Katarina Juselius

Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK

Abstract The paper develops some new tests for structural hypotheses in the framework of a multivariate error correction model with Gaussian errors. The tests are constructed by an analysis of the likelihood function and motivated by an empirical investigation of the PPP relation and the UIP relation for the United Kingdom. Three types of tests are discussed. First we consider the same linear restrictions on all cointegration relations, then we consider the hypothesis that certain relations are assumed to be cointegrating, and finally we formulate a general hypothesis that contains the previous ones. This hypothesis can be expressed by the condition that some of the cointegrating relations are subject to given linear restrictions, while others are unconstrained.

Identification of the long-run and the short-run structure an application to the ISLM model

In this paper we discuss the problem of identification in a model with cointegration. It is pointed out that there is an identification problem for both long-run parameters and short-run parameters. The identification of the equations and the cointegrating relations is achieved by linear restrictions on the parameters and a criterion for a statistical model to be identifying is given. We also define empirical identification of an estimated structure. A switching algorithm for calculating the restricted parameters is proposed. The concepts are illustrated with an empirical analysis of the ISLM model using Australian monetary data.

Do purchasing power parity and uncovered interest rate parity hold in the long run? An example of likelihood inference in a multivariate time-series model

The long-run foreign transmission effects are analyzed in a multivariate time-series model of Danish and German prices, exchange rates and interest rates. The analysis of the likelihood function reveals that the vector process is I(2), but that a linear transformation of the prices and the nomical exchange rate removes the I(2) trend from the data. A structural representation of the full cointegration space is found to facilitate the understanding of the interaction between the goods and the capital market and hence the mechanisms behind the inflationary effects transmitted from abroad.

THE FINANCIAL CRISIS AND THE SYSTEMIC FAILURE OF THE ECONOMICS PROFESSION

ABSTRACT Economists not only failed to anticipate the financial crisis; they may have contributed to it—with risk and derivatives models that, through spurious precision and untested theoretical assumptions, encouraged policy makers and market participants to see more stability and risk sharing than was actually present. Moreover, once the crisis occurred, it was met with incomprehension by most economists because of models that, on the one hand, downplay the possibility that economic actors may exhibit highly interactive behavior; and, on the other, assume that any homogeneity will involve economic actors sharing the economist’s own putatively correct model of the economy, so that error can stem only from an exogenous shock. The financial crisis presents both an ethical and an intellectual challenge to economics, and an opportunity to reform its study by grounding it more solidly in reality.

The financial crisis and the systemic failure of academic economics

The economics profession appears to have been unaware of the long build-up to the current worldwide financial crisis and to have significantly underestimated its dimensions once it started to unfold. In our view, this lack of understanding is due to a misallocation of research efforts in economics. We trace the deeper roots of this failure to the professions focus on models that, by design, disregard key elements driving outcomes in real-world markets. The economics profession has failed in communicating the limitations, weaknesses, and even dangers of its preferred models to the public. This state of affairs makes clear the need for a major reorientation of focus in the research economists undertake, as well as for the establishment of an ethical code that would ask economists to understand and communicate the limitations and potential misuses of their models.

Domestic and foreign effects on prices in an open economy: The case of Denmark

Abstract Domestic price determination in Denmark is investigated using three kinds of macroeconomic explanations: (1) internal labor market theories describing the relation between price and wage inflation, (2) pure monetarist theories describing the effect of excess money on the inflation rate. and (3) external theories describing the foreign transmission effects on a small open economy. The empirical analysis makes use of the multivariate cointegration model, which is based on the joint analysis of long- and short-run behavior. The deviations from derived underlying steady states in each sector were found to be the main determinants of the inflation rate. Among these, the domestic effects were small compared to the foreign effects. The empirical results strongly favored a backward-looking behavioral model in terms of structurally stable parameters as opposed to a forward-looking expectations model. The results stand up as quite strong evidence against the Lucas critique.

International parity relationships between the USA and Japan

Based on multivariate cointegration analysis we show that key parity conditions between the USA and Japan do not hold as stationary relations and that this is related to the nonstationarity of the real exchange rate. The latter seems almost exclusively to be related to similar nonstationary movements in interest rates. We obtain strong empirical results suggesting a reversal of the standard linkages, as predicted by the term structure of interest rates and the Fisher condition, between short and long interest rates and interest rates and inflation. Our findings may be important for the conduct of monetary policy, which is usually thought to be transmitted through short-term interest rates. Altogether, the empirical results suggest that it is agents’ behavior in the foreign exchange market, rather than in the goods market, which is crucial for the determination of the exchange rate.

The Long‐Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis

Studies of aid effectiveness abound in the literature, often with opposing conclusions. Since most time-series studies use data from the exact same publicly available data bases, our claim here is that such differences in results must be due to the use of different econometric models and methods. To investigate this we perform a comprehensive study of the long-run effect of foreign aid (ODA) on a set of key macroeconomic variables in 36 sub-Saharan African countries from mid-1960s to 2007. We use a well-specified (Cointegrated) VAR (CVAR) model as our statistical benchmark. It represents a much-needed general-to-specific approach which can provide broad confidence intervals within which empirically relevant claims should fall. Based on stringent statistical testing, our results provide broad support for a positive long-run impact of ODA flows on the macroeconomy. For example, we find a positive effect of ODA on investment in 33 of the 36 included countries, but hardly any evidence supporting the view that aid has been harmful. From a methodological point of view our study documents the importance of transparency in results reporting in particular when the statistical null does not correspond to a natural economic null hypothesis. Our study identifies three reasons for econometrically unsatisfactory results in the literature: failure to adequately account for unit roots and breaks; imposing seemingly innocuous but invalid data transformations; and imposing aid endogeneity/exogeneity without testing.

Taking a DSGE Model to the Data Meaningfully

All economists say that they want to take their model to the data. But with incomplete and highly imperfect data, doing so is difficult and requires carefully matching the assumptions of the model with the statistical properties of the data. The cointegrated VAR (CVAR) offers a way of doing so. In this paper we outline a method for translating the assumptions underlying a DSGE model into a set of testable assumptions on a cointegrated VAR model and illustrate the ideas with the RBC model in Ireland (2004). Accounting for unit roots (near unit roots) in the model is shown to provide a powerful robustification of the statistical and economic inference about persistent and less persistent movements in the data. We propose that all basic assumptions underlying the theory model should be formulated as a set of testable hypotheses on the long-run structure of a CVAR model, a so called ?theory consistent hypothetical scenario?. The advantage of such a scenario is that if forces us to formulate all testable implications of the basic hypotheses underlying a theory model. We demonstrate that most assumptions underlying the DSGE model and, hence, the RBC model are rejected when properly tested. Leaving the RBC model aside, we then report a structured CVAR analysis that summarizes the main features of the data in terms of long-run relations and common stochastic trends. We argue that structuring the data in this way offers a number of ?sophisticated? stylized facts that a theory model has to replicate in order to claim empirical relevance.Examples of simple economic theory models are analyzed as restrictions on the Cointegrated VAR (CVAR). This establishes a correspondence between basic economic concepts and the econometric concepts of the CVAR: The economic relations correspond to cointegrating vectors and exogeneity in the economic model implies the econometric concept of strong exogeneity for β. The economic equilibrium corresponds to the so-called long-run value (Johansen 2005), the comparative statics are captured by the long-run impact matrix, C; and the exogenous variables are the common trends. Also, the adjustment parameters of the CVAR are shown to be interpretable in terms of expectations formation, market clearing, nominal rigidities, etc. The general-partial equilibrium distinction is also discussed.

A Structured VAR for Denmark under Changing Monetary Regimes

Using recently developed statistical tools for analyzing cointegrated I(2) data, this article models money, income, prices, and interest rates in Denmark. The final model describes the dynamic adjustment to short-run changes of the process, to deviations from long-run steady states, and to several political interventions. It provides new insights about the effects of the liberalization of trade and capital in a small open European economy.