emerging Asia 2.6; United States 2.0; Remaining Countries 0.5
  - Productivity gap (Tradables minus Nontradables): Australia 1.4; Emerging Asia 3.9; United States 1.5; Remaining Countries 2.7
- Share of noncommodity imports from Emerging Asia (In percent):
  - Australia: 1997 = 24.4; 2007 = 40.0; Change = 15.6
  - United States: 1997 = 26.6; 2007 = 33.7; Change = 6.1
  - Remaining Countries: 1997 = 44.6; 2007 = 62.6; Change = 18.0

### Simulation analysis: modeling choices and scenarios
- Shock implemented: increase in emerging Asia tradable-sector productivity that raises emerging Asia GDP by 50 percent over a 10-year period.
- Learning: Kalman-filter-type signal extraction for persistent and temporary components; speed of learning depends on assumed relative variances.
- Commodity role: commodities enter as intermediate inputs with Land fixed; tradable goods are more commodity-intensive than nontradables (parameters for nontradables roughly half those for tradables, except in Emerging Asia where nontradables are ¾ of tradable commodity intensity).
- Two-good counterfactuals: model versions with and without commodities used to illustrate commodities’ moderating effects.

### Simulation results — historical-impact (emerging Asia tradable-sector productivity growth; EA GDP +50% over 10 years)
- Real GDP effects after 10 years (percent deviation from baseline):
  - Australia: 11 percent
  - United States: just under 2 percent
  - Remaining Countries: roughly 4 percent
- Terms of trade:
  - Real U.S. dollar price for commodities rises by 20 percent (proxy).
  - Australia and Remaining Countries see significantly larger terms-of-trade improvements than the United States.
- Real exchange rates (with vs without commodities):
  - Emerging Asia REER appreciation after 10 years:
    - With commodities: just under 7 percent
    - Without commodities: over 9 percent
  - Australia’s REER:
    - With commodities: just under 4 percent appreciation
    - Without commodities: small depreciation
  - Inclusion of commodities reduces Australian bilateral depreciation versus Asian currency by roughly 75 percent relative to model without commodities.
- Australia sectoral adjustments:
  - Capital reallocates toward nontradable and commodity sectors; capital in manufactured goods declines.
  - Commodity production constrained by Land; increases less than factor inputs.
  - GDP increase driven mainly by factor accumulation rather than domestic productivity gains.

### Simulation results — future-impact (continuation of tradable-driven growth; larger EA share/size)
- Scenario: emerging Asia GDP +50 percent over 10 years with larger EA share/size.
- Real GDP effects after 10 years (percent deviation from baseline):
  - Australia: 18 percent
  - Remaining Countries: roughly 7 percent
  - United States: roughly 3½ percent
- Commodity prices and terms of trade:
  - Commodity prices increase by 50 percent more than in the historical-impact simulation, producing roughly 50 percent larger terms-of-trade improvement for Australia and Remaining Countries.
- Real exchange rates:
  - Emerging Asia REER required appreciation after 10 years: about 1 percent (contrast to roughly 7 percent in the historical-impact simulation).
  - Australia’s REER appreciation: 6 percent (almost twice the appreciation in previous simulation).
  - Bilateral real appreciations after 10 years: Australia vs Asian currency ~5 percent; Australia vs Remaining Countries ~6 percent; Australia vs U.S. dollar >7 percent.
- Australia macro dynamics:
  - Consumption increases more than GDP; investment grows less.
  - Larger magnitudes of reallocation and factor accumulation than in historical-impact simulation.

### Simulation results — balanced-growth scenario (EA productivity growth split equally between tradable and nontradable; EA GDP +50% over 10 years)
- Real GDP effects after 10 years (percent deviation from baseline):
  - Australia: 9 percent
  - Remaining Countries: 4 percent
  - United States: 2 percent
- Mechanisms and implications:
  - Commodity demand and commodity price increases are smaller; improvements in import competitiveness from EA are also smaller.
  - Emerging Asia’s equilibrium real exchange rate must depreciate significantly because the relative price of EA tradables does not decline; depreciation is required to sell increased output abroad.
  - If EA growth becomes more balanced, underlying equilibrium EA exchange rates would decline, potentially reducing any existing undervaluation.
  - Australia responses are reduced in magnitude but follow similar reallocation patterns (from manufactures to commodities and nontradables, rising consumption, muted investment response).

### Quantitative summary of selected exact values
- Emerging Asia real GDP increase used in shocks: 50 percent (over 10 years).
- Historical-impact simulation Australian GDP rise: 11 percent.
- Historical-impact simulation U.S. GDP rise: just under 2 percent.
- Historical-impact simulation Remaining Countries GDP rise: roughly 4 percent.
- Real U.S. dollar commodity price increase (historical-impact proxy): 20 percent.
- Emerging Asia REER appreciation after 10 years:
  - With commodities (historical-impact): just under 7 percent.
  - Without commodities (historical-impact): over 9 percent.
- Australia REER after 10 years:
  - With commodities (historical-impact): just under 4 percent appreciation.
  - Future tradable-driven simulation: 6 percent appreciation.
- Future tradable-driven simulation Australian GDP rise after 10 years: 18 percent.
- Future tradable-driven simulation U.S. GDP rise after 10 years: roughly 3½ percent.
- Productivity growth averages, 1995–2004 (percents):
  - Emerging Asia tradables: 6.5; nontradables: 2.6; productivity gap: 3.9.
  - Australia tradables: 2.9; nontradables: 1.5; productivity gap: 1.4.
- Share of noncommodity imports from Emerging Asia (Australia):
  - 1997 = 24.4 percent; 2007 = 40.0 percent; Change = 15.6 percentage points.

### Policy implications and recommendations
- A substantial portion of recent Australian growth is linked to Emerging Asia (analysis suggests roughly 25 percent of GDP expansion in Australia over the last decade was due to Emerging Asia’s growth differential).
- Nature of Australian growth:
  - Much of the Australian output expansion arises from factor accumulation (capital and labor) driven by increasing returns (higher commodity and nontradable prices) rather than domestic productivity gains.
  - Policymakers should be cautious interpreting robust GDP growth as strong productivity growth; measured productivity may remain low even with continued strong GDP expansion.
- Structural and public-policy priorities:
  - Facilitate reallocation of resources across sectors (from manufactures to commodities and nontradables): continue reforms enhancing flexibility in product and labor markets.
  - Implement public measures to support reallocation: improved infrastructure and harmonization of state and federal regulation.
  - Avoid policies that artificially maintain manufacturing employment at the cost of slowing movement of labor and capital into commodities and nontradables.
- Macro policy and volatility management:
  - Fiscal policy: allow larger swings in the fiscal balance than would occur in economies less exposed to large exogenous shocks.
  - Monetary policy: continue to fully utilize the flexibility provided in the specification of the inflation target.
  - Financial sector regulation and supervision: err toward conservatism.
- Areas for further research:
  - Sensitivity to learning speed: faster learning by agents could alter adjustment dynamics.
  - Consideration of uncertainty and potential overestimation of Emerging Asia’s future growth by agents.
  - Sensitivity to commodity-sector supply elasticities, since benefits to Australia hinge critically on commodity price responses.

### Appendix: learning about persistence (signal-extraction specification)
- Observed change specification:
  - ∆O_t = P_t + T_t
  - P_t = ρ · P_{t-1} + ε_t
  - T_t = 0 + ν_t
  - ε_t ∼ N(0, σ²); ν_t ∼ N(0, σ²)
- Kalman filter generates optimal estimates of persistent (P_t) and temporary (T_t) components each period; forecasts updated as new observations arrive.
- Speed of learning depends on agents’ assumed relative variances of persistent vs temporary components; relative variance may be time-invariant or time-varying to deliver the desired learning speed.

*Source: _wp10262 - Section IV contains the simulation results. Section V concludes.*

### 1. Calibration for Key Trading Relationships, 1997 ..........................................................7

### 1. Calibration for Key Trading Relationships, 1997

### Introduction
- Rapid growth in emerging Asia over the last decade has had a significant impact on the world economy.
- Growth skewed toward the export sector:
  - Import of competitively priced goods from emerging Asia has helped keep inflation in tradable goods prices low.
  - Increased demand for raw materials associated with this rapid growth has been a factor raising commodity prices.
- Australia is uniquely positioned to benefit from both channels:
  - Relatively small manufactured goods sector; reliance on imported manufactured goods.
  - Endowment of key commodities heavily demanded by emerging Asia has increased export volumes and export incomes.
- The paper uses a version of the IMF’s Global Economy Model (GEM):
  - Four-region configuration: Australia, emerging Asia, the United States, and remaining countries.
  - Three goods: a tradable commodity good (used as an input), a tradable finished good (manufactures), and a nontradable finished good.
- Two stylized facts underpin the simulation analysis:
  - The gap in tradable sector productivity growth between emerging Asia and other countries driving differential real GDP growth over roughly the last decade.
  - The increase in the share of imports coming from emerging Asia evident in trade data.

### Simulation setup and calibration
- Simulation elements that replicate the last decade:
  - A 10-year increase in emerging Asia’s real GDP of 50 percent driven by tradable sector productivity growth.
  - An increase in imports from emerging Asia in other countries’ import bundles replicating observed data increases.
- Model purpose:
  - Estimate impact of emerging Asia’s rapid growth on Australian GDP over the last decade and potential next decade.
  - Capture two main channels affecting Australia: commodity exports and import of competitively priced manufactured goods.

### Key quantitative findings
- Simulation replicating the past decade:
  - Together the two factors raise Australian real GDP by almost 11 percent.
  - This accounts for roughly 25 percent of Australia’s increase in real GDP over the period.
  - The impact on Australia is several times larger than the impact on the United States and the block of remaining countries when considered as an aggregate.
- Simulation projecting the next 10 years (similar emerging Asia performance and increased Australian import share):
  - A 50 percent increase in emerging Asia’s real GDP driven by tradable sector productivity growth would raise Australian GDP by 18 percent.
  - The larger impact reflects both the increase in emerging Asia’s economic size and Australia’s growing integration with emerging Asia.
- Alternative growth composition scenario:
  - If emerging Asia’s faster growth becomes more balanced with productivity growth in both the tradable and nontradable sectors contributing equally, the growth dividend for Australia is roughly cut in half.

### Exchange rate and commodity price effects
- Balassa-Samuelson effect:
  - Productivity growth in tradable goods sector implies pressure for appreciation of emerging Asia’s real exchange rate.
- Role of commodities in moderating appreciation:
  - Inclusion of commodities in the framework moderates the magnitude of required appreciation.
  - Emerging Asia is a net importer of commodities; the relative price of commodities is highly sensitive to increases in demand due to a fixed factor in commodity production.
  - Import of increasingly expensive commodity goods helps balance emerging Asia’s current account, reducing the need for exchange rate adjustment.
- Future projections:
  - Rising commodity prices play an even larger role in moderating required appreciation in emerging Asia’s real exchange rate.
  - If emerging Asia’s growth remains notably faster but becomes more balanced across tradable and nontradable sectors, a significant depreciation of emerging Asia’s real exchange rate would be required to maintain external balance.
  - More balanced growth could help resolve undervalued exchange rates by lowering the underlying equilibrium exchange rate over time.

### Policy implications and recommendations
- Adjustment within Australia implies significant resource reallocation across sectors; policy can maximize benefits by facilitating reallocation.
- Australia’s longer-term growth potential will have a large externally determined component with high uncertainty; policies focused on long-term objectives should factor in this uncertainty.
- Managing volatility from variable emerging Asia growth:
  - Fiscal policy: allow larger swings in the fiscal balance than would occur in economies less exposed to large exogenous shocks.
  - Monetary policy: continue to fully utilize the flexibility provided in the specification of the inflation target.
  - Financial sector regulation and supervision: err toward conservatism.

### Structure of the remainder of the paper
- Section II provides an overview of GEM.
- Section III presents the stylized facts that serve as the basis for the simulation analysis.

*IMF working paper chapter: 1. Calibration for Key Trading Relationships, 1997*

### Section IV contains the simulation results. Section V concludes.

### _wp10262 - Section IV contains the simulation results. Section V concludes.

### The GEM model: structure and calibration
- GEM is a multi-region, multiple-good, optimizing model with households, firms, and government in each region.
- Goods: nontradable; tradable noncommodity (manufactures); tradable non-energy commodity.
- Production functions:
  - Noncommodity tradable and nontradable: Y = f(A, K, L, Q_C, M_C) with constant elasticity of substitution; calibrated as Cobb-Douglas for noncommodities.
  - Commodities: Q_C = f(A, K, L, Land) with Land a fixed factor and low elasticity of substitution.
- Households: infinitely lived, monopolistic suppliers of differentiated labor, habit persistence in consumption, wage markups, capital and land ownership.
- Governments: consume nontradables, finance via nondistorting tax, set short-term nominal interest rate; nominal anchors:
  - Australia, United States, Remaining Countries: inflation targets.
  - Emerging Asia: stability in the nominal exchange rate versus the U.S. dollar.
- Exchange rate role: maintain external balance; real exchange rates ultimately adjust to desired current accounts and net foreign asset positions.
- Calibration approach:
  - Two model calibrations: one reflecting 1997 characteristics, one reflecting 2007 characteristics.
  - Focus on steady-state trading relationships among four blocks: Australia, Emerging Asia, United States, Remaining Countries.
  - Behavioral and adjustment-cost parameters largely identical across blocks.
  - Key calibration differences between 1997 and 2007 are relative sizes and trade shares (see Tables 1 and 2 in source).

### Key stylized facts (1997–2007)
- Emerging Asia grew much faster than other regions:
  - "Between 1997 and 2007, emerging Asia’s real GDP grew by roughly 50 percent more than the average for the world."
- Table 3: Increase in Real GDP Between 1997 and 2007 (Percent)
  - Australia: 43.1
  - United States: 35.4
  - Emerging Asia: 97.3
  - Remaining Countries: 44.9
  - World: 47.2
- Table 4: Average Annual Labor Productivity Growth, 1995–2004 (Percent)
  - Tradables: Australia 2.9; Emerging Asia 6.5; United States 3.5; Remaining Countries 3.2
  - Nontradables: Australia 1.5; Emerging Asia 2.6; United States 2.0; Remaining Countries 0.5
  - Productivity gap (Tradables minus Nontradables): Australia 1.4; Emerging Asia 3.9; United States 1.5; Remaining Countries 2.7
- Share of noncommodity imports from Emerging Asia (Table 5, In percent):
  - Australia: 1997 = 24.4; 2007 = 40.0; Change = 15.6
  - United States: 1997 = 26.6; 2007 = 33.7; Change = 6.1
  - Remaining Countries: 1997 = 44.6; 2007 = 62.6; Change = 18.0

### Simulation analysis: setup and modeling choices
- Shock implemented: increase in emerging Asia tradable-sector productivity that raises emerging Asia GDP by 50 percent over a 10-year period.
- Learning about persistence: agents form forecasts of shock persistence each period via a Kalman-filter-type signal extraction; learning calibrated so agents initially learn slowly, then faster as shock endures (details in Appendix).
- Commodity role: commodities enter as intermediate inputs with land as fixed factor; tradable good is more commodity-intensive than nontradable (parameters for nontradables roughly half those for tradables, except in Emerging Asia where nontradables are ¾ of tradable commodity intensity).
- Two-good counterfactuals: comparisons made between model versions with and without commodities to show commodities’ moderating effects on exchange rate and terms-of-trade adjustments.

### Historical-impact simulation results (emerging Asia tradable-sector productivity growth raising EA GDP by 50% over 10 years)
- Real GDP effects (percent deviation from baseline after 10 years):
  - Australia: 11 percent
  - United States: just under 2 percent
  - Remaining Countries: roughly 4 percent
- Terms of trade:
  - Real U.S. dollar price for commodities rises by 20 percent (proxy noted in text).
  - Australia and Remaining Countries see significantly larger terms-of-trade improvements than the United States.
- Real exchange rates (model with commodities vs without):
  - Emerging Asia REER appreciation after 10 years:
    - With commodities: just under 7 percent
    - Without commodities: over 9 percent
  - Australia’s REER:
    - With commodities: appreciates by just under 4 percent
    - Without commodities: small depreciation
  - Commodities moderate appreciation pressure on Emerging Asia and reduce depreciation pressure on Australia relative to model without commodities (Australian bilateral depreciation vs Asian currency is roughly 75 percent less when commodities included).
- Australia sectoral and macro adjustments:
  - Consumption and investment both rise; consumption increases significantly.
  - Investment growth moderated by larger decline in relative price of investment goods (higher import content).
  - Capital reallocates toward nontradable and commodity sectors; capital in manufactured goods declines.
  - Commodity production increases less than factor inputs due to Land fixed factor.
  - GDP increase is driven primarily by factor accumulation (capital and labor) rather than domestic productivity growth.
- Inflation dynamics:
  - Tradable goods price declines initially push CPI inflation below baseline.
  - As agents learn persistence and wealth rises, nontradable inflation accelerates and eventually pushes CPI above baseline, but CPI does not rise much above baseline.
  - Reasons cited for muted CPI response: commodities not in CPI basket directly; costly pass-through from commodities; absence of fixed factor in nontradable production in model likely understates inflation pressures.

### Future-impact simulation: continued tradable-sector-driven growth (emerging Asia GDP +50% over 10 years; larger EA share/size)
- Real GDP effects (percent deviation from baseline after 10 years):
  - Australia: 18 percent
  - Remaining Countries: roughly 7 percent
  - United States: roughly 3½ percent
- Terms of trade and commodities:
  - Commodity prices increase by 50 percent more than in the historical-impact simulation, producing a roughly 50 percent larger terms-of-trade improvement for Australia and Remaining Countries.
- Real exchange rates:
  - Emerging Asia REER required appreciation after 10 years: about 1 percent in this simulation (contrast to roughly 7 percent in previous simulation).
  - Australia’s REER appreciation: 6 percent (almost twice the appreciation in previous simulation).
  - Bilateral real appreciations after 10 years: Australia vs Asian currency ~5 percent; Australia vs Remaining Countries ~6 percent; Australia vs U.S. dollar >7 percent.
- Australia macro dynamics:
  - Consumption increases more than GDP; investment grows less.
  - Larger magnitudes of reallocation and factor accumulation than in historical-impact simulation.

### Future-impact simulation: balanced growth (emerging Asia productivity growth split equally between tradable and nontradable; EA GDP +50% over 10 years)
- Real GDP effects (percent deviation from baseline after 10 years):
  - Australia: 9 percent
  - Remaining Countries: 4 percent
  - United States: 2 percent
- Mechanisms:
  - With nontradable productivity growth included, commodity demand and commodity price increases are smaller; improvements in import competitiveness from EA are also smaller.
  - Emerging Asia’s equilibrium real exchange rate must depreciate significantly in this scenario because the relative price of EA tradables does not decline; depreciation is required to sell increased output abroad.
  - If EA growth becomes more balanced, underlying equilibrium EA exchange rates would decline, potentially reducing any existing undervaluation.
- Australia impacts:
  - Magnitudes of responses are reduced relative to tradable-dominated growth, but adjustment patterns remain similar (reallocation from manufactures to commodities and nontradables, rising consumption, muted investment response).

### Quantitative summary of key numeric results (selected exact values from simulations and facts)
- Emerging Asia real GDP increase used in shocks: 50 percent (over 10 years).
- Historical-impact simulation Australian GDP rise: 11 percent.
- Historical-impact simulation U.S. GDP rise: just under 2 percent.
- Historical-impact simulation Remaining Countries GDP rise: roughly 4 percent.
- Real U.S. dollar commodity price increase (historical-impact simulation proxy): 20 percent.
- Emerging Asia REER appreciation after 10 years:
  - With commodities (historical-impact): just under 7 percent.
  - Without commodities (historical-impact): over 9 percent.
- Australia REER after 10 years:
  - With commodities (historical-impact): just under 4 percent appreciation.
  - Future tradable-driven simulation: 6 percent appreciation.
- Future tradable-driven simulation Australian GDP rise after 10 years: 18 percent.
- Future tradable-driven simulation U.S. GDP rise after 10 years: roughly 3½ percent.
- Productivity growth averages, 1995–2004 (percents):
  - Emerg. Asia tradables: 6.5; nontradables: 2.6; productivity gap: 3.9.
  - Australia tradables: 2.9; nontradables: 1.5; productivity gap: 1.4.
- Share of noncommodity imports from Emerging Asia (Australia): 1997 = 24.4 percent; 2007 = 40.0 percent; Change = 15.6 percentage points.

### Policy implications and recommendations
- A substantial portion of recent Australian growth is linked to Emerging Asia (analysis suggests roughly 25 percent of GDP expansion in Australia over the last decade was due to Emerging Asia’s growth differential).
- Nature of Australian growth:
  - Much of the Australian output expansion arises from factor accumulation (capital and labor) driven by increasing returns (higher commodity and nontradable prices) rather than domestic productivity gains.
  - Policymakers should be cautious interpreting robust GDP growth as strong productivity growth; measured productivity may remain low even with continued strong GDP expansion.
  - Policymakers should be cautious about assuming current factor accumulation will necessarily lead to future productivity bursts.
- Structural and public-policy priorities:
  - Facilitate reallocation of resources across sectors (from manufactures to commodities and nontradables): continue reforms enhancing flexibility in product and labor markets.
  - Implement public measures to support reallocation: improved infrastructure and harmonization of state and federal regulation.
  - Avoid policies that artificially maintain manufacturing employment at the cost of slowing movement of labor and capital into commodities and nontradables.
- Macro policy and volatility:
  - Greater dependence on Emerging Asia increases exposure to exogenous shocks (especially via terms of trade); macro policy in Australia may need to work harder to maintain stability.
- Areas for further research indicated:
  - Sensitivity to learning speed: faster learning by agents could alter adjustment dynamics.
  - Consideration of uncertainty and potential overestimation of Emerging Asia’s future growth by agents.
  - Sensitivity to commodity-sector supply elasticities, since benefits to Australia hinge critically on commodity price responses.

### Appendix: learning about persistence (signal-extraction specification)
- Implemented signal-extraction problem for observed change ∆O_t:
  - ∆O_t = P_t + T_t
  - P_t = ρ · P_{t-1} + ε_t
  - T_t = 0 + ν_t
  - ε_t ∼ N(0, σ²); ν_t ∼ N(0, σ²)
- Kalman filter used to generate optimal estimates of persistent (P_t) and temporary (T_t) components each period; forecasts updated each period as new observations arrive.
- Speed of learning depends on agents’ assumed relative variances of persistent vs temporary components; relative variance may be time-invariant or time-varying to deliver the desired learning speed.

*Source: _wp10262 - Section IV contains the simulation results. Section V concludes.*

### REFERENCES

### _wp10262 - REFERENCES

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- Hunt, B., and A. Rebucci, 2005, “The U.S. Dollar and Trade Deficit: What Accounts for the Late 1990s?” International Finance, Vol. 8, No. 3, pp 399–434.

### Productivity and Comparative Growth Studies
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- Kim, S., D. Park, and J. Park, 2010, “Productivity Growth Across the World, 1991–2003,” ADB Economics Working Paper 212.  
- Rahman, J., D. Stephan, and G. Tunny, 2009, “Estimating Trends in Australia’s Productivity,” Australian Treasury Working Paper 2009–01.  
- Sun, Y., 2010, “Potential Growth of Australia and New Zealand in the Aftermath of the Global Financial Crisis,” IMF Working Paper, WP/10/127.

### Inflation, Oil Price Shocks, and Relative Prices
- Hunt, B., 2005, “Oil Price Shocks: Can they Account for the Stagflation in the 1970s?” IMF Working Paper, WP/05/215.  
- Hunt, B., 2007, “U.K. Inflation and Relative Prices Over the Last Decade: How Important was Globalization?” IMF Working Paper, WP/07/208.

### Monetary Policy and Small Open Economies
- Laxton D., and P. Pesenti, 2003, “Monetary Policy Rules for Small, Open, Emerging Economies,” Journal of Monetary Economics, Vol. 50, pp 1109–46.

### Asia-focused Growth and Rebalancing
- Prasad, E., 2009a, “Rebalancing Growth in Asia,” NBER Working Paper 15169.  
- Prasad, E., 2009b, “Is the Chinese Growth Miracle Built to Last,” China Economic Review, Vol. 20, pp 103–23.

*Source: _wp10262 - REFERENCES*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp10262.pdf_