Use the data in PHILLIPS.RAW for this exercise, but only through 1996.
(i) In Example 11.5, we assumed that the natural rate of unemployment is constant. An alternative form of the expectations augmented Phillips curve allows the natural rate of unemployment to depend on past levels of unemployment. In the simplest case, the natural rate at time t equals unemt-1.If we assume adaptive expectations, we obtain a Phillips curve where inflation and unemployment are in first differences:
(inf = (0 + (1 (unem + u.
Estimate this model, report the results in the usual form, and discuss the sign, size, and statistical significance of 1.
(ii) Which model fits the data better, (11.19) or the model from part (i)? Explain.