Structural Error Correction Models: Instrumental Variables Methods and an Application to an Exchange Rate Model

Error correction models are widely used to estimate dynamic cointegrated systems. In most applications, estimated error correction models are reduced form models. As a result, nonstructural speed of adjustment coefficients are estimated in these applications. A single equation instrumental variable method can be used to estimate a structural speed of adjustment coefficient. This paper develops a system instrumental variable method to estimate the structural speed of adjustment coefficient in an error correction model. This method utilizes Hansen and Sargent’s (1982) instrumental variable estimator for linear rational expectations models, and is applied to an exchange rate model with sticky prices. ∗We thank seminar participants at the Bank of Japan, International Monetary Fund, the Ohio State University, Southern Methodist University, University of Houston, University of Memphis, University of Michigan, the 1997 North American Winter Meeting of the Econometric Society, and the 2003 Konstanz Seminar for Monetary Theory and Policy for their comments. Special thanks are due to Steve Cecchetti, Boris Hoffman, G.S. Maddala, Nelson Mark, Mat Shapiro, Bill Smith, Alan Viard, and Charles Whiteman.