Journal Article

The Role of Economic Theory in Modelling the Long Run

Pesaran, M. Hashem

1997

Overview

The theoretical issues involved in establishing links between the different notions of equilibrium in economics and the long-run are addressed. Formulating long-run relations as the steady state solutions of intertemporal optimization problems from economic theory is advocated. For empirical purposes the steady state solutions can then be embedded within a suitable multivariate dynamic model, such as the vector autoregressive models. The issues of estimation and inference are addressed, and it is argued that the abandonment of traditional methods in favor of the new unit-root-cointegration procedures might have been premature. The importance of a priority restriction is emphasized, obtainable from the steady state solution of suitable intertemporal optimization problems, in structural identification of long-run or cointegrating relations. The issue of aggregation and its implications for estimation theory-consistent long-run relations are raised, and alternative methods for dealing with dynamic heterogeneities across groups in estimation of long-run relations, using panel data, are discussed.

• Publisher: Blackwell Publishers,Blackwell,Cambridge University Press,Oxford University Press
• Subject: Aggregation / Applied economics / Coefficients / Controversy: On Modelling the Long Run in Applied Economics / Economic expectations / Economic modeling / Economic models / Economic problems / Economic theory / Equilibrium / Equilibrium models / Estimation / Estimation methods / Gleichgewichtstheorie / Inference / Modeling / Modelling / Optimization / Panel data / Prognoseverfahren / Rationale Erwartung / Regression analysis / Schätztheorie / Studies / Theorie / Time series