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Applied Economics LettersPublication details, including instructions for authors and subscription information:http://www.tandfonline.com/loi/rael20

Structural breaks in the US inflation processMohamed Safouane Ben Aïssa a & Jamel Jouini ba GREQAM and CEDERS, Université de la Méditerranée and Université de Paris X-Nanterreb GREQAM, Université de la MéditerranéePublished online: 06 Oct 2010.

To cite this article: Mohamed Safouane Ben Aïssa & Jamel Jouini (2003) Structural breaks in the US inflation process,Applied Economics Letters, 10:10, 633-636, DOI: 10.1080/1350485032000136360

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Structural breaks in the US

inflation process

MOHAMED SAFOUANE BEN AISSA* and JAMEL JOUINIy

GREQAM and CEDERS, Universite de la Mediterranee and Universite deParis X-Nanterre, and yGREQAM, Universite de la Mediterranee

The empirical evidence of the instability based on some selection procedures isexplored. The focus is on the problem of choosing the number of structural breaksand their locations for the US inflation series. The obtained results give reason forthinking that they are very significant since they coincide with important facts andeconomic events. They show in particular that the evolution curve of inflation in theUSA was flattened during the last 20 years since it is noted that this reduction inextent of inflation is stable and durable.

I . INTRODUCTION

The econometrics of structural change includes several

innovations, namely tests for structural change, estimation

of the break dates and the number of structural breaks in

the time series. The question of selecting the number of

changes in the level (mean-shifts) or trend of a time series

acquires a capital importance in the literature. Indeed, Yao

(1988), and Yin (1988), Yao and Au (1989) considered a

model with structural change in the level and estimate the

number of mean-shifts using the Bayesian information

criterion. The problem of the number of changes in the

level or trend of a time series has affected the literature

of testing for unit roots. In this context, Perron (1989)

has carried out standard tests of the unit root hypothesis

against trend-stationary alternatives with a break in the

trend occurring at the Great Crash of 1929 or at the 1973

Oil-Price Shock using the Nelson–Plosser macroeconomic

time series and a post-war quarterly real gross national

product series. In the same context, Zivot and Andrews

(1992) considered a variation of Perron’s tests in which

the break date is endogenous.

In this paper the instability problem in the US inflation

is evoked when the change affects the level and the persis-

tence of an autoregressive process of order 1. The number

of breaks that can exist and their locations are estimated

using some selection procedures and it is found that

economic explanations showing why in the dates chose

there are changes in the US inflation process. The secondsection presents the structural change model and theestimation method. Section III defines some selectionprocedures. Section IV presents the results of theseprocedures applied to the US inflation series. It is foundthat the breaks coincide with important internationaleconomic events. The last section concludes the paper.

II . THE MODEL AND ESTIMATORS

Consider the following pure structural change model whereall the coefficients are subject to change:

yt ¼ z0t�j þ ut t ¼ Tj�1 þ 1, . . . ,Tj ð1Þ

for j ¼ 1, . . . ,mþ 1, T0 ¼ 0 and Tmþ1 ¼ T . yt is theobserved dependent variable, zt 2 <

q is a vector of covari-ates, �j is the corresponding vector of coefficients, and ut isthe disturbance. The parameter m is the number of breaks.The break points ðT1, . . . ,TmÞ are explicitly treated asunknown.The estimation method considered is that based on the

least-squares principle proposed by Bai and Perron (1998).For each m-partition ðT1, . . . ,TmÞ, denoted {Tj}, theassociated least-squares estimate of �j is obtained byminimizing the sum of squared residuals

Pmþ1i¼1 �PTi

t¼Ti�1þ1 ð yt � z0t�iÞ2under the constraint that �i 6¼ �iþ1

14 i4mð Þ. Let ��ðfTjgÞ denote the resulting estimate.

Applied Economics Letters ISSN 1350–4851 print/ISSN 1466–4291 online # 2003 Taylor & Francis Ltdhttp://www.tandf.co.uk/journals

DOI: 10.1080/1350485032000136360

Applied Economics Letters, 2003, 10, 633–636

633

*Corresponding author: GREQAM, Centre de la Vieille Charite, 02, Rue de la Charite 13002 Marseille, France. E-mail: benaissa@ehess.cnrs-mrs.fr

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Substituting it in the objective function and denoting theresulting sum of squared residuals as ST ðT1, . . . ,TmÞ, theestimated break dates ðTT1, . . . , TTmÞ are such that

ðTT1, . . . , TTmÞ ¼ arg minðT1,...,TmÞ

ST T1, . . . ,Tmð Þ ð2Þ

where the minimization is taken over all partitionsðT1, . . . ,TmÞ such that Ti � Ti�1 5 h.1 Thus the breakpoint estimators are global minimizers of the objectivefunction. Finally, the regression parameter estimates arethe associated least-squares estimates at the estimatedm-partition fTTjg, i.e. �� ¼ ��ðfTTjgÞ:

III . THE MODEL SELECTION PROCEDURES

A common procedure to select the dimension of a modelis to consider an information criterion. Schwarz (1978)proposed the following criterion:

SICðmÞ ¼ ln ðST ðTT1, . . . , TTmÞ=ðT �mÞÞ þ 2p� ln ðTÞ=T

where p� ¼ ðmþ 1Þ qþm is the number of unknownparameters. Yao (1988) used the Bayesian informationcriterion defined as

BICðmÞ ¼ ln ðST ðTT1, . . . , TTmÞ=TÞ þ p� lnðTÞ=T

He shows that the number of changes estimator mm is con-sistent (at least for normal sequence of random variableswith shifts in mean) for m0, the true number of breaksprovided m0 4M with M a known upper bound for m.

Another criterion proposed by Yao and Au (1989) isgiven by:

YICðmÞ ¼ ln ðST ðTT1, . . . , TTmÞ=TÞ þmCT=T

where {CT} is any sequence satisfying CTT�2=n

! 1 andCT=T ! 0 as T ! 1. The error term is with finite 2nthmoment for any n5 3. In the simulation experiments, thesequence CT ¼ 0:368T0:7 proposed by Liu et al. (1997) isused who suggested a modified Schwarz’ criterion thattakes the form

MICðmÞ ¼ ln ðST ðTT1, . . . , TTmÞ=ðT � p�ÞÞ þ p�c0½lnðTÞ�2þ�0=T

They suggest using �0 ¼ 0:1 and c0 ¼ 0:299 based on theperformance of the estimator of the number of changesobtained by the criterion MIC for various simulationexperiments carried out with several models. Note thatthese information criteria cannot directly take into accountthe presence of serial correlation in the errors. Theestimated number of break dates mm is determined by mini-mizing the above-mentioned information criteria given Ma fixed upper bound for m.

IV. THE US INFLATION RATE

Data and results

Using the post-war monthly US inflation rate (seasonallyadjusted) covering the period 1956:1–2002:9 (yielding 561observations) and obtained from the St. Louis ReserveFederal Bank database, the number of breaks using theselection procedures outlined above (see Fig. 1). To that

1h is the minimal number of observations in each segment (h5 q, not depending on T ).

1960 1965 1970 1975 1980 1985 1990 1995 2000

-0.5

0

0.5

1

1.5

2

Monthly U.S. Inflation

Fig. 1. Monthly US inflation rate (seasonally adjusted) 1956:1–2002:9

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effect, are estimated an AR(1) process with drift is adoptedto describe the time series and the approach is directlyoriented at the issue of looking for multiple structuralchanges in the level and the persistence of the series, i.e.zt ¼ 1, yt�1ð Þ

0

. All the information criteria select three breakpoints (see Table 1).

From these results it is observed that the breaks dates areprecisely estimated since the 95% confidence intervalscover a few months before and after. The second featureis that the results give reason for thinking that they are verysignificant since they coincide with important facts andeconomic events.

Comments

In the United States, as in Britain, inflation began to accel-erate long before the boom in import prices began.Through the mid-1960s President Johnson’s administrationbroadly continued to pursue ‘Keynesian’ policies pre-viously introduced by President Kennedy. The turningpoint is generally taken to have been mid-1965 (seeBlinder, 1979) and the augmentation of defence spendingin connection with the Vietnam War.

In mid-1966 the emerging excessive Strain on resources,with the federal budget deficit on a seasonally adjustednational accounts basis sextupling in less than a year,was countered by higher interest rates and a ‘credit crunch’at the cost of a mini-recession; but at the end of this,continuous inflation finally emerged. By the followingyear the acceleration of inflation observed simultaneouslyin many countries was also unmistakable in the UnitedStates.

In August 1971, President Nixon announced new excep-tional measures. These latters related to the quasi-totalcontrol of prices and wages. Since the 1960, the capacityof policies of demand management and the inflationcontrol became less and less effective. Another reason,according to many authors such as Blinder (1979) andStein (1984), is the desire of President Nixon to carry outa greater popularity by reassuring the American peopleas for the effectiveness of control and the management ofthe country, in the hope of being re-elected in November1972. The fixing of prices continued until January 1973when he started to release them, although fixed pricescontinued in some sectors (in particular the food, health

and construction). However, wages were cold except for

some exceptions and inflation accelerated much in particu-

lar during the summer 1973. And as from August 1973, a

progressive return to the total liberalization of the prices is

noted which occurred in April 1974. The effectiveness of

the policy of the price control was the subject of an intense

empirical research. Gordon (1973) notes that the price

control avoided between 2 and 3,5% of inflation until

January 1973, but considers that since semi-1973 the prices

caught up with themselves compared to the level which

they would have reached without control. Bosworth and

Vroman (1977), by using equations estimated for the

period of price control, estimate that these measures

reduced approximately 0.5% of the annual rate of price

raising. Nadiri and Gupta (1977) also found light reduction

of wages and prices whereas Al Sammarie and Roberts

(1977) found a light effect on the prices but none on the

wages. But it is Blinder (1979) who finds the highest

reduction of the consumer price index of 1.6%. The price

control period was accompanied by an stimulated increase

in demand by the expansionist tax policy implying great

federal deficits. And in the fourth quarter of 1973, OPEC

quadrupled the oil prices which was imported massively by

the United States at that time, causing at the end of 1974, a

generalized increase in the detail prices of energy going up

to 47% and partly explaining the acceleration of the infla-

tion of this period. Moreover, the progressive elimination

of control on prices and wages especially made it possible

that wages catch up with the higher levels by amplifying the

acceleration of American inflation.

In 1981, the USA have known the desinflation wave and

which is known as ‘desinflation of Vockler’ concerning a

new control of the monetary policy. Indeed, before the year

1970, the repercussions of the real shocks on the economy

were regarded as tiny. The considerable fluctuations of oil

prices modified this point of view and led the federal

reserve of the United States to reconsider the implementa-

tion of the monetary policy. In 1977, unemployment was

running at 7%. Total labour costs to employers however,

rose both in January 1978 and in 1979 because of increases

in payroll taxes and the minimum wage, steps were

taken by administrative decision not market process but

widely regarded as constituting almost as powerful an infla-

tionary influence as were cash wage increases themselves.

By 1979 spare capacity was becoming limited and

Table 1. Time series using AR(1) process

Estimators TT1 TT2 TT3

Break dates 1967:5 1973:9 1982:695% C.I.a (1966:3–1967:11) (1973:3–1975:3) (1981:7–1982:12)

Note: aThe confidence intervals of the estimated break dates are obtained using the asymptoticdistribution given in Bai and Perron (1998).

Structural breaks in the US inflation process 635

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production costs were rising at an annual rate of some8%. During 1979–1980, moreover, the price of oil andoil-related products also rose sharply under the spur ofsupply restrictions and rising world demand. In someways the restrictive policies initially adopted to counterthe stagflation of 1979–1980, like some of the main causesat work, followed lines similar to those observed in1974–1975. At a deeper level, however, the two sets ofpolicies differed substantially. Couched primarily in termsof monetary aggregates, the post-1979 policies seemed toembody a willingness to permit, and even to bring about,greater rises in interest rates than did the policies five yearspreviously, and the Federal Reserve’s discount rate at onceedged up to 12%. After the election of Ronald Reagan inNovember 1980, the discount rates were raised to 14% inMay 1981. The tax proposals of the president were totallydifferent than the procedures taken in 1974–1975. PresidentReagan projected great tax cuts. The total effects of theselast measures should have led to the restoration of thefederal budget balance by 1984–1985. The year 1981, wasmarked by the rise of the tax deficit whereas the interestrates were on a rather high level of 9% and unemploymentkept the margin of 8%. Actuated by the bad news comingfrom Mexico which had borrowed heavily and whichstipulated that it doubts to refund its loans to the UnitedStates at the limits envisaged, the American economyembarked on a productivity growth phase supported by adecrease of oil prices and the reduction of the inflation rateof the with approximately 5%, but also by the decelerationof the raising of wages whereas the dollar, under theinfluence of the raised interest rates, attracted the flow offoreign capital, which appreciated approximately 30%.

V. CONCLUSION

In this article the question of the instability of theUS inflation process has been subjected to a meticulousexamination based on some selection procedures.The results obtained are significant since the dates of thebreaks are precisely estimated and coincide with importantinternational economic events. Indeed, they may be linkedto major events in the International Monetary System andthe two Oil-Price Shocks. This paper is then justified by the

aim to find economic explanations showing why in thedates selected there are shifts in the US inflation process.

ACKNOWLEDGEMENTS

We thank Eric Girardin and Mohamed Boutahar for theiruseful comments.

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