Constants do not stay constant because variables are varying

Rasmus Kattai ()

No 2007-01, Bank of Estonia Working Papers from Bank of Estonia

Abstract: This paper focuses on the dynamic properties of error correction models (ECM). It is shown that the absence of structural breaks in the cointegrating vector does not necessarily imply that also all parameters of the dynamic specification of the ECM are time invariant. In some cases, depending on the data generating process of regressors, the intercept has to be time varying in order to have the long run equilibrium of a dynamic model independent of the growth rates of the variables out of sample period, i.e. to satisfy the dynamic homogeneity condition. It is found to be common when estimating ECMs on macroeconomic time series of converging countries. Dynamic homogeneity can be achieved by imposing the state dependent dynamic homogeneity restriction on the intercept. Applying the restriction is illustrated by an empirical example using Estonian data on real wages and labour productivity

Keywords: dynamic homogeneity; error correction models; forecasting (search for similar items in EconPapers)
JEL-codes: C32 C51 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-for
Date: 2007-01-02, Revised 2007-01-02
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