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On Error Correction Models: Specification, Interpretation, Estimation

George Alogoskoufis () and Ronald Smith ()

Journal of Economic Surveys, 1991, vol. 5, issue 1, 97-128

Abstract: Error Correction Models (ECMs) have proved a popular organizing principle in applied econometrics, despite the lack of consensus as to exactly what constitutes their defining characteristic, and the rather limited role that has been given to economic theory by their proponents. This paper uses a historical survey of the evolution of ECMs to explain the alternative specifications and interpretations and proceeds to examine their implications for estimation. The various approaches are illustrated for wage equations by application to U.K. labor market data 1855-1987. We demonstrate that error correction models impose strong and testable nonlinear restrictions on dynamic econometric equations, and that they do not obviate the need for modeling the process of expectations formation. With the exception of a few special cases, both the nonlinear restrictions and the modeling of expectations have been ignored by those who have treated ECMs as merely reparameterizations of dynamic linear regression models or vector autoregressions. Copyright 1991 by Blackwell Publishers Ltd

Date: 1991
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