Testing the Nominal-to-Real Transformation

Hans Christian Kongsted
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Hans Christian Kongsted: Institute of Economics, University of Copenhagen

No 02-06, Discussion Papers from University of Copenhagen. Department of Economics

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.

Keywords: cointegration; stochastic trend; I(2); price homogeneity; Monto Carlo experiment (search for similar items in EconPapers)
JEL-codes: C32 C51 C52 E41 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2002-03
New Economics Papers: this item is included in nep-ecm
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Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:kud:kuiedp:0206

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