Consider the following Phillips-type model of money-wage and price determination:
where W = rate of change of money wages UN = unemployment rate, % P = rate of change of prices R= rate of change of cost of capital M = rate of change of price of imported raw material t = time U|, u2 = stochastic disturbances
Since the price variable P enters into the wage equation and the wage variable W enters into the price equation, the two variables are jointly dependent. Therefore, these stochastic explanatory variables are expected to be correlated with the relevant stochastic disturbances, once again rendering the classical OLS method inapplicable to estimate the parameters of the two equations individually.
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