Chapter

Serial Correlation as a Convenient Simplification, not a Nuisance: A Comment on a Study of the Demand for Money by the Bank of England

David F. Hendry and Grayham E. Mizon

in Econometrics: Alchemy or Science?

Published in print October 2000 | ISBN: 9780198293545
Published online November 2003 | e-ISBN: 9780191596391 | DOI: http://dx.doi.org/10.1093/0198293542.003.0007
 Serial Correlation as a Convenient Simplification, not a Nuisance: A Comment on a Study of the Demand for Money by the Bank of England

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Sargan's COMFAC procedure for single equations (common factors in lag polynomials) is exposited. Four important conceptual clarifications arise. First, residual autocorrelation does not entail error autoregression. Secondly, autoregressive errors are common factor dynamics. Thirdly, discriminating between systematic dynamics and error dynamics can only be done in the context of a general‐to‐simple strategy, with autocorrelated errors potentially reducing the parameterization. Fourthly, differencing imposes common factors of unity. The empirical performance of COMFAC was illustrated for modelling broad money demand, and for integrating economic analysis with statistical modelling; long‐run money demand theory guided the empirical estimates of the equilibrium‐correction model.

Keywords: autoregressive errors; broad money demand; COMFAC; differencing; equilibrium‐correction model; error dynamics; general‐to‐simple; residual autocorrelation; systematic dynamics

Chapter.  9621 words.  Illustrated.

Subjects: Econometrics and Mathematical Economics

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