TESTING INTERNATIONAL PRICE TRANSMISSION UNDER ...

Empirical Analysis: Cointegration Models, Structural Breaks and Policy Reform
show how the residuals from the overall cointegration relation have a constant
which changes over time, in correspondence to structural breaks. In particular, the
two series have a common patter up to 1993:06, after which the structural breaks
are considered in the error correction term of the VECM estimated by allowing
for a lower constant and an increased price transmission elasticity.
Figure 6.1 Long run residuals of the VECM with structural breaks (EU and WTO policy
regimes, 2001/02 campaign)
0,8
0,6
0,4
0,2
0
-0,2
-0,4
1978:12
1980:12
1982:12
1984:12
1986:12
1988:12
1990:12
When cointegration is present, we expect IRFs not to always die out: their
effect can be permanent, as the whole system will move to a new long run
equilibrium. Both transitory and permanent shocks can be present (Goodwin et al.
1999, p.168). To calculate orthogonal IRFs, the ordering of the Choleski
decomposition for the VAR reformulated in levels is swfrt, hrwt. This means that,
at time t, the French price depends on only one contemporaneous structural shock,
whereas the US price depends on the two of them. We could interpret the first one
as a shock occurring in the EU market, which affects contemporaneously both the
French and the US price, and the second one as a shock happening on world
markets, which at time t affects the US price only. In other words, we assume that
the US price has no contemporaneous effects on the French price, but lagged
values of the US price have an effect on the French price. The French price has,
instead, a contemporaneous effect on the US one. We see that all IRFs, for a 12
months time horizon, are generally low but different from zero (figure 6.2), with
the exception of the French response to a shock in the US price. Both the French
and the US price response to a shock in themselves tend to be persistent, whereas
the response of each price to a shock in the other price is generally lower and
1992:12
1994:12
1996:12
1998:12
EC 3
residuals 3
2000:12
2002:12
4,2
4
3,8
3,6
3,4
3,2
3
105