Department of Economics
University of Maryland
Draft of April 2004
In Part 1, we developed a very simple model and suggested some directions in which it could be
expanded. In the present chapter, we will carry out some of the suggestions while trying to
follow the good advice of the last chapter of Part
1. In particular, our model will
refine the consumption and employment functions presented previously.
divide fixed investment into three major components, equipment, residences, and other
structures, and develop appropriate equations for each.
develop equations for exports and imports.
complete the income side of the model with equations for capital consumption, profits,
dividends, interest rates, interest payments and income, employee compensation
and proprietor income.
calculate revenues from various taxes, government expenditures in current prices (from
variables exogenous in constant prices), interest payments, and budgetary deficits
or surpluses for the federal government and, separately, for the combination of
state and local governments.
The word structural in the name of the Quest model is noteworthy. Quest is a model intended
to embody and test an understanding of how the economy works. It is concerned with how
aggregate demand affects employment, how employment affects unemployment, how
unemployment affects prices, how prices and money supply affect interest rates and incomes,
and how incomes, interest rates, and prices affect investment, consumption, imports, and exports,
which make up aggregate. demand. The model embodies a view of how each link in this closedloop
chain works. Satisfactory performance is not to judged by how well it works forecasting a
few quarters ahead, but by how well it holds up over a much longer period. Can it keep
employment within a few percent of the labor force over decades? Can it keep inflation in line
with the increase in money supply though it does not use money supply in the inflation equation?
Can it right itself if thrown off course for a few quarters? We will test it in 21-year historical
simulation, time enough for it to go seriously astray if it is inclined to do so
