Canadian Money Demand Functions Cointegration¨CRank Stability

This paper applies conventional tests (Johansen, 1995) and new tests (Chao and Phillips, 1999) for cointegration to long¨Crun money demand functions using historical Canadian data back to 1872. If cointegration is found, recently proposed tests by Quintos (1998a) for stability of the cointegration rank are carried out. The paper focuses on two spans of data: one span starting in 1872, the other in 1957 or 1968. Annual data are used for the former span, and annual and quarterly data for the latter. The preferred money demand specification involves M1.Vector error-correction; unknown change points; long spans of monetary data

A Closer Look at Long Run Money Demand

We study annual United States data from 1869 or 1900 to 1999. We find evidence for a well-specified and stable model of money demand with data from 1946 to 1999. We carry out diagnostic and stability tests, including nonlinearity tests. A linear cointegration model with the monetary base performs better than a model with M1. A specification with M2 is not supported. We use real GNP as the scale variable and a short term interest rate as the opportunity cost measure. We estimate an income elasticity of .86 and an interest rate elasticity of -.44 for the monetary base.

Unit Roots, Nonlinear Cointegration and Purchasing Power Parity

We test long¨Crun PPP within a general model of cointegration of linear and nonlinear form. Nonlinear cointegration is tested with rank tests proposed by Breitung (2001). We start with determining the order of integration of each variable in the model, applying relatively powerful DF¨CGLS tests of Elliott, Rothenberg and Stock (1996). Using monthly data from the post¨CBretton Woods era for G¨C10 countries, the evidence leads to a rejection of PPP for almost all countries. In several cases the price variables are driven by permanent shocks that differ from the ones that drive the exchange rate. Also, nonlinear cointegration cannot solve the PPP puzzle.Purchasing power parity; unit roots; nonlinear cointegration

Longer-term effects of monetary growth on real and nominal variables, major industrial countries, 1880-2001

Abstract: We study how fluctuations in money growth correlate with fluctuations in real and nominal output growth and inflation. We pick cycles from each time series that last 2 to 8 (business cycles) and 8 to 40 (longer-term cycles) years, using band-pass filters. We employ a data set from 1880 to 2001 for eleven countries, without gaps. Fluctuations in money growth do not play a systematic and important role at the business cycle frequency. However, money growth leads or contemporaneously affects nominal output growth and inflation in the longer run. This result holds despite differences in policies and institutions across countries. JEL Classification: E32 to 8 year cycles, 8 to 40 year cycles, Band-pass filters

Empirical evidence on inflation and unemployment in the long run

We examine the relationship between inflation and unemployment in the long run, using quarterly US data from 1952 to 2010. Using a band-pass filter approach, we find strong evidence that a positive relationship exists, where inflation leads unemployment by some 3 to 3 1/2 years, in cycles that last from 8 to 25 or 50 years. Our statistical approach is atheoretical in nature, but provides evidence in accordance with the predictions of Friedman (1977) and the recent New Monetarist model of Berentsen, Menzio, and Wright (2011): the relationship between inflation and unemployment is positive in the long run.Inflation, Unemployment, Long-Run Phillips Curve

The Term Spread International Evidence of Non-Linear Adjustment

This study tests whether changes in the short-term interest rate can best be modelled in a nonlinear fashion. We argue that there are good theoretical and empirical reasons for adopting this strategy. Using monthly data from several industrialized countries, namely Canada, Germany, Sweden, Switzerland, UK, and US, we show that the short-term interest rate movements are better explained, usually via the exponential smooth transition autoregression (ESTR). Unlike the existing literature on non-linear estimation, we consider a number of candidates for the transition variable. These include: an error correction term, estimated from an underlying cointegrating relationship predicted by the expectations hypothesis, the US spread, the domestic spread, inflation and output growth forecasts, and deviations from an inflation target in the case of Canada, the UK and Sweden. The sample spans the period from 1960-1998. We cannot reject non-linearity in the behavior of interest rate changes most often when the (lagged) domestic spread serves as the transition variable. In the case of the inflation targeting countries in our sample, the most appropriate transition variable can be the deviation from the publicly announced inflation target. We supplement estimates with extensive diagnostic testing to ensure that we can reject the linear alternative with reasonable confidence. We believe that changes in central bank policies and in the reaction of market participants over time to such changes argue in favor of the non-linear estimation approach. We would also argue that any model of the term spread over a fairly long span of time necessitates resort to non-linear estimation methods.

Monetary policy transmission mechanisms and currency unions A vector error correction approach to a Trans-Tasman currency union

Differences in transmission mechanisms can generate asymmetric behaviour among currency union partners when they experience shocks. This has the potential to widen existing cyclical variation between members of a currency union. Our analysis suggests that the transmission mechanisms of GDP and the CPI of a monetary shock appear to be similar in Australia and New Zealand. However, there are differences in terms of the size of the responses of some variables to identical monetary policy shocks. In a currency union with a different exchange rate pattern and with different monetary policy shocks, New Zealand may experience some new challenges.Impulse responses; vector error correction; monetary transmission mechanism

Oil prices, exchange rates and emerging stock markets

While two different streams of literature exist investigating 1) the relationship between oil prices and emerging market stock prices and 2) the relationship between oil prices and exchange rates, relatively little is known about the dynamic relationship between oil prices, exchange rates and emerging market stock prices. This paper proposes and estimates a structural vector autoregression model to investigate the dynamic relationship between these variables. Impulse responses are calculated in two ways (standard and projection based methods). The model supports stylized facts. In particular, positive shocks to oil prices tend to depress emerging market stock prices and US dollar exchange rates in the short run. The model also captures stylized facts regarding movements in oil prices. A positive oil production shock lowers oil prices while a positive shock to real economic activity increases oil prices. There is also evidence that increases in emerging market stock prices increases oil prices.Emerging market stock prices; oil prices; exchange rates

Structural breaks, cointegration and the Fisher effect

There is scant empirical support in the literature for the Fisher effect in the long run, though it is often assumed in theoretical models. We argue that a break in the cointegrating relation introduces a spurious unit root that leads to a rejection of cointegration. We applied new break tests and tested for nonlinearity in the cointegrating relation with post-war data for 15 countries. Our empirical results support cointegration, after accounting for breaks, and a linear Fisher relation in the long run. This is in contrast to several recent studies that found no support for linear cointegration. JEL Classification: E43, C32Fisher effect, linear and nonlinear cointegration, Structural change

A New Test of Ricardian Equivalence Using the Narrative Record on Tax Changes

This paper empirically tests the Ricardian equivalence hypothesis with a narrative measure of tax shocks. The present value, at the time of legislation, of tax increases motivated solely by concerns for improving the fiscal health of the government is used for the tests. These tax news represent a switch from debt to tax financing that should have no effects on the economy if Ricardian equivalence holds as a good approximation. For the post-1980:IV period, I find evidence for fiscal anticipation as many of the tax increases are implemented with substantial delays and distortionary taxes increase economic activity before taxes go up, which iscaused by intertemporal substitution. Therefore, Ricardian equivalence is rejected