Introductory Econometrics: A Modern Approach 6th Edition by Jeffrey M Wooldridge

Exercise 13

Use the data in PHILLIPS.RAW for this exercise.

(i) In Example 11.5, we estimated an expectations augmented Phillips curve of the form

?inft =?0 + ?1unemt + et,

where ?inft = inft — inftt-1. In estimating this equation by OLS, we assumed that the supply shock, et, was uncorrelated with unemt. If this is false, what can be said about the OLS estimator of i1?

(ii) Suppose that et is unpredictable given all past information: E(et inft-1, unemt-1, ...) = 0. Explain why this makes unemt-1 a good IV candidate for unemt.

(iii) Regress unemt on unemt-1. Are unemt and unemt—l significantly correlated?

(iv) Estimate the expectations augmented Phillips curve by IV. Report the results in the usual form and compare them with the OLS estimates from Example 11.5.

Step 1 of 5

(i)

The expected-augmented Phillips curve of the form:

When this equation is estimated using OLS despite being correlated with, the OLS estimator of is considered biased and inconsistent