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In this paper, two macro models of the New Zealand have been compared. The analysis investigates the dynamic properties of the models over the business cycle following a variety of temporary shocks. Although the models are both based on a similar microeconomic theoretical framework and are both characterised by a balanced growth path, there are some differences in the model structures that are highlighted by the simulations.

Providing the major contrast between the two models is the adjustment mechanism through which the economy returns to the equilibrium after a shock. In FPS, the 90-day rate is the key variable that helps the economy to adjust to the impact of various shocks. It seems the demand side of the FPS is more responsive to monetary policy than that of the NZTM. Most noticeably, changes in monetary policy lead to an immediate change in consumption, as some consumers are forward-looking. In contrast, there is always a lagged response from consumption to changes in the yield curve in NZTM.

In NZTM, relative prices (and the real exchange rate) play a significant role in the model, determining how resources are shifted from one sector to the other. On the demand side of the economy, the demand for imports and nontraded goods are also a function of income and the real exchange rate. Thus, NZTM is sensitive to external price shocks as there is a direct connection between the real exchange rate and world prices. In contrast, FPS displays a more muted response to external price shocks.

Furthermore, the dynamics of the real exchange are strongly influenced by external imbalances in NZTM, as the real exchange rate is the key variable enabling the economy to attain its external equilibrium. However, in FPS the real exchange rate is not responsive to external imbalances and the external balance is partly attained by adjusting consumption.

Another notable difference is the dynamic behaviour of investment. In FPS, the adjustment of business investment is rather muted and slow in response to shocks compared with NZTM. As mentioned above, the 90-day rate is the key factor in determining the level of investment in FPS. In NZTM, besides relative prices, current sales and profits are major factors in determining the level of investment. High profits and sales could be interpreted as an indication of future demand for the firm’s product, which in turn affects the desired capital stock.

Inflation is slightly more persistent in FPS than in NZTM. This reflects inflation expectations being more stable in NZTM. Therefore, FPS generally requires a larger monetary response than does NZTM to return inflation to the target rate in response to a demand shock.

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