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Mr. Corker was a member of the Asian Department when this paper was prepared. Both authors are grateful to Jorge R. Marquez-Ruarte for helpful comments.
See Hallman et al (1989). These authors attribute Federal Reserve Chairman Alan Greenspan with motivating the research into P* for the United States (op cit, page 1).
Hallman et al justify the inflation equation as a model of economic behavior based upon an inflation expectations mechanism in much the same vein as a Phillips curve, although Pecchenino and Rasche (1990) are somewhat critical of this interpretation.
See Bordo and Jonung (1987) for an analysis of long-run velocity trends in several countries. Their analysis finds clear evidence of cycles in velocity which appear related to institutional factors.
That is, LjZt = Zt-1 and ΔZt = Zt - Zt-1.
M3 is defined as M2 (currency in circulation and deposits at monetary institutions, including foreign currency deposits) plus deposits at other financial institutions, debentures, commercial bill, CDs and repurchase agreements.
The data used in this, and the following sections, is described in the data annex.
Cointegration-regression Durbin Watson (CRDW), Dickey-Fuller (DF) and augmented Dickey-Fuller (ADF) tests on the residuals of the regression of log(money) on log(income). Approximate 5 percent significance levels in parentheses taken from Engle and Yoo (1987).
Whether it is reasonable to believe that money demand can be identified, given a history of credit controls that may have rationed demand, is an issue that is not addressed here.
This definition assumes, among other things, that all demand deposits are non-interest bearing.
OLS is a consistent estimator if money, income, and interest rates are cointegrated (Engle and Granger, 1987).
Individually, Ra was not statistically significant, but was included in the restricted form shown for theoretical reasons. As shown below, its inclusion makes little contribution to developments in velocity during the sample period.
Granger and Engle (1987) show that the power of the cointegration tests is low and are biased against accepting cointegration if the residuals of the cointegrating regression lie close to the unit circle.
This equation is included for completeness, although it is, strictly speaking, not important for the construction, later, of V* and P*. The statistics AUTO(5) and FORE(16) are, respectively, tests for fifth-order autocorrelation (Godfrey (1978)) and parameter stability in the last 16 periods of the data sample (Hendry (1980)). Both are distributed as Chi-squared: critical 95 percent significance levels are shown in parentheses.
The assumption affects the measured size of the output gap in 1979-80 and, therefore, the price gap. However, the results in the next section concerning the usefulness of the price gap are not very sensitive to the chosen phasing of the decline in potential output.
This result was also found by Hallman et al for the United States.