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All Change! The Implications of Non-Stationarity for Empirical Modelling, Forecasting and Policy

Oxford Martin School Policy Paper Series, Forthcoming

28 Pages Posted: 16 Jan 2017  

David F. Hendry

University of Oxford - Department of Economics

Felix Pretis

University of Oxford; University of Oxford - Institute for New Economic Thinking at the Oxford Martin School

Date Written: November 24, 2016

Abstract

Economies, societies, and many natural systems evolve and change, sometimes dramatically, so good models and accurate forecasts are vital for policymakers to prepare for and navigate these changes successfully. Yet history is littered with forecasts that went badly wrong, sharply illustrated during the recent recession. A glance at most economic and related time series, such as greenhouse gases, reveals the invalidity of an assumption of stationarity, whereby the mean and variance are constant over time. Nevertheless, many models used in empirical research, forecasting or for guiding policy have been predicated on treating observed data as stationary, when in fact such analysis must take non-stationarity into account if it is to deliver useful outcomes. The problem for policymakers is not a plethora of excellent models from which to choose, but to find stable relationships that survive long enough to be useful. This paper offers guidance for policymakers and researchers on identifying what forms of non-stationarity are prevalent, what hazards each form implies for empirical modelling and forecasting, and for any resulting policy decisions, and what tools are available to overcome such hazards.

Keywords: nonstationarity, cointegration, location shifts, forecast

JEL Classification: C10, C22, C50, C53

Suggested Citation

Hendry, David F. and Pretis, Felix, All Change! The Implications of Non-Stationarity for Empirical Modelling, Forecasting and Policy (November 24, 2016). Oxford Martin School Policy Paper Series, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2898761

David F. Hendry

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom
+44 1865 278544 (Phone)
+44 1865 278557 (Fax)

Felix Pretis (Contact Author)

University of Oxford

Mansfield Road
Oxford, OX1 4AU
United Kingdom

University of Oxford - Institute for New Economic Thinking at the Oxford Martin School ( email )

Eagle House
Walton Well Road
Oxford, OX2 6ED
United Kingdom

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