Research Discussion Paper – RDP 2013-11 Issues in Estimating New-Keynesian Phillips Curves in the Presence of Unknown Structural Change Abstract

Structural change has been conjectured to lead to an upward bias in the estimated forward expectations coefficient in New-Keynesian Phillips curves. We present a simple New-Keynesian model that enables us to assess this proposition. In particular, we investigate the issue of upward bias in the estimated coefficients of the expectations variable in the New-Keynesian Phillips curve based on a model where we can see what causes the structural breaks and how to control for them. We find that structural breaks in the means of the series can often change the properties of instruments a great deal, and may well be a bigger source of small-sample bias than that due to specification error. Moreover, we also find that the direction of the specification bias is not predictable. It is necessary to check for weak instruments before deciding that the magnitude of any estimator bias reflects specification errors coming from structural change.

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