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The common trends representation
Measuring common driving trends
From Chapter 2:
With long-run price homogeneity:
Illustrations
Just-identification of alpha orthogonal
The transformation matrix:
1980 1990 2000
-0.1
0.0
0.1Cumulated residuals from money equation
1980 1990 2000
-0.05
0.00
0.05
0.10Cumulated residuals from income equation
1980 1990 2000
0.00
0.05Cumulated residuals from inflation rate equation
1980 1990 2000
0.000
0.005
Cumulated residuals from the short rate equation
1980 1990 2000
0.000
0.005
0.010 Cumulated residuals from the bond rate equation
1975 1980 1985 1990 1995 2000
-0.01
0.00
0.01
0.02
Common trend 1
1975 1980 1985 1990 1995 2000
-0.01
0.00
0.01
Common trend 2
Is a weakly exogenous variable a common stochastic trend?
The MA representation under the weak exogeneity restriction
Assessing the economic scenario
Where does the nonstationarity of the hypothetical relations come from?
The income – inflation relationship:
The nonstationarity of real interest rates:
Imposing exclusion restrictions on commontrends
If nominal money stock and price levels contain just one I(2) trend, thenInflation should only be affected by one stochastic trend. This can be achieved by a linear transformation.
Example 1:
Example 2:
Example 3: