Publications on Maximum entropy
Working Paper No. 811 | July 2014
An Evaluation Using the Maximum Entropy Bootstrap Method
This paper challenges two clichés that have dominated the macroeconometric debates in India. One relates to the neoclassical view that deficits are detrimental to growth, as they increase the rate of interest, and in turn displace the interest-rate-sensitive components of private investment. The second relates to the assumption of “stationarity”—which has dominated the statistical inference in time-series econometrics for a long time—as well as the emphasis on unit root–type testing, which involves detrending, or differencing, of the series to achieve stationarity in time-series econometric models. The paper examines the determinants of rates of interest in India for the periods 1980–81 and 2011–12, using the maximum entropy bootstrap (Meboot) methodology proposed in Vinod 1985 and 2004 (and developed extensively in Vinod 2006, Vinod and Lopez-de-Lacalle 2009, and Vinod 2010 and 2013). The practical appeal of Meboot is that it does not necessitate all pretests, such as structural change and unit root–type testing, which involve detrending the series to achieve stationarity, which in turn is problematic for evolutionary short time series. It also solves problems related to situations where stationarity assumptions are difficult to verify—for instance, in mixtures of I(0) and nonstationary I(d) series, where the order of integration can be different for different series.
What makes Meboot compelling for Indian data on interest rates? Prior to interest rate deregulation in 1992, studies to analyze the determinants of interest rates were rare in India. Analytical and econometric limitations to dealing with the nonvarying administered rates for a meaningful time-series analysis have been the oft-cited reason. Using high-frequency data, the existing attempts have focused on the recent financially deregulated interest rate regime to establish possible links between interest rates and macroeconomic variables (Chakraborty 2002 and 2012, Dua and Pandit 2002, and Goyal 2004). The results from the Meboot analysis revealed that, contrary to popular belief, the fiscal deficit is not significant for interest rate determination in India. This is in alignment with the existing empirical findings, where it was established that the interest rate is affected by changes in the reserve currency, expected inflation, and volatility in capital flows, but not by the fiscal deficit. This result has significant policy implications for interest rate determination in India, especially since the central bank has cited the high fiscal deficit as one of the prime constraints for flexibility in fixing the rates.Download:Associated Program:Author(s):Hrishikesh Vinod Lekha S. Chakraborty Honey Karun