Economic Models - Convex Optimization

Inflation Control in Central and Eastern European Countries 185
the literature. The reader may then want to consider the estimates and the
statistics computed on the estimated parameters more as general indications
in small samples (especially, if the sub-sample 1998–2004 only is used),
but we think that despite these drawbacks, the estimates and the tests do
still provide some information on the structure that we intend to analyze,
albeit an approximate one.
Autocorrelation in the residuals is a serious mis-specification since it
results in inconsistent estimates given that both the equations include a
lagged dependent variable. Heteroskedasticity is a minor problem, because
estimation is simply inefficient (compared to the GLS estimator) but not
inconsistent. Yet, since the standard errors indicated by the regression are
not correct, evidence of heteroskedasticity requires at least a different estimation
of the variance-co-variance matrix of the estimates.
Due to the peculiarity of the transition, we think it is particularly important
to control the parameter stability over time, and possibly to model it
when apparent. We used as preliminary diagnostic the CUSUM squared
test, but also considered as a particular breakpoint in 1998, because of the
opening of the negotiation to access the EU. Clearly, this is just a broad
indication: one could also argue that by that time the negotiation opened
the transition to a market economy was already nearly complete, and the
issue was convergence to the EU standards. Yet, that period may still be
informative about a potential break even if it was not located exactly there.
We also considered country-specific breakpoints in the PC equations to
analyze the effect on the inflation dynamics of monetary regime changes:
for Germany, we allowed a break in 1999Q1, when the control of monetary
policy was transferred from the Bundesbank to the ECB, because it may
have been perceived as a weakening of the anti-inflationary stance, inducing
higher inflationary expectations; for Poland, we considered a break in
2000Q2, when the exchange rate commitment was formally abandoned;
for Slovenia, the change is in 2001Q1, when the approach towards the real
exchange rate became effective. We tested the presence of the break with a
standard Chow test, unless the sample after the break was very little, in this
case we used the Forecast test, which is exactly designed to test for breaks
when only a little data are located after the break.
If the model was correctly specified and stable, we improved the efficiency
of the estimates by removing the variables whose coefficients were
estimated with a sign opposite to the one prescribed in the economic theory
(we assumed that α y , α q , β y , β w , β q , β r are not negative), and by imposing
other restrictions (including ∑ 4
j=1 α πj = 1): we tested these with a Wald
statistic, and referred to these tests as W in the tables.