Hi! I have a question regarding VECM and IRF interpretation in Gretl. According to the speed of adjustment coefficient (error correction term) in the VEC, the target variable adjusts at a speed of 15,5% per year to equilibrium. But the IRF says that the cumulative change in the target variable is only 2% from year four trough the time horizon of the IRF, which is nine years. How can I interpret this?
Look for ECT short run equation 1, and compare it to the IRF in the files below please.
Best regards,
Lars
The two numbers you are looking at don't really have the same interpretation.
The 15.5% adjustment mean that 15.5% of the "misalignment" (i.e. the deviation of variables from the long term relationship) is adjusted through changes of debt to GDP within a year. Since your data is measured in percentage points, you have to be careful to keep in mind that this is a percentage of your percentages. (If 10% change by 15% you get 11.5% not 25%).
The 2 percentage points, are the change of the total debt to GDP ratio in response to a stocks/GDP shock.
The latter 2 percentage points, are a function of the (a) size of the initial shock (usually normalized to one standard deviation), (b) the contemporaneous reaction of all other variables (and thus the resulting size of said misalignment), (c) the adjustment over time, and (d) the dynamics of the first differences (e.g. stocks are highly autocorrelated, i.e. if the misalignment is created by a movement of stocks, actually it might even grow for a while or at least stay at a high level, because stocks are not immediately adjusting by keep moving in the wrong direction due to their momentum).
Best
Makram
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