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Trend instrumental variable regression with an application to the US New Keynesian Phillips Curve

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  • Chen, Zhihong
  • Xia, Huizhu

Abstract

When a linear model suffers from endogeneity, a conventional solution is to use external instrumental variables. Sometimes, however, there are either no suitable external IVs or they are of poor quality. This paper constructs an internal instrumental variable from the time trend in the endogenous regressor without using any external IVs. We show that under some mild conditions this new trend IV estimator has desirable asymptotic properties, and also provide a robust Durbin-Wu-Hausman specification test to demonstrate the necessity of the IV method. Monte Carlo simulations show that the estimator and the test have good finite sample performance. In the end, we apply the trend IV estimator to the US New Keynesian Phillips Curve and find that it works as well as the usual external IVs in the literature.

Suggested Citation

  • Chen, Zhihong & Xia, Huizhu, 2020. "Trend instrumental variable regression with an application to the US New Keynesian Phillips Curve," Economic Modelling, Elsevier, vol. 93(C), pages 595-604.
    • Handle: RePEc:eee:ecmode:v:93:y:2020:i:c:p:595-604
    DOI: 10.1016/j.econmod.2020.09.003
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    More about this item

    Keywords

    Durbin-Wu-Hausman test; Endogeneity; Instrumental variable; Local linear regression; Local trends; New keynesian phillips curve;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C26 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Instrumental Variables (IV) Estimation
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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