Premium
Modelling & Controlling Monetary and Economic Identities with Constrained State Space Models
Author(s) -
Pandher Gurupdesh S.
Publication year - 2007
Publication title -
international statistical review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.051
H-Index - 54
eISSN - 1751-5823
pISSN - 0306-7734
DOI - 10.1111/j.1751-5823.2007.00012.x
Subject(s) - context (archaeology) , benchmark (surveying) , economics , econometrics , state space , balance of payments , state variable , computer science , monetary economics , mathematics , statistics , paleontology , physics , geodesy , biology , geography , thermodynamics
Summary The paper presents a method for modelling and controlling time series with identity structures. The approach is presented in the context of monetary targeting where the monetary identity (e.g. reserve money equals net foreign assets plus domestic credit) is modelled using a constrained state space model and next‐period changes in domestic credit (policy variable) are estimated to reach the target level of reserve money. The constrained modelling ensures that aggregation and identity relations among items are dynamically satisfied during estimation, leading to more accurate forecasting and targeting.Applications to Germany, UK and USA show that the constrained state space model provides significant improvements in targeting and forecasting performance over the AR(1) benchmark and the unconstrained model. Reduction in the mean square error of targeting over AR(1) is in the range of 76–95% for the three countries while the gain in targeting efficiency over unconstrained modelling is between 21% and 55%. Beyond monetary targeting, the method has wide application to the dynamic modelling and control of economic and financial time series with identity and aggregation constraints (e.g. balance of payment, national income, purchasing power parity, company balance sheet).