ToTEM III: The Bank of Canada’s Main DSGE Model for Projection and Policy Analysis
The Terms-of-Trade Economic Model (ToTEM) has been the Bank of Canada’s main dynamic stochastic general equilibrium model for about 15 years. We provide a technical description of the model’s third generation, ToTEM III.
Two key features distinguish ToTEM III from previous generations of ToTEM.
The first is that the modelling of both household debt and the housing market has been significantly enhanced. For example, the model now features:
- a set of borrower households who contribute to overall housing demand
- a clear distinction between the stock and flow of household debt
- a mix of variable- and fixed-rate household debt
- a role for loan-to-value regulation
- a new sector specifically focused on the production of residential investment goods
The second is that the model has been estimated using a state-of-the-art Bayesian method.
Both of these new features have resulted in significant improvements to the model’s empirical properties.
We discuss ToTEM III’s new features and compare its responses to key shocks with ToTEM II’s responses. To illustrate how ToTEM III’s new features allow Bank staff to address a broader range of economic issues, we also explore two policy applications:
- analyzing how higher household indebtedness affects the sensitivity of consumption to interest rates
- assessing the effects of loan-to-value regulation