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Testing the Nominal-to-Real Transformation

Author

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  • Hans Christian Kongsted

    (Institute of Economics, University of Copenhagen)

Abstract

Nominal-to-real data transformations are routinely used in empirical work. A common example is the transformation of nominal money and prices to real money and the rate of inflation. This paper establishes the necessary and sufficient condition for a transformation to reduce the order of integration of an I(2) vector process while retaining the cointegrating relations among the variables. A particular direction in which the condition potentially fails is often treated by assumption in applied work. In this case, the transformed process satisfies a well-specified vector equilibrium model, yet I(1) inference and interpretation based on the real transformed system is invalidated. An easy-to-implement sequential test of the transformation based on I(1) cointegration methods is suggested. It demonstrates good size and power properties in a small-scale simulation experiment. An empirical example illustrates the need to test the nominal-to-real transformation.

Suggested Citation

  • Hans Christian Kongsted, 2002. "Testing the Nominal-to-Real Transformation," Discussion Papers 02-06, University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:kuiedp:0206
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    Cited by:

    1. Omtzigt, Pieter & Paruolo, Paolo, 2005. "Impact factors," Journal of Econometrics, Elsevier, vol. 128(1), pages 31-68, September.
    2. Oliver Holtemöller, 2004. "A monetary vector error correction model of the Euro area and implications for monetary policy," Empirical Economics, Springer, vol. 29(3), pages 553-574, September.
    3. Fabrizio CORICELLI & Bostjan JAZBEC & Igor MASTEN, 2004. "Exchange Rate Pass-Through in Acceding Countries: The Role of Exchange Rate Regimes," Economics Working Papers ECO2004/16, European University Institute.
    4. Fabrizio Coricelli & Bostjan Jazbec & Igor Masten, 2004. "Linfluence du régime de change sur linflation dans les pays adhérents," Économie et Prévision, Programme National Persée, vol. 163(2), pages 51-61.
    5. Coricelli, Fabrizio & Jazbec, Bostjan & Masten, Igor, 2003. "Exchange Rate Pass-Through in Candidate Countries," CEPR Discussion Papers 3894, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    cointegration; stochastic trend; I(2); price homogeneity; Monto Carlo experiment;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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