Any research or policy analysis exercise in economics must be consistent with the time-series properties of observed macroeconomic data. This paper discusses in detail the specification of a six-variable vector error-correction forecasting model. We test for cointegration among those variables: the CPI, the implicit price deflator for GDP, real money balances (M1), the federal funds rate, the yield on long-term (10-year) government bonds, and real GDP. We also examine the estimated dynamic parameters of the vector error correction structure, and analyze the properties of the model residuals in detail; discuss the forecasting performance of the model with particular reference to the 1990-91 recession and the 1994-95 expansion; compare alternative permanent/transitory decompositions of the data series that are implied by the estimated parameters of the model; discuss the role of weak exogeneity in our estimated structure, and the identifying restrictions that are sufficient to determine a 'historical policy rule' within the sample; discuss the conditions required for identification of 'dynamic economic models' from the reduced form VECM structure and apply one set of exactly identifying restrictions to derive impulse response functions for a permanent nominal shock and a permanent real shock; and, report some ex-ante forecasts from recent history.
https://doi.org/10.20955/wp.1997.008
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