IDEAS home Printed from https://ideas.repec.org/a/pid/journl/v54y2015i2p123-145.html
   My bibliography  Save this article

Re-estimation of Keynesian Model by Considering Critical Events and Multiple Cointegrating Vectors

Author

Listed:
  • Hafsa Hina

    (Pakistan Institute of Development Economics (PIDE), Islamabad.)

  • Abdul Qayyum

    (Pakistan Institute of Development Economics (PIDE), Islamabad.)

Abstract

This study employs the Mundell (1963) and Fleming (1962) traditional flow model of exchange rate to examine the long run behaviour of rupee/US $ exchange rate for Pakistan economy over the period 1982:Q1 to 2010:Q2. This study investigates the effect of output levels, interest rates and prices and different shocks on exchange rate. Hylleberg, Engle, Granger, and Yoo (HEGY) (1990) unit root test confirms the presence of non-seasonal unit root and finds no evidence of biannual and annual frequency unit root in the level of series. Johansen and Juselious (1988, 1992) likelihood ratio test indicates three long-run cointegrating vectors. Cointegrating vectors are uniquely identified by imposing structural economic restrictions on purchasing power parity (PPP), uncovered interest parity (UIP) and current account balance. Finally, the short-run dynamic error correction model is estimated on the basis of identified cointegrated vectors. The speed of adjustment coefficient indicates that 17 percent of divergence from long-run equilibrium exchange rate path is being corrected in each quarter. US war with Afghanistan has significant impact on rupee in short run because of high inflows of US aid to Pakistan after 9/11. Finally, the parsimonious short run dynamic error correction model is able to beat the naïve random walk model at out of sample forecasting horizons.

Suggested Citation

  • Hafsa Hina & Abdul Qayyum, 2015. "Re-estimation of Keynesian Model by Considering Critical Events and Multiple Cointegrating Vectors," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 54(2), pages 123-145.
  • Handle: RePEc:pid:journl:v:54:y:2015:i:2:p:123-145
    as

    Download full text from publisher

    File URL: http://www.pide.org.pk/pdf/PDR/2015/Volume2/123-145.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Roman Frydman & Michael D. Goldberg, 2001. "Macroeconomic Fundamentals and the DM/$ Exchange Rate: Temporal Instability and the Monetary Model," Working Papers 50, Oesterreichische Nationalbank (Austrian Central Bank).
    2. Najand, Mohammad & Bond, Charlotte, 2000. "Structural models of exchange rate determination," Journal of Multinational Financial Management, Elsevier, vol. 10(1), pages 15-27, January.
    3. Razzaque H. Bhatti, 1996. "A Correct Test of Purchasing Power Parity: The Case of Pak-Rupee Exchange Rates," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 35(4), pages 671-682.
    4. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
    5. Hylleberg, S. & Engle, R. F. & Granger, C. W. J. & Yoo, B. S., 1990. "Seasonal integration and cointegration," Journal of Econometrics, Elsevier, vol. 44(1-2), pages 215-238.
    6. Goldberg, Michael D & Frydman, Roman, 2001. "Macroeconomic Fundamentals and the DM/$ Exchange Rate: Temporal Instability and the Monetary Model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 6(4), pages 421-435, October.
    7. Afia Malik, 2008. "Crude Oil Price, Monetary Policy and Output: The Case of Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 47(4), pages 425-436.
    8. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-144, January.
    9. Diamandis, Panayiotis F. & Georgoutsos, Dimitris A. & Kouretas, Georgios P., 1998. "The Monetary Approach to the Exchange Rate: Long-Run Relationships, Identification and Temporal Stability," Journal of Macroeconomics, Elsevier, vol. 20(4), pages 741-766, October.
    10. Jae-Kwang Hwang, 2001. "Dynamic forecasting of monetary exchange rate models: Evidence from cointegration," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 7(1), pages 51-64, February.
    11. Robert A. Mundell, 1962. "The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability," IMF Staff Papers, Palgrave Macmillan, vol. 9(1), pages 70-79, March.
    12. repec:kap:iaecre:v:7:y:2001:i:1:p:51-64 is not listed on IDEAS
    13. Alan M. Taylor & Mark P. Taylor, 2004. "The Purchasing Power Parity Debate," Journal of Economic Perspectives, American Economic Association, vol. 18(4), pages 135-158, Fall.
    14. Rodolfo Helg & Massimiliano Serati, "undated". "Does the PPP need the UIP?," Working Papers 97, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    15. Cheung, Yin-Wong & Chinn, Menzie D. & Pascual, Antonio Garcia, 2005. "Empirical exchange rate models of the nineties: Are any fit to survive?," Journal of International Money and Finance, Elsevier, vol. 24(7), pages 1150-1175, November.
    16. Serletis, Apostolos & King, Martin, 1997. "Common Stochastic Trends and Convergence of European Union Stock Markets," The Manchester School of Economic & Social Studies, University of Manchester, vol. 65(1), pages 44-57, January.
    17. Balke, Nathan S & Fomby, Thomas B, 1994. "Large Shocks, Small Shocks, and Economic Fluctuations: Outliers in Macroeconomic Time Series," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 9(2), pages 181-200, April-Jun.
    18. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
    19. Kirstin Hubrich & Helmut Lutkepohl & Pentti Saikkonen, 2001. "A Review Of Systems Cointegration Tests," Econometric Reviews, Taylor & Francis Journals, vol. 20(3), pages 247-318.
    20. Abdul Qayyum, 2005. "Modelling the Demand for Money in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 44(3), pages 233-252.
    21. Razzaque Bhatti & Imad Moosa, 1994. "A new approach to testing ex ante purchasing power parity," Applied Economics Letters, Taylor & Francis Journals, vol. 1(9), pages 148-151.
    22. Davidson, James, 1998. "Structural relations, cointegration and identification: some simple results and their application," Journal of Econometrics, Elsevier, vol. 87(1), pages 87-113, August.
    23. Kasa, Kenneth, 1992. "Common stochastic trends in international stock markets," Journal of Monetary Economics, Elsevier, vol. 29(1), pages 95-124, February.
    24. Gylfason, Thorvaldur & Helliwell, John F, 1983. "A Synthesis of Keynesian, Monetary, and Portfolio Approaches to Flexible Exchange Rates," Economic Journal, Royal Economic Society, vol. 93(372), pages 820-831, December.
    25. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-328, August.
    26. Hendry, David F., 1995. "Dynamic Econometrics," OUP Catalogue, Oxford University Press, number 9780198283164.
    27. MacDonald, Ronald, 1993. "Long-Run Purchasing Power Parity: Is It for Real?," The Review of Economics and Statistics, MIT Press, vol. 75(4), pages 690-695, November.
    28. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-1580, November.
    29. Gonzalo, Jesus, 1994. "Five alternative methods of estimating long-run equilibrium relationships," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 203-233.
    30. Levent KORAP, 2008. "Exchange Rate Determination Of Tl/Us$:A Co-Integration Approach," Istanbul University Econometrics and Statistics e-Journal, Department of Econometrics, Faculty of Economics, Istanbul University, vol. 7(1), pages 24-50, May.
    31. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    32. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
    33. George Tweneboah, 2009. "Relevance of Financial Markets for Exchange Rate Modeling in Ghana," The IUP Journal of Financial Economics, IUP Publications, vol. 0(3 & 4), pages 24-36, September.
    34. Muhammad Arshad Khan & Abdul Qayyum, 2008. "Long-Run and Short-Run Dynamics of the Exchange Rate in Pakistan: Evidence FromUnrestricted Purchasing Power Parity Theory," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 13(1), pages 29-56, Jan-Jun.
    35. Razzaque H. Bhatti, 1997. "Do Expectations Play Any Role in Determining Pak Rupee Exchange Rates?," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 36(3), pages 263-273.
    36. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-218, March.
    37. Razzaque H. Bhatti, 2001. "Determining Pak Rupee Exchange Rates vis-à-vis Six Currencies of the Industrial World: Some Evidence Based on the Traditional Flow Model," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 40(4), pages 885-897.
    38. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Exchange Rate Determination; Keynesian Model Out of Sample Forecasting; Random Walk Model;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pid:journl:v:54:y:2015:i:2:p:123-145. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Khurram Iqbal). General contact details of provider: http://edirc.repec.org/data/pideipk.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.