International Evidence on Monetary Neutrality Under Broken Trend Stationary Models

We analyze the issue of the impact of multiple breaks on monetary neutrality results, using a long annual international data set. We empirically verify whether neutrality propositions remain addressable (and if so, whether they hold or not), when unit root tests are carried out allowing for multiple structural breaks in the long-run trend function of the variables. It is found that conclusions on neutrality are sensitive to the number of breaks allowed. In order to interpret the evidence for structural breaks, we utilize a notion of deterministic monetary neutrality, which naturally arises in the absence of permanent stochastic shocks to the variables. We utilize a resampling procedure to discriminate between DS and TS models with multiple breaks, based on the fact that changes in the trend function bias unit root tests towards a non-rejection, and a dynamic pro-gramming algorithm for locating breaks. We present evidence on the inability to reject plausible broken-trend stationary models that exhibit transitory dynamics around a long-run deterministic trend subject to infrequent structural breaks. This leads to interesting questions about the testing for monetary neutrality