DYNAMIC ECONOMETRIC MODELS:

AUTOREGRESSIVE AND
DISTRIBUTED-LAG MODELS
Reference : Gujarati, Chapter 17
A distributed-lag model the regression model
includes the lagged values of the explanatory variables,
for example,
Yt = 0 + 1Xt + 2Xt1 + 3Xt2 + ut
A dynamic model the regression model includes
one or more lagged values of the dependent variable
among its explanatory variables, for example,
Yt = 0 + 1Xt + 2Yt1 + 3Yt2 + ut

6-1

The Role of Lag

For the following distributed-lag model
Yt = +0Xt+1Xt1+2Xt2+ +k Xtk +ut (1)
The coefficient 0 is the short-run, or impact,
multiplier. These coefficients and their partial sums
are called interim, or intermediate, multiplier.
k
X
i=0

i = 0 + 1 + 2 + + k =

is the long-run, or total, distributed-lag

multiplier.
We define

i
=
= Pk

i=0 i
be standardized i which give the proportion of the
i

long-run, or total, impact felt by a time period i.

6-2

Example: The consumption function.

Suppose a persons consumption function is
Yt = + 0.4Xt + 0.3Xt1 + 0.2Xt2 + ut
where Yt is consumption expenditure and X is annual
income. If he receives a salary increase of $2000 in
annual pay, he will increase consumption expenditure
by $800 in the first year, by another $600 in the next
year, and by another $400 in the following year. By
the end of the third year, his consumption expenditure
will be increased by $1800.
The short-run multiplier is 0.4 and the long-run
multiplier is 0.9.
If we divide each i by 0.9, we obtain respectively,
0.44, 0.33 and 0.23, which indicate that 44 percent of
the total impact of a unit change in X on Y is felt
immediately, 77 percent after one year, and 100
percent by the end of the second year.
6-3

Estimation of Distributed-lag Model

Equation (1) is called a finite (lag)
distributed-lag model while the following model
is called an infinite (lag) model:
Yt = + 0Xt + 1Xt1 + 2Xt2 + + ut . (2)
Two approaches to estimate the parameters:
ad hoc estimation, and
a priori restriction on the s.

6-4

Ad Hoc Approach
First, use OLS to regress Yt on Xt, then regress Yt on
Xt and Xt1, then regress Yt on Xt, Xt1 and Xt2
and so on. The precedure stops when becomes
statistically insignificant.
Consider the following example with SAS program:
DATA a ;
infile c:\ec5103\G17_23.dat firstobs = 2 ;
INPUT Year Y X ;
X1 = lag(X) ;
X2 = lag(X1) ;
X3 = lag(X2) ;
X4 = lag(X3) ;
label Y = Expenditure
X = Sale ;
proc reg data=a;
model Y = X ;
model Y = X X1 ;
model Y = X X1 X2 ;
model Y = X X1 X2 X3 ;
run ;
6-5

Model: MODEL1
Dependent Variable: Y
Analysis of Variance

Expenditure

Sum of
Mean
Source
DF
Squares
Square
F Value
Prob>F
Model
1 40493.24354 40493.24354
857.570
0.0001
Error
17
802.71596
47.21859
C Total
18 41295.95949
Root MSE
6.87158
R-square
0.9806
Dep Mean
117.08053
Adj R-sq
0.9794
C.V.
5.86910
Parameter Estimates
Parameter
Standard
T for H0:
Variable DF
Estimate
Error
Parameter=0
Prob > |T|
INTERCEP
1
-26.001181
5.13397793
-5.065
0.0001
X
1
0.876207
0.02992072
29.284
0.0001

Variable
INTERCEP
X

DF
1
1

Variable
Label
Intercept
Sale

Model: MODEL2
Dependent Variable: Y
Root MSE
6.50264
Dep Mean
117.08053

Variable
INTERCEP
X
X1

DF
1
1
1

Parameter
Estimate
-20.932059
0.474206
0.392746

Expenditure
R-square
Adj R-sq
Standard
Error
5.67585062
0.23444150
0.22736735

6-6

0.9836
0.9816
T for H0:
Parameter=0
-3.688
2.023
1.727

Prob > |T|

0.0020
0.0601
0.1034

Model: MODEL3
Dependent Variable: Y

Expenditure

Analysis of Variance
Sum of
Mean
Source
DF
Squares
Square
F Value
Prob>F
Model
3 40842.46575 13614.15525
450.309
0.0001
Error
15
453.49375
30.23292
C Total
18 41295.95949
Root MSE
5.49845
R-square
0.9890
Dep Mean
117.08053
Adj R-sq
0.9868
Parameter Estimates
Parameter
Standard
T for H0:
Variable DF
Estimate
Error
Parameter=0
Prob > |T|
INTERCEP
1
-26.300379
5.19035250
-5.067
0.0001
X
1
0.460543
0.19830090
2.322
0.0347
X1
1
0.984994
0.29069565
3.388
0.0041
X2
1
-0.579260
0.21325893
-2.716
0.0159
Model: MODEL4
Dependent Variable: Y
Root MSE
5.62999
Dep Mean
117.08053
Parameter Estimates
Parameter
Variable DF
Estimate
INTERCEP
1
-27.799462
X
1
0.501062
X1
1
0.944238
X2
1
-0.452785
X3
1
-0.126689

Expenditure
R-square
Adj R-sq
Standard
Error
5.96304344
0.21580167
0.30659655
0.31581698
0.22855144

6-7

0.9893
0.9862
T for H0:
Parameter=0
-4.662
2.322
3.080
-1.434
-0.554

Prob > |T|

0.0004
0.0358
0.0082
0.1736
0.5881

The Koyck Approach

Koyck assumes follows the relation:
k = 0 k .

(3)

with , such that 0 < < 1, which is known as the

rate of decline, or decay, of the distributed lag model
and 1 is known as the speed of adjustment.
From (3), we have

i = 0
i=0
1
and Equation (2) can be re-written as

Yt = + 0Xt + 0Xt1 + 02Xt2 + + ut . (4)

Consider time t 1, we have
Yt1 = + 0Xt1 + 0Xt2 + 02Xt3 + + ut1 .
(5)
Equation (4) - Equation (5), we have
Yt = (1 ) + 0Xt + Yt1 + t
where t = ut ut1.
6-8

(6)

Note
1. In (2), the error term ut is iid N (0, 2). However
in (6), the error term t is correlated with t1.
2. We can use Durbin-Watson test or Durbin h test
to test the correlation in t.
The Median Lag is the time required for 50% of
the total change in Y following a unit sustained
change in X. For Koyck model,
log 2
Median lag =
log
= 0.2 =

Median lag = 0.4306 and hence it takes

less than half a period to obtain 50% of the total

change in Y .
= 0.8 =

Median lag = 3.1067 and hence it takes

more than three periods to obtain 50% of the total

change in Y .

6-9

The Mean Lag is the weighted average of time such

that

Mean lag =

i=0 kk
P
i=0 k

if all the k is positive.

For Koyck model,
Mean lag =

The Median Lag and the Mean Lag measure the speed
with which Y responds to X.
Example : Consider
PPCEt = 841 + 0.7117 PDPIt + 0.2954 PPCEt1 + et
Assume it is the Koyck model, = 0.954, the Median
lag = 0.5684, and the Mean lag = 0.4192. Hence,
PPCE adjust to PDPI within a relatively short time.

6-10

The Adaptive Expectation Model

Suppose
Yt = 0 + 1Xt + ut

(7)

where
Y

= demand for money

X = equilibrium, optimum, expected long-run or

normal rate of interest
As Xt is not observable, we propose:

Xt Xt1
= ( Xt Xt1
)

(8)

where such that 0 < < 1, is the coefficient of

expectation and X is observable.
From (8), we have

Xt = Xt + (1 )Xt1

(9)

Substituting (9) into (7), we have

Yt = 0 + 1 [ Xt + (1 )Xt1
] + ut

= 0 + 1Xt + 1(1 )Xt1

+ ut
6-11

(10)

lag (7) one period, multiply it by 1 , and subtract

(9), we have
Yt = 0 + 1Xt + (1 )Yt1 + ut (1 )ut1
= 0 + 1Xt + (1 )Yt1 + t
Example (Continued) :
PPCEt = 841 + 0.7117 PDPIt + 0.2954 PPCEt1 + et
The coefficient of expectations,
= 1 0.2954 = 0.7046. About 70% of the
discrepancy between actual and expected PDPI is
eliminated within a year, a fairly rapid adjustment.

6-12

The Stock Adjustment Model

Another reationalization is the Stock Adjustment
or Partial Adjustment Model
Yt = 0 + 1Xt + ut
Yt Yt1 = It = ( Yt Yt1 )

(11)
(12)

where
Y

= actual capital stock (observable)

= desired level of capital (unobservable)

It

= investment in time period t

Yt Yt1

= actual change in capital stock

Yt Yt1 = desired change in capital stock

= the coefficient of adjustment (0 < < 1)

(12) can be written as

Yt = Yt + (1 )Yt1
From (11) and (13), we have
Yt = ( 0 + 1Xt + ut ) + (1 )Yt1
6-13

(13)

= 0 + 1Xt + (1 )Yt1 + ut

(14)

(11) is the long-run, or equilibrium, demand for capital

stock, and (14) is the short-run demand for capital
stock. Once we estimate (14), we can obtain (11).
Example (Continued) :
PPCEt = 841 + 0.7117 PDPIt + 0.2954 PPCEt1 + et
The coefficient of adjustment,
= 1 0.2954 = 0.7046.

6-14

Combination of Adoptive Expectations and

Partial Adjustment Model
Consider
Yt = 0 + 1Xt + ut

(15)

where
Y

= desired level of capital (unobservable)

= expected level of output (unobservable)

From (15), (9) and (13), we have

Yt = 0 + 1Xt + [(1 ) + (1 )]Yt1
(1 )(1 )Yt2 + [ut (1 )ut1]
= 0 + 1Xt + 2Yt1 + a3Yt2 + t
where t = [ut (1 )ut1].

6-15

(16)

Durbin-h Test for Autocorrelation

If the random error terms may follow a first-order
autoregressive process such that
t = t1 + ut
where
is a parameter such that || < 1
ut are independent N (0, 2).
To test:
H0 : = 0
against
H1 : 6= 0
We can use the Durbin-h statistics
v
u
u
n
u
h = u
t
1 n[V ar(
2)]

v
u
1 u
n

u
1 d u
t
2
1 n[V ar(
2)]
where
2 is the coefficient of Yt1 and d is the
Durbin-Watson statistic.
6-16

h AN (0, 1) (h is asymptotically normally

distributed with zer mean and unit variance).
If |h| < z/2, conclude H0
If h > z/2, conclude H1 and there is positive
first-order autocorrelation, and
If h < z/2, conclude H1 and there is negative
first-order autocorrelation.
For the hypothesis: H1 : > 0, if h > z, conclude
H1 and there is positive first-order autocorrelation;
Otherwise, conclude H0 and there is no first-order
autocorrelation.
For the hypothesis: H1 : < 0, if h < z, conclude
H1 and there is negative first-order autocorrelation;
Otherwise, conclude H0 and there is no first-order
autocorrelation.

6-17

Example :
Suppose n = 100, d = 1.9 and V ar(
2) = 0.005, then

v
u
u
u
u
t

1
1.9
2
= 0.7071

h 1

100
1 100 0.005

For the hypothesis: H1 : 6= 0, as |h| < 1.96 = z.05/2,

we conclude H0.
For the hypothesis: H1 : > 0, as h < 1.6456 = z.05,
we conclude H0.

6-18