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Do long-run equilibrium relations suggested by economic theory help to improve the forecasting performance of a cointegrated vector error correction model (VECM)? In this paper we try to answer this question in the context of a two-country model developed for the Canadian and US economies. We compare the forecasting performance of the exactly identified cointegrated VECMs to the performance of the over-identified VECMs with the long-run theory restrictions imposed. We allow for model uncertainty and conduct this comparison for every possible combination of the cointegration ranks of the Canadian and US models. We show that the over-identified structural cointegrated models generally outperform the exactly identified models in forecasting Canadian macroeconomic variables. We also show that the pooled forecasts generated from the over-identified models beat most of the individual exactly identified and overidentified models as well as the VARs in levels and in differences. Copyright

Conventional VAR and non-VAR methods of identifying the effects of monetary policy shocks on the economy have found a negative output response to monetary tightening using U.S. data over the 1960s-1990s. However, we show that these methods fail to find this contractionary effect when the sample is restricted to the period since the 1980s, apparently due to changes in the policymaking environment that reduce their effectiveness. Identifying policy shocks using Fed Funds futures data, we recover the contractionary effect of monetary tightening on output and find that almost half of output variation over the period appears due to policy shocks.

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