Palgrave Handbook of Econometrics: Applied Econometrics

Katarina Juselius 377

1980 1985 1990 1995

–1.00

–0.75

–0.50

–0.25

0.00

0.25

0.50

0.75

1.00 The polynomially cointegrated relation

Figure 8.5 The graph of the polynomially cointegrated relationβ′xt+δ′xt

opposite of price homogeneity, the results explain why long-run price homogeneity
inτwas so strongly rejected.
That inflation rates are moving in opposite directions is a puzzling and even
implausible result. Therefore, it is useful to check whether this result still holds for
the combined estimates,ζτ′xt, calculated below:

p1,t p2,t s12,t

^2 p 1 t: −0.75 0.18 0.10

^2 p2,t: 0.44 −0.13 0.04

^2 s12,t: 1.25 −1.00 0.17

Fortunately, the combined estimates are more plausible: German, as well as US,
inflation rates are now equilibrium error-correcting to each other. The US inflation
rate is equilibrium error-correcting to German price inflation with the correct sign,
but to the Dmk–$ rate with an “incorrect” sign. However, the coefficient is very
small and may not be significantly different from zero. Finally, the Dmk–$ rate
is not equilibrium error correcting but even error increasing with the US–German
inflation spread. Since the coefficientsζ 13 andζ 23 were both insignificant, this is,
however, not necessarily an empirically strong result.
To summarize, the VAR analysis has detected four puzzling results:

1. Nominal exchange rates tend to move in the opposite direction to relative prices
   for extended periods of time.


2. The US inflation rate is not equilibrium error correcting toβ′xt.