DP8157 Why crises happen - nonstationary macroeconomics

Author(s): James Davidson, David Meenagh, Patrick Minford, Michael R. Wickens
Publication Date: December 2010
Keyword(s): banking crisis, banking regulation, Bootstrap, Indirect Inference, Nonstationarity, Productivity, Real Business Cycle
JEL(s): E32, F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8157

A Real Business Cycle model of the UK is developed to account for the behaviour of UK nonstationary macro data. The model is tested by the method of indirect inference, bootstrapping the errors to generate 95% confidence limits for a VECM representation of the data; we find the model can explain the behaviour of main variables (GDP, real exchange rate, real interest rate) but not that of detailed GDP components. We use the model to explain how 'crisis' and 'euphoria' are endemic in capitalist behaviour due to nonstationarity; and we draw some policy lessons.