The Phillips curve, parameter instability and the Lucas critique

Abstract

Empirical estimation of Phillips curve relationships typically indicates the presence of parameter instability. This is argued to be due to the fact that the parameters of these equations are reduced form rather than structural parameters. Estimation of a Phillips curve model by methods which allow for time-varying parameters permits investigation of the nature and timing of the structural breaks which generate instability. This paper estimates such a model by the Kalman filter using quarterly data over the period 1972.4 to 1993.3. We find evidence of a gradual decline in the private sector's assessment of the steady-state inflation rate during the 1980s, but little evidence of the sort of dramatic regime shift predicted by some of the more extreme rational expectations models.