Generalized Impulse Response Functions Research Articles

Currency Shocks and Dynamics of Trade Flows in the Euro Area: Evidence from Quarterly and Monthly Data

This work examines euro area's trade flows over the last two decades, taking jointly into account their long-run determinants and short-run dynamics. This framework builds on a reinterpretation of the long-run structural vector autoregressive approach, drawing from both economic theory and econometric analysis. Generalized impulse response functions are employed to assess the effects of a real exchange rate shock on the trade balance, using different model specifications and frequencies of data. The main findings are: i) euro-area's trade flows are determined in the long-run by non-price competitiveness factors; ii) short-run adjustments follow an S-pattern; iii) a real devaluation produces detrimental effects on the trade balance.

Re-examination of J-curve effect for Japan, Korea and Taiwan

This study uses the generalized impulse response function from the vector error correction (VEC) model to examine whether the J-curve effect exists for Japan, Korea, and Taiwan. Both bilateral (with the US) and aggregate (with the rest of the world) cases are considered. Special attention has been given to the number of lag orders and conintegration selection and the tests of exogeneity of foreign income and structural changes. The conventional J-curve phenomenon can only be observed in Japan’s aggregate trade case. In Korea and Taiwan, where most export to import ratio increases during the currency contract period, is consistent with the theory that both economies are small.

Purchasing power parity over two centuries: trends and nonlinearity

In two recent contributions Lothian and Taylor, and Cuddington and Liang, produced empirical evidence that annual data for the dollar-sterling real exchange rate spanning two centuries exhibited a non-linear deterministic trend. This trend could be proxying Harrod-Balassa-Samuelson effects. Lothian and Taylor showed that a linear stationary autoregressive mode, which embodied a cubic trend, implied much faster mean reversion of the real exchange rate to shocks than a model that excluded the trend. This article shows that both non-linearity and a deterministic trend can be allowed for in a theoretically appealing manner and that the fitted models provide a parsimonious explanation of both the dollar-sterling and franc-sterling real exchange rates over the two centuries of data. Generalized impulse response function analysis of the models demonstrates that the speed of adjustment to shocks can be even faster when trends are considered.

The Impacts of Foreign Capital and Price Discovery Process between Taiwan and Singapore Futures Contracts

This paper investigates the cross-market linkage between Singapore and Taiwan futures markets for the pre- and post-participation of qualified foreign institutional investors (QFIIs) in Taiwan futures' trading. We employ error correction model and generalized impulse response function to gauge the causal transmission patterns between the two markets. The two markets cointegrated after the participation of QFIIs in Taiwanese market, suggesting that QFIIs play an important role between the two markets. We also find that Singapore futures market performs the price discovery of Taiwan stock index futures.

Credit Market Imperfections and Business Cycle Dynamics: A Nonlinear Approach

Linear Vector Autoregression (VAR) models provide a useful starting point for analysing multivariate relationships between economic variables. They are frequently used for empirical macroeconomic modelling, policy analysis and forecasting. However, linear VAR systems fail to capture non-linear dynamics such as regime switching and asymmetric responses to shocks, suggested by the recent theoretical developments in macroeconomic research. In addition, an increasing body of empirical evidence suggests that the linear conditional expectations implied by standard VAR models do not always accord with the observed facts. For example, a significant number of empirical studies document asymmetries in the effects of monetary policy on output growth. This paper employs a more general nonlinear VAR methodology to re-examine previous findings that credit market conditions contribute to economic fluctuations as a propagator of shocks. Unlike linear projections it allows for nonlinear dynamics and asymmetric effects of shocks. We estimate a threshold vector autoregression (TVAR), in which the system's dynamics change back and forth between credit constrained and unconstrained regimes. Using generalised impulse response functions (GIRF) generated from the estimated nonlinear model, we examine the real effects of monetary policy. We find evidence of asymmetry in the effects of monetary policy in the credit constrained and unconstrained regimes as well as different output effects of monetary contractions and expansions.

Impulse responses in a threshold cointegrated system: the case of natural gas markets

The response of a futures contract to an exogenous shock may partially depend upon the maturity of the contract. Investigation of the speed with which the contract returns to its long run equilibrium is dependent upon the time series specification of the contract. This paper estimates generalized impulse response functions that result from exogenous shocks to a threshold error correction model of the natural gas futures market. The estimation results of the threshold model indicate that it is an appropriate model of the natural gas futures market. Therefore the calculation of impulse responses should account for both the size of the shock and the history of the series. This is accomplished via a generalized impulse response function. Calculation of the generalized impulse response functions indicates that the length of the futures contract is an important determinant of the ability of the system to return to its long run equilibrium following a shock.

The net barter terms of trade: A smooth transition approach

AbstractThis paper analyses the net barter terms of trade measured by the primary commodity price index relative to the indexes of unit values of export of manufactures from industrial countries. The starting point is that the series is stationary but possibly non‐linear. Statistical tests indicate that the logarithmed series is non‐linear and we estimate a Smooth Transition Autoregressive model to describe the process. The dynamics of the model are illustrated by use of parametrically estimated local spectra and generalized impulse response functions. Our model encompasses models from several previous studies, and our conclusion is that the starting point very much decides the outcome. Copyright © 2003 John Wiley & Sons, Ltd.

Is the J-Curve Effect Observable for Small North European Economies?

The present study tests for the J-curve for five North European countries—Belgium, Denmark, The Netherlands, Norway, and Sweden—using generalized impulse response functions. The results provide empirical support for the J-curve. Each country has an impulse response function generated from a vector error-correction model that suggests that after a depreciation, there will be a dip in the export-import ratio within the first half-year after the depreciation. The long-run export-import ratio appears to be higher than the low point of this early dip in almost all cases. Also, in most cases, the export-import ratio appears in many periods after the depreciation to be converging from below to a higher long-run equilibrium.

Wages and prices in the UK

This paper investigates the relationship between wages and prices in the UK using a VECM formulation and generalized impulse response functions and persistence profiles. Because of significant feedbacks, it finds that fluctuations in wage growth cannot be used directly to predict fluctuations in inflation.

Forecasting the US unemployment rate

The primary interest is in out-of-sample forecasting of the US monthly unemployment rate. Several linear unobserved components models are fitted and their comparative forecasting accuracy is assessed by means of an extensive rolling-origin procedure using a test period that covers the last two decades. An attempt is made to link forecasting performance to the time domain properties of the models and the evidence is that highly persistent models perform better. Deletion diagnostics and normality tests, along with documenting possible departures from linearity and Gaussianity attributable to business cycle and turning point asymmetries, foster the conclusion that these are mostly concentrated in the pre-forecast period (1948–1980). A search is made for plausible nonlinear extensions capable of accounting for dynamic asymmetries in unemployment rates, leading to the specification of a cyclical trend model with smooth transition in the underlying parameters that improves forecast accuracy at short lead times and at the end of the sample period; as expected, though significant, the gains are not exceptionally large. The generalised impulse response function casts some light on the interpretation of the results. In particular, the main evidence is that persistence is not a stable feature over the business cycle.

Cyclical fluctuations in Brazil's real exchange rate: the role of domestic and external factors (1988-95)

This paper examines the behavoir of capital inflows and the real exchange rate in Brazil during the period 1988-95. The first part describes the analytical framework. The second part estimates (using monthly data) a near-VAR linking capital flows, changes in domestic and foreign nominal interest rates, changes in the expected depreciation rate, the government spending-output ratio, and changes in the real exchange rate. Generalized variance decompositions indicate that world interest rate shocks explain only a fraction of medium-term fluctuations in capital flows, whereas fluctuations in the real exchange rate are driven mostly by its own innovations. Generalized impulse response functions show that a reduction in the world interest rate leads on impact to a fall in domestic interest rates, a reduction in the rate of nominal exchange rate appreciation, a capital inflow, and a depreciation of the real exchange rate.

Structural Vector Autoregressive Models and Monetary Policy Analysis

In this paper, the structural vector autoregressive (SVAR) model is used to analyze short-run and contemporaneous relationships between monetary aggregates and other macroeconomic variables. This requires imposing restrictions on the correlation structure of the VAR residuals. Different approaches can be followed to serve this task. One approach is to use the Cholesky decomposition together with the assumption of a recursive structure of the contemporaneous relationships between the variables. Another approach uses the information given by the history of the variables (generalized impulse response functions). A third possibility is to adopt restrictions from economic theory. The purpose of this paper is to investigate the implications of the latter technique in a simple monetary framework for both Germany and the Euro area. VAR/VECM residuals are interpreted as deviations of the variables from their conditional expected values, which are also analyzed in a broad set of theoretical monetary models. The model used here builds upon the framework proposed by McCallum (1989) with an extension in order to consider the role of private banks in the money supply process. The implications of this model for impulse response analysis are discussed, and impulse responses for different models are calculated and compared to each other.

The Differential Effects of Output Shocks on Unemployment Rates by Race and Gender

1. Introduction The issues of unemployment and output are central to many macroeconomic policy debates. A major source of disagreement among policymakers deals with the maximum sustainable level of output growth that is consistent with the absence of inflation. When the economy's rate of output growth exceeds the maximum sustainable rate, there will be upward pressure on the economy's overall price level. Traditional macroeconomic theory emphasizes the role that tight labor markets play in this inflationary pressure. The commonly held belief is that, in a tight labor market, firms must bid workers away from other firms if they wish to expand the size of their workforce. Hence, labor costs in the economy will tend to rise. Since labor is a major input in the production of virtually all goods and services, an increase in labor costs without an accompanying increase in productivity will tend to increase the economy's overall price level. Conversely, when the economy contracts, labor costs in the economy will tend to fall, inducing a downward movement in the economy's overall price level. The labor market is therefore linked to changes in economic activity and to changes in the economy's price level. A common feature in many macroeconomic models is the connection between departures from the equilibrium rate of unemployment (i.e., the natural or normal rate) and the business cycle. These macroeconomic models suggest that unanticipated departures from a steady state in the output market should be related to departures of the actual unemployment rate from the normal rate. However, the economy's aggregate unemployment rate is actually a weighted average of the unemployment rates of various demographic groups. The rate of each demographic group is influenced by that group's flows into and out of unemployment. Since many of the factors that determine these flows have been found to differ by demographic group, it is expected that a given aggregate output shock may have differential effects on the unemployment rates of various groups. This article focuses on how unanticipated changes in real output affect the unemployment rate of different demographic groups. We examine the time-series behavior of black male, white male, black female, and white female monthly unemployment rates over the January 1972August 1999 period. Specifically, we estimate a vector autoregression (VAR) and then conduct simulations in the form of impulse responses to determine the extent to which each of these unemployment rates is affected by an aggregate output shock (i.e., an unanticipated change in aggregate output). We compare and contrast the magnitude and the persistence of these responses across the groups. Because the traditional impulse response function generated from a VAR is sensitive to how the researcher chooses to order the variables, with different orderings often giving vastly different results, we employ the recently developed generalized impulse response function (Koop, Pesaran, and Potter 1996; Pesaran and Shin 1998). This technique allows researchers to examine impulse responses that are robust to changes in ordering. In the following sections, we highlight the major literature that this article builds upon and then we discuss the basics behind the nature of the relationship between the unemployment rate and output. A discussion of the data, the methodology, and the results follows. The article closes with concluding remarks and policy implications. 2. Related Literature A number of studies have examined racial differences in unemployment rates and in factors that may affect unemployment rates. Using data on displaced workers, Fairlie and Kletzer (1998) examine racial differences in job displacement over the years 1984-1992 and find that black males experienced greater rates of job displacement and lower rates of reemployment than white males. Petterson (1998) uses data from the National Longitudinal Survey of Youth for the 19791986 period to examine the reservation wages of black males compared with those of white males and, contrary to earlier research, argues that these differences do not explain much (if any) of the racial employment gap. …

Do reductions in black market exchange rate premia cause inflation?

Unification of the black and official exchange rates and increasing the rate of crawl of the official rate are the competing prescriptions to reduce inefficiencies caused by the black market premia. Pinto (1991) showed that the removal of implicit export taxes could force governments to raise inflation to finance their budget deficit. Park (1995) and Morris (1995) demonstrated that unification need not raise the steady-state level of inflation. In this paper, we investigate the inflation-black market exchange rate premium relationship using time series techniques for Argentina, Peru and Zambia. The empirical evidence from Argentina and Peru tends to support Park and Morris' post-unification low inflation scenario. In contrast, the generalized impulse response functions derived from Zambia's cointegrating VAR support Pinto's result since a temporary positive shock to the black market premium cause a permanent reduction in inflation. However, stability tests suggest that the relationships embodied in the cointegrated system of Zambia are unstable.

Real exchange rate effects on the balance of trade: cointegration and the Marshall–Lerner condition

AbstractA typical finding in the empirical literature is that import and export demand elasticities are rather low, and that the Marshall–Lerner (ML) condition does not hold. However, despite the evidence against the ML condition, the consensus is that real devaluations do improve the balance of trade, though after a lag because of J‐curve effects. The aim of this paper is to try and measure the effects of the real exchange rate on the balance of payments using structural cointegrating vector autoregressive distributed lag (VARDL) models for domestic and foreign output, the balance of trade and the real exchange rate. Small systems are estimated for eight OECD countries to investigate long‐run cointegration. Generalized impulse response functions are calculated to investigate the response to shocks. These show evidence of J‐effects. The VARDL estimates suggest a single cointegrating vector and that output and the real exchange rate can be treated as weakly exogenous for the parameters of the balance of payment equation. This allows estimation using a single‐equation ARDL. Although there is considerable heterogeneity, overall the results suggest that the ML condition is satisfied in the long run. Copyright © 2001 John Wiley & Sons, Ltd.

A nonlinear time series model of El Niño

A smooth transition autoregressive model is estimated for the Southern Oscillation Index, an index commonly used as a measure of El Niño events. Using standard measures there is no indication of nonstationarity in the index. A logistic smooth transition autoregressive model describes the most turbulent periods in the data (these correspond to El Niño events) better than a linear autoregressive model. The estimated nonlinear model passes a battery of diagnostic tests. A generalised impulse response function indicates local instability, but as deterministic extrapolation from the estimated model converges, the nonlinear model may still be useful for forecasting the El Niño Southern Oscillation a few months ahead.

Evaluating forecasts from SETAR models of exchange rates

We consider the forecasting performance of two SETAR exchange rate models proposed by Kräger and Kugler [J. Int. Money Fin. 12 (1993) 195]. Assuming that the models are good approximations to the data generating process, we show that whether the non-linearities inherent in the data can be exploited to forecast better than a random walk depends on both how forecast accuracy is assessed and on the ‘state of nature’. Evaluation based on traditional measures, such as (root) mean squared forecast errors, may mask the superiority of the non-linear models. Generalized impulse response functions are also calculated as a means of portraying the asymmetric response to shocks implied by such models.

Nonparametric estimation of generalized impulse response function

A local linear estimator of generalized impulse response (GIR) functions for nonlinear conditional heteroskedastic autoregressive processes is derived and shown to be asymptotically normal. A plug-in bandwidth is obtained that minimizes the asymptotical mean squared error of the GIR estimator. A local linear estimator for the conditional variance function is proposed which has simpler bias than the standard estimator. This is achieved by appropriately eliminating the conditional mean. Alternatively to the direct local linear estimators of the k-step prediction functions which enter the GIR estimator the use of multi-stage prediction techniques is suggested. Simulation experiments show the latter estimator to perform best. For quarterly data of the West German real GNP it is found that the size of generalized impulse response functions varies across different histories , a feature which cannot be captured by linear models.

SETS, arbitrage activity, and stock price dynamics

This paper provides an empirical description of the relationship between the trading system operated by a stock exchange and the trading behaviour of heterogeneous investors who use the exchange. The recent introduction of SETS in the London Stock Exchange provides an excellent opportunity to study the impact of an electronic trading system upon traders who use the exchange. Using the cost-of-carry model of futures prices we estimate (non-linearly) the transaction costs and trade speeds faced by arbitragers who take advantage of mispricing of FTSE100 futures contracts relative to the spot prices of the stocks that make up the FTSE100 stock index. We divide the sample period into pre-SETS and post-SETS sample periods and conduct a comparative study of arbitrager behaviour under different trading systems. The results indicate that there has been a significant reduction in the level of transaction costs faced by arbitragers and in the degree of transaction cost heterogeneity. Finally, generalised impulse response functions show that both spot and futures prices adjust more quickly in the post-SETS period. These results suggest that both spot and futures markets have become more efficient under SETS.

Nonlinear impulse response functions

The standard linear technique of impulse response function analysis is extended to the nonlinear case by defining a generalized impulse response function. Measures of persistence and asymmetry in response are constructed for a wide class of time series.