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Does Linearity in the Dynamics of Inflation Gap and Unemployment Rate Matter?

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  • Roque Montero

    () (Department of Economics, Rutgers University)

Abstract

This paper test the null hypothesis of linearity against a specific form of nonlinearity in the Data Generating Process (DGP) of the unemployment rate and the difference between the inflation rate (measured as the twelve months variation of CPI and CPIX1) and the inflation target, using twenty years of data (1990-2009) and time series models. The rejection of the null implies that the series has more than one regime or state. The regime switching process could explain the recent boom/bust of inflation observed during these years, or the unemployment rate after the Asian crisis, for instance. The main results are: it is not possible to reject linearity in the deviation of inflation from the inflation target. During the last twenty years, inflation has converged smoothly to the target without any regime switching. The speed of convergence to the target has been constant over the years and inflationary shocks have been dissolved with the usual degree of persistency. Finally, strong evidence is found against linearity in the unemployment rate. On the contrary, it fluctuates with high probability between states or regimes through time.

Suggested Citation

  • Roque Montero, 2012. "Does Linearity in the Dynamics of Inflation Gap and Unemployment Rate Matter?," Revista de Analisis Economico – Economic Analysis Review, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines, vol. 27(1), pages 3-26, April.
  • Handle: RePEc:ila:anaeco:v:27:y:2012:i:1:p:3-26
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    References listed on IDEAS

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    1. Hansen, Bruce E, 1992. "The Likelihood Ratio Test under Nonstandard Conditions: Testing the Markov Switching Model of GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(S), pages 61-82, Suppl. De.
    2. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    3. Hansen, Bruce E, 1999. " Testing for Linearity," Journal of Economic Surveys, Wiley Blackwell, vol. 13(5), pages 551-576, December.
    4. Javier García - Cicco & Roque Montero, 2011. "Modeling Copper Price: A Regime-Switching Approach," Working Papers Central Bank of Chile 613, Central Bank of Chile.
    5. Laurent Ferrara & Dominique Guégan, 2006. "Detection of the Industrial Business Cycle using SETAR Models," Journal of Business Cycle Measurement and Analysis, OECD Publishing, Centre for International Research on Economic Tendency Surveys, vol. 2005(3), pages 353-371.
    6. Hansen Bruce E., 1997. "Inference in TAR Models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 2(1), pages 1-16, April.
    7. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
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    More about this item

    Keywords

    Inflation; unemployment; SETAR models; regime switching; nonlinear models.;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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