Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?

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Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?

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Jeremy Rudd
Karl Whelan

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Karl T. Whelan

Abstract

The canonical inflation specification in sticky-price rational expectations models (the new-Keynesian Phillips curve) is often criticized for failing to account for the dependence of inflation on its own lags. In response, many studies employ a "hybrid" specification in which inflation depends on its lagged and expected future values, together with a driving variable such as the output gap. We consider some simple tests of the hybrid model that are derived from its closed form. We find that the hybrid model describes inflation dynamics poorly, and find little empirical evidence for the type of rational, forward-looking behavior that the model implies.

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 96 (2006)
Issue (Month): 1 (March)
Pages: 303-320
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Handle: RePEc:aea:aecrev:v:96:y:2006:i:1:p:303-320

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Paper
- Jeremy Rudd & Karl Whelan, 2003. "Can rational expectations sticky-price models explain inflation dynamics?," Finance and Economics Discussion Series 2003-46, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
- Karl Whelan & Jeremy Rudd, 2003. "Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?," Computing in Economics and Finance 2003 181, Society for Computational Economics.

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