Modelling the Foreign Sector in a Macroeconometric Model of Sweden

The purpose of this paper is to estimate a rudimentary model of the “rest of the world", which may serve as the foreign sector in a model of the Swedish economy. The “rest of the world" is here represented by the US and the euro zone which together cover some two thirds of the Swedish foreign trade. The underlying theoretical model is the so-called Svensson model as of Svensson (1997). This model has the advantage that it is small and simple, but still allows for both supply and demand shocks with realistic responses. The Svensson model is estimated (OLS) for the US and the euro zone separately using quarterly data. Furthermore, following Smeets and Peersman (1999), alternative models with the outputgap treated as an unobserved component are estimated as well. Impulse response analyses indicate that all individual models react reasonably well to both supply and demand shocks. The models for the US and the euro zone are aggregated temporally to annual data (since the model of the Swedish economy uses annual data) and are subsequently aggregated into one model of the foreign sector.