CoPS/IMPACT Working Paper Number G-300

Title: Econometric Foundations of the Great Ratios of Economics

Author: Don Harding


We study the puzzle that econometric tests reject the great ratios hypothesis but economic growth theorists and quantitative macroeconomic model builders continue to embed that hypothesis in their work. We develop an econometric framework for the great ratios hypothesis and apply that framework to investigate the commonly used econometric techniques that produce rejection of the great ratios hypothesis. We prove that these methods cannot produce valid inference on the great ratios hypothesis. Thus we resolve the puzzle in favour of the growth theorists and quantitative macroeconomic model builders. We apply our framework to investigate the econometric basis for an influential paper that uses unit root and cointegration tests to reject the great ratios hypothesis for a vector that comprises consumption, financial wealth and labour income.

JEL classification: C12, C18, C32, E00

Keywords: Great Ratios Hypothesis; Cointegration; Likelihood Ratio Inference

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