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Denise Osborn

Economics

A time series is a set of data observed over time Examples: o Stock market returns each trading day over the last month o Monthly rainfall in Manchester o Number of recorded property crimes each year for the last 50 years o Weekly online sales by Amazon since 2005

Time series analysis: statistical models to represent characteristics of time series data Why??? May want/need to: Understand changing world temperature patterns Predict river flows Forecast future stock market returns Evaluate effects of macroeconomic policy change

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 4

Time Series Patterns Temporal patterns sometimes divided into: o Trend (or change in level) o Seasonality (over the year) o Cycles (eg, recession/expansion in the economy) Useful way to think about features to be represented

15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0

o Main characteristic is seasonality: January & July price declines, April peaks

19 93 J 19 an 94 J 19 an 95 J 19 an 96 J 19 an 97 J 19 an 98 J 19 an 99 J 20 an 00 J 20 an 01 J 20 an 02 J 20 an 03 J 20 an 04 J 20 an 05 J 20 an 06 J 20 an 07 J 20 an 08 J 20 an 09 J 20 an 10 Ja n

Exploring Time Series Patterns Can use visual or statistical approaches - Better: use both! Graphs are invaluable Summary statistics: autocorrelations

Autocorrelations Correlations provide important information on strength of relationships: in time series, use autocorrelations Say we have observations on a variable over time:

y1, y2, , yT

o Eg, inflation each month, January 1988 to October 2010

0.8 0.6 0.4 0.2 0 -0.2 -0.4 0 3 6 9 12 15 18 21 24 27 30 33 36

Autocorrelation at k = 12 (one year lag) very strong (0.71); only marginally lower at 2 & 3 year lags o Also 6, 18, 30-month autocorrelations 0.4 Confirms importance of seasonality for monthly CPI inflation

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 9

Output Growth: Another Example o Real output growth is a key measure for the economy o Available quarterly, seasonally adjusted

Quarterly Real UK Output Growth 1960-2010

4 2 0 -2 -4

19 60 Q 1 19 63 Q 1 19 66 Q 1 19 69 Q 1 19 72 Q 1 19 75 Q 1 19 78 Q 1 19 81 Q 1 19 84 Q 1 19 87 Q 1 19 90 Q 1 19 93 Q 1 19 96 Q 1 19 99 Q 1 20 02 Q 1 20 05 Q 1 20 08 Q 1

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 10

Sample Autocorrelations of Growth 1960-2010

0.2

0.1

-0.1

-0.2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Relatively low! Growth each quarter close to random o But some evidence of positive relationship with preceding 3 quarters

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 11

Sample Autocorrelations of Growth 1985-2010

0.8 0.6 0.4 0.2 0 -0.2 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Much stronger autocorrelations since 1985! Each quarter strongly related to following one o Suggests possibility of forecasting future growth

12

Time Series Models Graphical and autocorrelation analyses are only preliminary steps for time series modelling o Statistical models used for formal analysis and forecasting Simplest time series model has form: o yt = + yt-1 + ut

ut random

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 13

Models for Output Growth Constant 1960-1984 1985-2010 0.501 (3.87) 0.192 (2.94) AR(1) coefficient 0.009 (0.08) 0.664 (8.86) R2 0.00007 0.440 Residual St.Dev. 1.18 0.50

(t-ratios in parentheses) AR(1) explains nothing before 1985; but highly significant after 1985

14

Point Forecasts Time series models are important in forecasting For growth example o Estimated AR(1), 1985Q1-2010Q2:

o Using this to forecast:

and so on

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How well would AR(1) have forecast recent past? o Assume growth to 2008Q4 known; forecast 2009 & 2010: Forecast 2009Q1 2009Q2 2009Q3 2009Q4 -1.20 -0.58 -0.18 0.08 Actual -2.12 -0.82 -0.21 0.51 2010Q1 2010Q2 2010Q3 2010Q4 Forecast 0.25 0.36 0.43 0.47 Actual 0.31 1.22

16

Repeating exercise for 2008 & 2009 (data to 2007Q4): Forecast 2008Q1 2008Q2 2008Q3 2008Q4 0.50 0.59 0.64 0.65 Actual 0.48 -0.29 -1.16 -2.17 2009Q1 2009Q2 2009Q3 2009Q4 Forecast 0.66 0.67 0.67 0.67 Actual -2.12 -0.82 -0.21 0.51

Would NOT have forecast onset of recession! Simple linear models, such as AR(1), are useful, but have limitations in forecasting

17

Model Specification Much of time series analysis concerns methods to specify the appropriate model form o A (univariate) time series model has form

ut random

f(yt-1, yt-2, )

18

Higher p may help to capture seasonality and cycles; But need to decide appropriate p LARGE TOPIC: But can use hypothesis tests or other data-based procedure o In yt = f(yt-1, yt-2, ) + ut f can be nonlinear but difficult in practice o Also diagnostic tests available to check that model residuals are random over time

What is Time Series Analysis? Denise Osborn, Methods@Manchester, 11 November 2010 19

Multivariate Time Series Modelling single time series in isolation not always very useful o Including in Economics o Or any (other) context where relationships between variables are important

20

o Represents dynamic interactions o Similarly more variables and longer lags o Model specification is again key consideration o Known as a VAR (vector autoregressive) model

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Example: US and Euro Area US/Euro area interest rate interactions (from a 7-variable VAR analysis of the relationships between these economies):

0.3 0.2 0.1 0 -0.1 1 9 17 25 33 41 49 57

0.06 0.03 0 -0.03 -0.06 -0.09 1 9 17 25 33 41 49 57

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Here illustrate the strong effect of US policy on interest rates in the Euro Area; o But little in opposite direction Such VAR models are widely used in economic policy analyses o Especially in central banks (including Bank of England)

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Concluding Remarks Time series analysis focuses on capturing patterns over time Intuition fairly straightforward o But implementation can be difficult o And theory of time series analysis is complex! Techniques have a wide variety of applications o Some illustrated today for Economics

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