Structural Changes in Inflation Dynamics: Multiple Breaks at Different Dates for Different Parameters

33 Pages Posted: 13 Oct 2015 Last revised: 2 Dec 2015

See all articles by Yunjong Eo

Yunjong Eo

The University of Sydney - School of Economics

Date Written: November 30, 2015

Abstract

I make inferences about complicated patterns of structural breaks in inflation dynamics. I extend Chib's (1998) approach by allowing multiple parameters such as the unconditional mean, a group of persistence parameters, and/or the residual variance to undergo mutually independent structural breaks at different dates with the different number of breaks. Structural breaks are modeled as abrupt changes to identify potential regime shifts in economic structure such as a long-run inflation target, monetary policy, and price-setting behavior. I consider postwar quarterly U.S. inflation rates based on the CPI and the GDP deflator over the period from 1953:Q1 to 2013:Q4. I find that two inflation measures had distinct structural changes in different parameters as well as at different dates using Bayesian model selection procedures. CPI inflation experienced a dramatic drop in persistence around the early 1980s, but GDP deflator inflation is still persistent. In addition, the residual variance for both inflation measures switched from a low volatility regime to a high volatility regime in the early 1970s, but it returned to another low volatility regime at different dates: the early 1980s for GDP deflator inflation and the early 1990s for CPI inflation. The residual variance for CPI inflation has increased again since the early 2000s, while GDP deflator inflation has remained less volatile. These volatility shifts are confirmed by the empirical results based on the unobserved components model with stochastic volatility. However, I do not find evidence of a structural shift in the unconditional mean. When reviewing the recent literature, considerable controversy exists over the structural break in inflation persistence around the early 1980s but this appears to be dependent on the measures of inflation, as highlighted by the empirical findings in this paper.

Keywords: Bayesian Analysis; Structural Breaks; Multiple-Group Changepoint; Inflation Dynamics; Persistence; UC-SV Model

JEL Classification: C11, C22, E31

Suggested Citation

Eo, Yunjong, Structural Changes in Inflation Dynamics: Multiple Breaks at Different Dates for Different Parameters (November 30, 2015). Available at SSRN: https://ssrn.com/abstract=2673286 or http://dx.doi.org/10.2139/ssrn.2673286

Yunjong Eo (Contact Author)

The University of Sydney - School of Economics ( email )

Social Sciences Building (A02)
Sydney, NSW 2006
Australia

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