Interpreting an error correction model: Partial adjustment, forward‐looking behaviour, and dynamic international money demand

Ian H. Domowitz · Craig S. Hakkio

33 citations0/0 files storedJournal of Applied Econometrics

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Monetary Policy and Economic Impact Economic Theory and Policy Economic theories and models

Abstract

Abstract An error correction model is derived from a stochastic dynamic programming problem incorporating rational expectations. A parametric restriction is derived that allows a test for the theoretical proposition that the optimal strategy behind the error correction from entails the failure to asymptotically close the gap between the choice variable and the growing target. This is accomplished by nesting a partial adjustment model with forward‐looking expectations within the error correction paradigm. The counterintuitive behaviour embodied in the error correction model is not supported by the data in the context of a cross‐country comparison of cash balances relationships.

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References

1987Co-Integration and Error Correction: Representation, Estimation, and Testing 1982Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation 1978Specification Tests in Econometrics 1982Trends and random walks in macroeconmic time series 1952The Transactions Demand for Cash: An Inventory Theoretic Approach 1980Formulating and estimating dynamic linear rational expectations models 1973Rational Expectations, the Real Rate of Interest, and the Natural Rate of Unemployment 1982The Search for a Stable Money Demand Function: A Survey Of the Post-1973 Literature

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2003Monetary dynamics, exchange rates and parameter instability: an empirical investigation 2003Inflation-rate volatility and money demand: Evidence from less developed countries 1994The linear quadratic adjustment cost model and the demand for labour 1994In search for stability: An empirical appraisal of the demand for money in the G7 and EC countries 2012The Demand for Money in Asia: Some Further Evidence

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