Abstract. A key application of long memory time series models concerns ination. Long memory implies that shocks have a long-lasting e¨ect. It may however be that empirical evidence for long memory is caused by neglecting one or more level shifts. Since such level shifts are not unlikely for in¯ation, where the shifts may be caused by sudden oil price shocks, we examine whether evidence for long memory (indicated by the relevance of an ARFIMA model) in G7 in¯ation rates is spurious or exaggerated. Our main ®ndings are that apparent long memory is quite resistant to level shifts, although for a few in¯ation rates we ®nd that evidence for long memory disappears.

We examine recursive out-of-sample forecasting of monthly postwar U.S. core inflation and log price levels. We use the autoregressive fractionally integrated moving average model with explanatory variables (ARFIMAX). Our analysis suggests a significant explanatory power of leading indicators associated with macroeconomic activity and monetary conditions for forecasting horizons up to two years. Even after correcting for the effect of explanatory variables, there is conclusive evidence of both fractional integration and structural breaks in the mean and variance of inflation in the 1970s and 1980s and we incorporate these breaks in the forecasting model for the 1980s and 1990s. We compare the results of the fractionally integrated ARFIMA(0,d,0) model with those for ARIMA(1,d,1) models with fixed order of d = 0 and d = 1 for inflation. Comparing mean squared forecast errors, we find that the ARMA(1,1) model performs worse than the other models over our evaluation period 1984-1999. The ARIMA(1,1,1) model provides the best forecasts, but its multi-step forecast intervals are too large.

We argue that the failure to disentangle the evolution of the Canadian currency from the U.S. currency leads to potentially incorrect conclusions regarding the case of Dutch disease in Canada. We propose a new approach that is aimed at extracting both currency components and energy-and commodity-price components from observed exchange rates and prices. We first analyze the separate influence of commodity prices on the Canadian and the U.S. currency components. We then estimate the separate impact of the two currency components on the shares of manufacturing employment in Canada. We show that 42 per cent of the manufacturing employment loss that was due to exchange rate developments between 2002 and 2007 is related to the Dutch disease phenomenon. The remaining 58 per cent of the employment loss can be ascribed to the weakness of the U.S. currency.

Adaptive radial-based direction sampling (ARDS) algorithms are speciÿed for Bayesian analysis of models with non-elliptical, possibly, multimodal target distributions. A key step is a radial-based transformation to directions and distances. After the transformation a MetropolisHastings method or, alternatively, an importance sampling method is applied to evaluate generated directions. Next, distances are generated from the exact target distribution. An adaptive procedure is applied to update the initial location and covariance matrix in order to sample directions in an e cient way. The ARDS algorithms are illustrated on a regression model with scale contamination and a mixture model for economic growth of the USA.

SUMMARYWe construct models which enable a decision maker to analyse the implications of typical time series patterns of daily exchange rates for currency risk management. Our approach is Bayesian where extensive use is made of Markov chain Monte Carlo methods. The eects of several model characteristics (unit roots, GARCH, stochastic volatility, heavy-tailed disturbance densities) are investigated in relation to the hedging strategies. Consequently, we can make a distinction between statistical relevance of model speci®cations and the economic consequences from a risk management point of view. We compute payos and utilities from several alternative hedge strategies. The results indicate that modelling time-varying features of exchange rate returns may lead to improved hedge behaviour within currency overlay management.