Unit Roots in the Presence of Abrupt Governmental Interventions with an Application to Brazilian Data

Abstract

This paper considers econometric issues related to time series data that have been subject to abrupt governmental interventions. The motivating example for this study is the Brazilian monthly inflation and interest rate series (1974:1- 1994:6) which we use throughout for illustration. These series have been heavily influenced by the effect of so-called shock plans implemented by various governments starting in the mid 80's. The plans act as "inliers" in the sense that the series are temporarily brought down to low levels before returning to their previous trend path. We analyze the effects on standard unit root tests and measures of persistence caused by the presence of these "inliers". We show a substantial bias in favor of concluding that the series are stationary and that shocks have temporary effects. We then construct appropriately corrected statistics which take into account the presence of the plans. These show, unlike the standard tests, that the stochastic behavior of inflation and interest rate was indeed explosive over this period. Simulation results are presented to support the adequacy of our corrected statistics.

JEL Classification: C22