Closure choices

Overview of closure choices

The closure of a CGE model refers to the elements that we tell the model about (exogenous variables) and those which we want the model to tell us about (endogenous variables).

In MDG6NZ the closure is extremely flexible, allowing us to incorporate a wide variety of inputs into simulations depending on the availability of data in a particular country, often including expert speciality forecasts from official or other expert sources.

The policy simulation closure looks like a ‘standard’ economic closure. By this we mean that if we were to write down an economic model’s equation in a standard theoretical manner, most of the left-hand side variables would be endogenous in the deviation simulation.

Closure choice reflects choices about the economic environment and normally goes beyond a simple assessment of matching exogenous variables with shocks.

We can adjust the closure assumptions from year to year, depending on the policy simulations we are considering. There is no need, for example, to assume full employment in all years.

Project-specific closure choices

In the core scenarios conducted for this report, the policy closure contained a few key blocks of settings:

• The real balance of trade was fixed as a share of real GDP.
• Real wages are sticky in the short run, meaning the immediate labour market impacts of biofuels policies are seen largely through changes in employment. Over time, employment trends back towards baseline and real wages adjust to clear the labour market.
• Population growth and land supply growth are exogenous.
• The nominal exchange rate is exogenous, but the real exchange rate is determined by the model.
• Most industry-specific and commodity-specific technological change and preference variables are exogenous.
• Changes in total government investment are exogenous.
• Transport emissions are exogenous in scenarios 2-4, and the share of bioethanol in the light vehicle fuel blend is exogenous in scenario 1.
• Biofuels and fossil fuels world prices are exogenous, based on Hale & Twomey (2021).
• EV uptake is constant across the baseline and four counterfactual scenarios and imposed through changes to the emissions intensity of the light vehicle fleet.

Our choice of closure with respect to the balance of trade is an appropriate and conservative one since we had no specific information regarding, for example, the likely source of financing (domestic or international) for biofuels-related investment in capacity expansion.

Alternative assumptions about the path of the balance of payments can influence welfare results in particular, for example because the deviation in GNI and GDP that would result from changes in the primary account balance in the current account due to foreign ownership of domestic capital would lead to impacts on household disposable income (HDI) and consumption as HDI is more closely related to GNI than GDP.

Examples of alternative balance of payments closure assumptions could include allowing the current account balance to adjust to accommodate a change in domestic investment without short term constraints, or tying the path of the current account balance to a macroeconomic aggregate like GDP. Additionally, as the current account reflects domestic savings and investment behaviour, the path of the balance of payments could be influenced by imposing certain assumptions on the domestic propensity to save.