Modeling German unification in a disequilibrium framework

Abstract

Unification fundamentally changed the terms of quantitative macroeconomic analysis for Germany. Two main areas concerned are data availability for the eastern part of Germany and structural changes within the behavioural equations after unification. Our paper presents results from the estimation of a macroeconometric disequilibrium model formerly developed for West Germany. The challenge is to handle the structural break in the time series and the economic model by applying a SUR estimator for West Germany and the Federal Republic of Germany, respectively. The main focus here is the modeling of investment expenditures and employment adjustment. The empirical results are encouraging and show that the disequilibrium model is flexible enough to analyze the changes induced by unification. In particular, our results reveal that most behavioural relationships remained fairly stable when switching from West Germany to the Federal Republic of Germany. One notable exception is investment behaviour which { during the first years after unification { was strongly affected by fiscal incentives in East Germany. Preliminary policy simulations show effects of these fiscal incentives and the demand shock to the West German economy. The simulated responses depend on the prevailing regimes on goods and labour markets.