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We thank Larry Christiano, Martin Eichenbaum, Jesús Gonzalo, Jim Nason, Fabrizio Perri, Gabriel Rodríguez, and Barbara Rossi for very useful comments. NSF support is acknowledged. Pau Rabanal is an economist in the IMF Research Department. Juan Rubio-Ramirez is an associate professor in the Economics Department at Duke University. Vicente Tuesta is an economist in Deutsche Bank and a visiting professor at CENTRUM Católica..
Some early discussion of the Great Moderation can be found in Kim and Nelson (1999). A discussion of different interpretations for this phenomenon and some international evidence can be found in Stock and Watson (2002) and Stock and Watson (2005), respectively.
Interestingly, Baxter and Crucini (1995) estimate a VECM using TFP processes for the United States and Canada, but they dismiss this evidence when simulating their model.
The Φ(·) cost is introduced to ensure stationarity of the level of D(st) in IRBC models with incomplete markets, as discussed by Heathcote and Perri (2002). We choose the cost to be numerically small, so it does not affect the dynamics of the rest of the variables.
Here we restrict ourselves to a VECM with two lags. This assumption is motivated by the empirical results to be presented in section IV., where only two lags are significant.
We also included in our definition of the rest of the world Mexico and South Korea, which resulted in a shortening of the starting point to 1982:3, which is when the Korean employment series starts. The results were similar including these two countries, but to take advantage of the longer time series in our subsample analysis, we decided to exclude them.
where ρa = 0.97,
We assume that the cointegrating relationship is the same across samples.