1 A Recursive Dynamic Computable General Equilibrium Model For ...

pick up) rather than a long term structural problem. This implies a more elastic capital
supply function below KE. Consequently, this criteria favours the choice of a smaller α
parameter value. On running repeated robustness tests a value of 0.5 was elected.
Having determined the impact of excess capacity on capital rental rates, it is also
necessary to modify the impacts of excess capacity on expected rates of return and capital
accumulation. Concentrating first on expected rates of return, we follow Dixon and
Rimmer (op. cit.), by modifying equation (21) to:
[ ( 1−
x)
E + xR ] − ( 1 U ). D
Et = U.
t−
1 t −
0 ≤ x ≤ 1 (26)
Thus, in the crisis years only, the rate of return is adjusted downwards owing to the
existence of capital which is held idle (i.e., excess supply of capital). More specifically, the
rule for investors’ expectations remains unchanged for that proportion of capital which is
in usage (U < 1), whilst the rate of return on idle capital (1-U) is a negative function of the
depreciation rate (D). In other words, capital which is not in use accrues no return and
deteriorates at the rate of depreciation (Dixon and Rimmer, (op. cit.)). In the remaining
years where no excess stocks of capital are held, equation (26) collapses to equation (21)
and equation (24) is effectively switched off via a change in the model closure.
Finally, the impact of excess capital capacity is introduced into the capital growth
equation:
β
t
β
t
G = Q.
G M U /( Q −1
+ M )
(27)
t
trend
where the impacts of new investment on capital growth rates are moderated when there is
excess capital stock in the crisis years (i.e., U < 1).
7. Adjustment of (sticky) real wages to employment
In a recursive year-on-year recursive dynamic framework, it is useful to have a
mechanism for capturing the medium term relationship between changes in wage growth
and employment. In particular, when modelling labour market rigidities (particularly
pertinent in the case of Spain), it is useful to be able to calibrate the relationship between
changes in real wages and employment levels, if possible via the usage of historical
secondary data. In the dynamic version of ORANI, the approach is to gauge the
relationship between changes in the employment level in a given period ‘t’ (Lt) and changes
in the long run ‘trend’ level of employment (Tt), with changes in the real wage. 29 In our
typical dynamic ORANI closure, employment in each period is controlled exogenously, 30
29 The trend level could be thought of as as the level of employment corresponding to NAIRU
30 It should be noted that by controlling employment rates year on year, we are implicitly taking account of
changes in unemployment.
39