Cointegration Analysis in a German Monetary System

1 Introduction.- 1.1 Motivation.- 1.2 Outline.- 2 Systems Cointegration Tests.- 2.1 Introduction.- 2.2 Cointegration Rank Tests: The Framework.- 2.2.1 Data Generating Process.- 2.2.2 Hypotheses and Testing Procedure.- 2.3 Likelihood Ratio Tests.- 2.3.1 DGPs and Test Statistics.- 2.3.1.1 Arbitrary Mean and Trend Term.- 2.3.1.2 Trending Variables and No Trend in the Cointegration Relations.- 2.3.1.3 Arbitrary Mean and No Trend Term.- 2.3.2 Summary of Models and Test Statistics.- 2.3.3 Previous Simulation Studies.- 2.4 Other Tests.- 2.4.1 Tests Based on Canonical Correlations of Levels.- 2.4.1.1 DGPs and Test Statistics.- 2.4.1.2 Previous Simulation Results.- 2.4.2 Stock-Watson Tests.- 2.4.2.1 DGPs and Test Statistics.- 2.4.2.2 Previous Simulation Results.- 2.4.3 Bierens’ Nonparametric Tests.- 2.4.3.1 DGPs and Test Statistics.- 2.4.3.2 Previous Simulation Results.- 2.5 New Small Sample Simulations.- 2.5.1 Previous Simulation Studies.- 2.5.2 Simulation Details.- 2.5.3 The Toda DGP.- 2.5.4 Two-dimensional VAR(1): Simulation Results.- 2.5.4.1 Sizes of the Tests.- 2.5.4.2 Power Performance: DGP without Linear Trend.- 2.5.5 Three-dimensional VAR(1): Simulation Results.- 2.5.5.1 Size of the Tests.- 2.5.5.2 Power Performance: DGP with Linear Trend.- 2.5.6 Three-dimensional VAR(2): DGP and Simulation Results.- 2.5.7 Conclusions from Simulations.- 2.6 Further Deterministic Terms: Dummy Variables.- 2.7 Recommendations for Applied Research.- 3 A Cointegrated Monetary System for Germany.- 3.1 Introduction.- 3.2 Monetary Policy Strategies and the ECB.- 3.2.1 Inflation Targeting versus Monetary Targeting.- 3.2.2 ‘Discretion versus Rule’ or ‘Flexibility versus Transparency’.- 3.2.3 German Monetary Policy: Monetary Targeting and the Stability of the Demand for Money.- 3.3 Long-Run Monetary Relations.- 3.3.1 The Demand for Money.- 3.3.1.1 Theories on Money Demand.- 3.3.1.2 Recent Empirical Literature of the Demand for the Monetary Aggregate M3 in Germany.- 3.3.1.3 Estimation of Money Demand Systems for other Countries.- 3.3.2 The Term Structure of Interest Rates.- 3.3.2.1 The Expectations Theory of the Term Structure.- 3.3.2.2 Cointegration Analysis of the Term Structure of Interest Rates.- 3.3.3 The Fisher Effect.- 3.3.3.1 Is the Real Interest Rate Stationary?.- 3.3.3.2 Recent Empirical Evidence for the Fisher Effect.- 3.4 Empirical Analysis.- 3.4.1 The initial VAR.- 3.4.1.1 Data.- 3.4.1.2 Univariate Tests for Unit Roots.- 3.4.1.3 Model Specification.- 3.4.2 Tests for the Cointegration Rank.- 3.4.2.1 The Johansen Rank Test.- 3.4.2.2 Trend-adjusted LR Tests.- 3.4.2.3 Rank Test for a Model without a linear Trend.- 3.4.3 Testing Restrictions on the Cointegration Space.- 3.4.3.1 Weak Exogeneity and Stationarity.- 3.4.3.2 Long-run Restrictions.- 3.4.3.3 The Cointegration Vectors: Economic Interpretation.- 3.4.4 Conclusion.- 4 Concluding Remarks and Outlook.- 4.1 Systems Cointegration Tests.- 4.2 Empirical Analysis of a German Monetary System.- 4.3 Further Research.- 4.4 Outlook: Lessons for the ECB.- A Trend-adjusted LR Tests: Dummy Variables.- B Data.- List of Figures.- List of Tables.