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How Do Oil Shocks A¤ect the Structural Stability of Hybrid New Keynesian Phillips Curve?

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  • Somayeh Mardaneh

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    In this paper, the structural stability of the hybrid New Keynesian Phillips Curve (NKPC) and possible changes in pricing behaviour of firms are investigated in the context of oil price shocks. Using quarterly US aggregate data, this curve is estimated in subsamples formed with oil price shock dates by generalized method of moments (GMM) and continuously updated GMM (CU-GMM). The results for the structural break test confirm 1974:I, 1979:II and 1990:III as identified oil price shock dates and do not reject the structural stability of the over-identifying restrictions implied by the Gali and Gertler’s (1999) hybrid NKPC. However, there is evidence for parameter instability for this hybrid NKPC in terms of backward-looking rule-of-thumb behaviour in both set of estimations. The standard GMM estimates suggest that although the forward-looking behaviour is predominant in the period before the 1974 Oil Crisis, it loses ground against backward-looking behaviour after every oil shock. In contrast, the CU-GMM estimates suggest the opposite: forward-looking behaviour becomes more important after oil price shocks, and inflation persistence decreases as a result. The difference between the two sets of results may be due to weak instruments. Alternatively, given that the CU-GMM seems to suffer smaller bias in the finite sample than the 2-step GMM in the presence of weak instruments, it is more likely that the structural instability of the hybrid NKPC is captured by the CU-GMM estimates.

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    Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 12/20.

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    Date of creation: Oct 2012
    Handle: RePEc:lec:leecon:12/20
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