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Issues in Estimating New Keynesian Phillips Curves in the Presence of Unknown Structural Change

  • Mariano Kulish

    ()

    (UNSW)

  • Adrian Pagan

    ()

    (University of Sydney)

Many papers which have estimated models with forward looking expectations have reported that the magnitude of the coefficients of the expectations term is very large when compared with the effects coming from past dynamics. This has sometimes been regarded as implausible and led to the feeling that the expectations coefficient is biased upwards. A relatively general argument that has been advanced is that the bias could be due to structural changes in the means of the variables entering the structural equation. An alternative explanation is that the bias comes from weak instruments. In this paper we investigate the issue of upward bias in the estimated coefficients of the expectations variable based on a model where we can see what causes the breaks and how to control for them. We conclude that weak instruments are the most likely cause of any bias and note that structural change can affect the quality of instruments. We also look at some empirical work in Castle et al. (2011) on the NK Phillips curve in the Euro Area and U.S, assessing whether the smaller coefficient on expectations that Castle et al. (2011) highlight is due to structural change. Our conclusion is that it is not. Instead it comes from their addition of variables to the NKPC. After allowing for the fact that there are weak instruments in the estimated re-specified model it would seem that the forward coefficient estimate is actually quite high rather than low.

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File URL: http://www.ncer.edu.au/papers/documents/WP94.pdf
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Paper provided by National Centre for Econometric Research in its series NCER Working Paper Series with number 94.

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Date of creation: 08 Oct 2013
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Handle: RePEc:qut:auncer:2013_6
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  1. Leandro M. Magnusson & Sophocles Mavroeidis, 2009. "Identification-Robust Minimum Distance Estimation of the New Keynesian Phillips Curve," Working Papers 0904, Tulane University, Department of Economics.
  2. Nymoen, Ragnar & L. Castle, Jennifer & A. Doornik, Jurgen & F. Hendry, David, 2010. "Testing the Invariance of Expectations Models of Inflation," Memorandum 21/2010, Oslo University, Department of Economics.
  3. Mariano Kulish & Adrian Pagan, 2014. "Estimation and Solution of Models with Expectations and Structural Changes," CAMA Working Papers 2014-15, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. Bill Russell & Anindya Banerjee & Issam Malki & Natalia Ponomareva, 2010. "A Multiple Break Panel Approach to Estimating United States Phillips Curves," Discussion Papers 10-14, Department of Economics, University of Birmingham.
  5. Sophocles Mavroeidis, 2004. "Weak Identification of Forward-looking Models in Monetary Economics," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 66(s1), pages 609-635, 09.
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