The Almost Ideal Demand System in Error Correction Form

Abstract

In this chapter we develop a dynamic AIDS model based on the error correction form. In their original paper, Deaton and Muellbauer (1980b) noted the apparent dynamic deficiency in the static demand system, as revealed by positively autocor-related residuals in the estimated system. Later developments of dynamic systems encountered difficulties in introducing dynamics without violating some of the theoretical restrictions of a demand system, in particular the adding up condition.1 Anderson and Blundell (1983) used the error correction form to analyse the long-run properties of the AIDS model. Their conclusion was that restrictive dynamic forms were rejected in favour of the more general error correction model. In this chapter we follow a similar strategy. We use the error correction model as a maintained hypothesis and test restrictions in the dynamic form. In addition, theoretical restrictions are tested. The tests are done for the Nordic countries, and differences are revealed among these countries. Contrary to Anderson and Blundell (1983), we find significant restrictions on the dynamic form, which considerably reduces the number of parameters to be estimated.