Dynamic Error Correction Model Research Articles

Demand for M2 in an Emerging-Market Economy: An Error-Correction Model for Malaysia

This paper analyses demand for M2 in Malaysia from August 1973 to December 1995 under both the closed- and open-economy framework. Based on the cointegration and weak-exogeneity test results, short-run dynamic error-correction models are specified and estimated. The results indicate that the demand is for real M2. Both the long- and short-run models are well-specified and are fairly stable. The long-run income elasticity is close to one with the opportunity cost variables carrying the expected signs. The external events have some influence on the stability.

Demand for M2 in an Emerging-Market Economy: An Error-Correction Model for Malaysia

This paper analyses demand for M2 in Malaysia from August 1973 to December 1995 under both the closed- and open-economy framework. Based on the cointegration and weak-exogeneity test results, short-run dynamic error-correction models are specified and estimated. The results indicate that the demand is for real M2. Both the long- and short-run models are well-specified and are fairly stable. The long-run income elasticity is close to one with the opportunity cost variables carrying the expected signs. The external events have some influence on the stability.

A multivariate cointegrated modelling approach in testing temporal causality between energy consumption, real income and prices with an application to two Asian LDCs

Unlike previous studies on the casual relationship between energy consumption and economic growth, this paper illustrates how the finding of cointegration(i.e. long-term equilibrium relationship) between these variables, may be used in testing Granger causality. Based on the most recent Johansen's multiple cointegration tests preceded by various unit root or nonstationarity tests, we test for cointegration between total energy consumption, real income and price level of two Asian LDCs: Thailand and Sri Lanka. Nonrejection of cointegration between variables rules out Granger noncausality and implies at least one way of Granger-causality either unidirectional or bidirectional. Secondly, by using a dynamic vector error-correction model, we then analyse the direction of Granger-causation and hence the within-sample Grangerexogeneity or endogeneity of each of the variables. Thirdly, the relative strength of the causality is gauged (through the dynamic variance decomposition technique) by decomposing the total impact of an unanticipated shock to each of the variables beyond the sample period, into proportions attributable to shocks in the other variables including its own, in the multivariate system. Finally, these response paths of shocks to the system are traced out using impulse response graphs. Results based on these four tools of methodology, broadly indicate that all three variables are cointegrated and exhibit two common trends within each system. Energy consumption seems to be relatively exogenous as neither income nor prices seems to Granger cause this variable via any of the channels where potential casuality may occur. Though, energy consumption itself plays an important role in influencing income and prices by varying degrees of significance for each country. Overall, shocks to the system seemed to have had a more sustained if not pronounced effect in Thailand than in Sri Lanka.

The Demand for M0 in the United Kingdom Reconsidered: Some Specification Issues

This paper provides tests of an econometric model of the demand for UK M0. The existence of a long-run cointegrating relationship between M0 and key economic variables is established and a plausible dynamic error-correction model is estimated. A model that passes standard specification tests is achieved without resort to arbitrary proxies for financial innovation. Some of the recent decline in M0 velocity is explained by the move to a lower inflation environment.

Incorporating cointegration relations in a short-run model of the Finnish sawlog market

This paper reports on the results of a simultaneous equations sawlog market model using monthly data for Finland in 1985-1997. Johansen's multivariate method is used to estimate cointegration vectors, which are then included in a dynamic error-correction model. Rank tests indicate two cointegrating vectors, which is theoretically consistent with the demand and supply equations. In the sawlog demand, the equilibrium is established for sawlog stumpage price and quantity and sawn wood price and capital stock, while the supply function in a perfect capital market entails sawlog price and quantity, real interest rate, and the effect of increasing timber stock as captured by a linear trend. Contrary to earlier findings, stumpage price seems to have a positive effect on sawlog supply, both in the short and long run, while only the long-run price effect is present in the sawlog demand. Disequilibrium in demand is corrected within one quarter, while the speed of adjustment is found to be slow in the sawlog supply.

The Price Incentive to Smuggle and the Cocoa Supply in Ghana, 1950-1996

From the early 1960s to the early 1980s, the officially recorded production of cocoa in Ghana declined by 60 percent. During the 1983–95 Economic Recovery Program, however, cocoa production doubled. Although these developments have inspired much empirical research, most of the studies have been unable to explain the medium-term persistence of cocoa output to remain below its estimated capacity level. The paper argues that the price incentive to smuggle can explain as much as one-half of the observed decline in output and the subsequent recovery. A cointegration analysis and a dynamic error-correction model of cocoa supply support the analysis.

The Price Incentive to Smuggle and the Cocoa Supply in Ghana, 1950-96

From the early 1960s to the early 1980s, the officially recorded production of cocoa in Ghana declined by 60 percent. During the 1983-95 Economic Recovery Program, however, cocoa production doubled. Although these developments have inspired much empirical research, most of the studies have been unable to explain the medium-term persistence of cocoa output to remain below its estimated capacity level. The paper argues that the price incentive to smuggle can explain as much as one-half of the observed decline in output and the subsequent recovery. A cointegration analysis and a dynamic error-correction model of cocoa supply support the analysis.

The Demand for Football in the Regions of England and Wales

DOBSON S. M. and GODDARD J. A. (1996) The demand for football in the regions of England and Wales, Reg. Studies 30, 443–453. This paper investigates the determinants of the demand for football in the regions of England and Wales. Using annual time series data over a 37-year period, we use a dynamic error correction model to identify economic and football-specific factors which determine attendances in the short run and long run. The short run influences on demand are performance, admission price and goal scoring. Performance and the unemployment rate are identified as significant long run determinants of attendance. Although the relationship between attendance share and performance seems to exhibit a strong regional dimension, we find only weak evidence of regional variation in the coefficients of the attendance model itself. DOBSON S. M. et GODDARD J. A. (1996) La demande de football aux regions de l'Angleterre et des Pays de Galles, Reg. Studies 30, 443–453. Cet article examine les determinants de la de...

Small Country Experiences with Exchange Rates and Inflation: the Case of Botswana

The dominant influence of South African goods on the Bostwana CPI basket leads to the expectation that South African prices have a significant role in determining prices in Bostwana. This paper examine Botswana's price and inflation relationships and their interation. Cointegration analysis is used to develop a dynamic error correction model that established the link between long run equilibrium prices and short run inflation. Results show that the exchange rate (and South African prices) rather than money is cointegrated with prices, supporting theoretical predictions of a dominant long term equilibrium relationship between prices and the exchange rate in a pegged exchange rate regime with capital controls. In the short run both domestic and imported inflationary pressures determine growth in the price level each month. This suggests monetary, exchange rate and fiscal policy can be used to temper inflation in the short run. Changes in the exchange rate and prices will, however, only have short term price competitiveness effects, over time complete adjustment back to the equilibrium real exchange rate occurs.

Stock prices, dividends and retention: Long-run relationships and short-run dynamics

In this paper we present a modified version of the present value stock price model in which stock prices are explained by dividends and a retention term. It is argued that the retention term may have important information for stock prices over-and-above that contained in dividends. The model is tested using a well-known US data base and recently developed time series techniques. We demonstrate, inter alia, that a unique cointegrating relationship exists amongst stock prices, dividends and the retention term, and we establish a dynamic error correction model which has a number of appealing features.

Has M2 demand in the USA become unstable? evidence from an error-correction model

The purpose of this paper is to estimate an appropriate broad-money demand function for the United States and to examine its stability after 1987, when the Federal Reserve System began using M2 as a policy guide. Special attention is paid to the model specification, its dynamic structure, and to its cointegration properties. The results from various dynamic error-correction models suggest that: (i) the money demand relationship is stable; (ii) most previously estimated models have undoubtedly misspecified the interest rate variable; (iii) interest-rate variability is another important determinant of real money demand; and (iv) in contrast of previous studies, the long-run scale variable is real GDP, whereas real consumer spending is the short-run scale variable. The sample period examined is 1953:1 to 1991:4.

Dynamic modeling of the demand for narrow money in Norway

The role and stability of the demand for money are recurring issues in applied econometrics. Does a constant long-run demand for money function exist? If so, is money exogenous, and hence a policy variable, or endogenous? The notion of cointegration provides a tool for identifying long-run relationships, to be embedded in dynamic error correction models with constant parameters, while the assumed exogenuity status of variables for the parameters of interest can be assessed by recently developed tests. This paper derives a demand function for narrow money in Norway by applying these tools, starting out with a vector autoregressive representation that includes money (Ml), prices, real expenditure and several interest rates. Given a sample riddled with financial deregulation, changing monetary policy, and an economy switching its basis from industrial production towards oil exportation, one should not be surprised to find an unstable demand for money function. A conditional model with constant parameters is nevertheless established. Finally tests for weak and super exogeneity are conducted. Prices, real expenditure, and interest rates are super exogenous for the parameters of the demand for money. This means that simulation experiments can be conducted for the effects of monetary and fiscal policy on the demand for money.

Cointegration, error correction and the demand for money in Cyprus

This paper applies the recently developed technique of cointegration to estimate the demand for broad money in the case of Cyprus. Cyprus is an example of a country which does not have a sophisticated financial sector and which faced a severe political shock at a certain point in her history. The hypothesis of instability in the demand for money function cannot be rejected if the effects of this shock are not taken into account. In particular, it is argued that there was a once and for all increase in the income elasticity of this function at the time of the shcock. When this shift is accounted for by the introduction of an appropriate variable in the cointegrating regression the hypothesis of instability in the demand for money is rejected. Two dynamic error correction models are then specified with income and consumption as the scale variables respectively. Non-nested tests are carried out which reveal that consumers' expenditure is a more appropriate scale variable than GDP.

THE DETERMINATION OF LIQUID ASSET HOLDINGS OF THE U.K. PERSONAL SECTOR*

The general-to-specific methodology and cointegration techniques are used to examine the demand for liquid assets by the UK personal sector. The demand for real liquid assets are found to depend positively on the level of transactions, the wealth to income ration and the own rate on liquid assets. In addition a higher rate of return on long-term securities or on bank lending reduces the level of liquid assets in the long run. Evidence in favour of cointegration between these variables is found and a dynamic error correction model with stable parameter estimates is found to hold over the 1970s and 1980s. The stable demand for this broad monetary aggregate however does not imply that it should form the basis for monetary targets since the equation is estimated from a regime that could be broadly characterised as one of interest rate setting. Copyright 1990 by Blackwell Publishers Ltd and The Victoria University of Manchester

An Econometric Analysis of UK Money Demand In Monetary Trends in the United States and the United Kingdom by Milton Friedman and Anna J. Schwartz

This paper evaluates an empirical model of UK money demand developed by Friedman and Schwartz in Monetary Trends... .Testing reveals mis-specification and hence the potential for an improved model. Using recursive procedures on their annual data, we obtain a better-fitting, constant, dynamic error-correction (cointegration) model. Results on exogeneity and encompassing imply that our money-demand model is interpretable as a model of money but not of prices since its constancy holds only conditional on contemporaneous prices.

ENERGY PRICE‐ and INCOME‐ELASTICITIES OF DEMAND: SOME ESTIMATES FOR THE UK USING THE COINTEGRATION PROCEDURE

The aim of this paper is to reexamine aggregate energy demand in the United Kingdom using the relatively recent procedure of cointegration. It shows energy consumption, the real price of energy, and real GDP cointegrate, which implies the existence of a long-run equilibrium. The associated long-run price-elasticity estimate is about -0.3 and the long-run income-elasticity estimate is about 0.5. The associated dynamic error-correction model yields short-run price- and income-elasticities of -0.1 and 0.6, respectively. Copyright 1989 by Scottish Economic Society.

Asset Substitution, Money Demand, and the Inflation Process in Brazil

Various domestic financial assets in Brazil have provided relatively liquid nonmonetary alternatives. Monthly money demand estimates, which include domestic asset opportunity costs and take account of T-bill repurchase agreements in a dynamic error-correction model, demonstrate the importance of domestic substitutes in explaining money holdings. Money demand appears responsive and stable. Moreover, T-bills and indexed bonds have acted as an alternative to central bank liabilities as a source of finance for government deficits. Evidence indicates that the initial financing of government deficits through bonds, bills, and other nonmonetary liabilities may explain why money lags price shocks rather than vice versa. Copyright 1989 by Ohio State University Press.

An error-correction approach to money demand: The case of Sudan

An empirical analysis of money demand behavior in Sudan is presented, based on the dynamic error-correction model. A theoretical basis for the model is offered, which allows an explicit, parameterized division of effects into long-run influences, short-term adjustments, and proportional equilibrium conditions. We refute previous claims that income and price effects may be abnormally high in Sudan, in part by accounting for both foreign exchange and inflationary influences.