The model ITEM is the econometric model developed and utilized at the Department of Treasury of the Italian Ministry of the Economy and Finance. Being designed for the needs of a Treasury Department, ITEM has a public finance section developed in great detail, on both the expenditure and revenue side. In general, the model has a quarterly frequency and includes 371 variables (247 of which are endogenous). The model structure features 36 behavioral equations and 211 identities, referring to accounting definitions and institutional relationships among variables. As a medium-size econometric model, ITEM is suitable to track and explain the behavior of a considerable number of macroeconomic aggregates of the Italian economy.

It also features a complete modeling of financial assets and liabilities of the institutional sectors, with the economy being divided into four sectors: Household, Business, Government, and Foreign sector. Exogenous variables are grouped in three categories: a) those dealing with the international economic environment. These are essentially world demand, exchange rate, oil and commodity prices, and – in forecasting exercises – short-term interest rates; b) fiscal policy variables: i.e. a variety of tax and contribution rates, as well as several public expenditure aggregates; and c) other domestic exogenous variables, such as those related to demographics and, most importantly, the non-cyclical component of total factor productivity (TFP).

With regard to the general structure, ITEM belongs to the class of macroeconomic models that assign a prominent role to the supply side of the economy. Indeed, one of its key features is the joint and explicit representation of the economic environment on both the demand and the supply side.

Behavioral equations for private consumption, investment, exports and imports included in the model structure are conventional. A notable characteristic of ITEM is that gross domestic product is computed, via an accounting identity, on the supply side. In particular, total GDP is the sum of value added of market and non-market sectors and net indirect taxes. Importantly, the value added of market sector is obtained through a Cobb-Douglas production function with constant returns to scale, where value added depends on labor, capital stock and TFP.

Output in ITEM – albeit computed directly on the supply side from an accounting identity – is determined in the short run by demand conditions. Conversely, the output level is determined on the supply side by long run factors. In ITEM, as we will show, the shocks that generate permanent effects on output are associated with: a) variation of variables affecting the tax wedge in the labor market and the user cost of capital; b) labor supply changes; and c) variation in the trend component of TFP (technical progress). By contrast, variables that exert their effects on the demand side have only temporary effects on output and, in general, on the economy.