Are Apparent Findings of Nonlinearity Due to Structural Instability in Economic Time Series?

Abstract

Many modelling issues and policy debates in macroeconomics depend on whether macroeconomic times series are best characterized as linear or nonlinear. If departures from linearity exist, it is important to know whether these are endogenously generated (as in, e.g., a threshold autoregressive model) or whether they merely reflect changing structure over time. We advocate a Bayesian approach and show how such an approach can be implemented in practice. An empirical exercise involving several macroeconomic time series shows that apparent findings of threshold type nonlinearities could be due to structural instability.

Keywords: bayes factor, markov chain monte carlo, threshold autoregressive model, time varying parameter model

JEL Classification: C11, C22, E30