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Beware of econometricians bearing estimates: Policy analysis in a “unit root” world

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  • Menzie David Chinn

    (Assistant Professor of Economics at the University of Califormia, Santa Cruz)

Abstract

Current statistical approaches to modeling many economic relationships are grounded in traditional ideas of deterministic trends. Some of the failures of these approaches are due to inappropriate models using time series with “unit roots.” After a shock, unit root processes do not revert to some time trend, but rather can drift up or down without bounds. A “random walk” is a well-known example of a unit root process. The purpose of this paper is to explain the importance of unit root processes to policy analysts who make or rely upon econometric models using time series dat. In particular, the presence of unit root processes in GNP, energy and electricity consumption exports, imports, and other variables suggests that modifications to the way economic relationships are estimated may be necessary. Once these modifications are made, many important parameters turn out to be much different, with substantive implications for both forecasting and policy.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Policy Analysis and Management.

Volume (Year): 10 (1991)
Issue (Month): 4 ()
Pages: 546-567

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Handle: RePEc:wly:jpamgt:v:10:y:1991:i:4:p:546-567

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Web page: http://www3.interscience.wiley.com/journal/34787/home

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  1. Boothe, Paul & Glassman, Debra, 1987. "Off the Mark: Lessons for Exchange Rate Modelling," Oxford Economic Papers, Oxford University Press, vol. 39(3), pages 443-57, September.
  2. Jeffrey A. Frankel & Richard Meese, 1987. "Are Exchange Rates Excessively Variable?," NBER Chapters, in: NBER Macroeconomics Annual 1987, Volume 2, pages 117-162 National Bureau of Economic Research, Inc.
  3. Banerjee, Anindya & Galbraith, John W & Dolado, Juan, 1990. "Dynamic Specification and Linear Transformations of the Autoregressive-Distributed Lag Model," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(1), pages 95-104, February.
  4. Meese, Richard & Geweke, John, 1984. "A Comparison of Autoregressive Univariate Forecasting Procedures for Macroeconomic Time Series," Journal of Business & Economic Statistics, American Statistical Association, vol. 2(3), pages 191-200, July.
  5. Campbell, John Y & Mankiw, N Gregory, 1987. "Are Output Fluctuations Transitory?," The Quarterly Journal of Economics, MIT Press, vol. 102(4), pages 857-80, November.
  6. Perron, P., 1986. "Trends and Random Walks in Macroeconomic Time Series: Further Evidence From a New Approach," Cahiers de recherche 8650, Universite de Montreal, Departement de sciences economiques.
  7. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  8. Baldwin, Richard, 1988. "Hyteresis in Import Prices: The Beachhead Effect," American Economic Review, American Economic Association, vol. 78(4), pages 773-85, September.
  9. Stephen K. McNees, 1988. "How accurate are macroeconomic forecasts?," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 15-36.
  10. Chinn, Menzie David, 1991. "Some linear and nonlinear thoughts on exchange rates," Journal of International Money and Finance, Elsevier, vol. 10(2), pages 214-230, June.
  11. William R. Melick, 1990. "Estimating pass-through: structure and stability," International Finance Discussion Papers 387, Board of Governors of the Federal Reserve System (U.S.).
  12. Sims, Christopher A & Stock, James H & Watson, Mark W, 1990. "Inference in Linear Time Series Models with Some Unit Roots," Econometrica, Econometric Society, vol. 58(1), pages 113-44, January.
  13. Nelson, Charles R & Kang, Heejoon, 1981. "Spurious Periodicity in Inappropriately Detrended Time Series," Econometrica, Econometric Society, vol. 49(3), pages 741-51, May.
  14. Hunt, Lester & Manning, Neil, 1989. "Energy Price- and Income-Elasticities of Demand: Some Estimates for the UK Using the Cointegration Procedure," Scottish Journal of Political Economy, Scottish Economic Society, vol. 36(2), pages 183-93, May.
  15. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  16. Paul R. Krugman, 1988. "Long-Run Effects of the Strong Dollar," NBER Chapters, in: Misalignment of Exchange Rates, pages 277-298 National Bureau of Economic Research, Inc.
  17. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  18. Kim, Yoonbai, 1990. "Exchange Rates and Import Prices in the United States: A Varying-Parameter Estimation of Exchange-Rate Pass-Through," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(3), pages 305-15, July.
  19. Jaime Marquez, 1988. "The dynamics of uncertainty or the uncertainty of dynamics: stochastic J-curves," International Finance Discussion Papers 335, Board of Governors of the Federal Reserve System (U.S.).
  20. Meese, Richard A & Rose, Andrew K, 1991. "An Empirical Assessment of Non-linearities in Models of Exchange Rate Determination," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 603-19, May.
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Cited by:
  1. Chinn, Menzie, 2002. "Incomes, Exchange Rates and the U.S. Trade Deficit, Once Again," Center for Global, International and Regional Studies, Working Paper Series qt0tc442fc, Center for Global, International and Regional Studies, UC Santa Cruz.

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