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The New Keynesian Phillips Curve of rational expectations: A serial correlation extension

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Abstract

This paper evaluates the empirical validity of the New Keynesian Phillips Curve (NKPC) model of rational expectations. We employ an instrumental variable (IV) projection method to approximate inflation expectations, and show that the inference based on this approach can differ significantly from the one based on rational expectations. More importantly, using an IV test for serial correlation in the GMM context, we find that the error term in the stylized NKPC model is significantly serially correlated. To compensate for the serial correlation problem, we propose an extended framework which can be easily rationalized in terms of sticky price setting of backward-looking firms. Empirical results show that further lags of inflation are needed in the hybrid specification of the NKPC in order to rule out serial correlation in the Euler equation.

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Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

Volume (Year): XIII (2010)
Issue (Month): (May)
Pages: 159-179

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Handle: RePEc:cem:jaecon:v:13:y:2010:n:1:p:159-179

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Keywords: NKPC; GMM; serial correlation; monetary policy;

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Cited by:
  1. Malikane, Christopher, 2013. "A New Keynesian Triangle Phillips Curve," MPRA Paper 43548, University Library of Munich, Germany.
  2. Malikane, Christopher, 2012. "The Microfoundations of the Keynesian Wage-Price Spiral," MPRA Paper 42923, University Library of Munich, Germany, revised 2012.
  3. Zorica Mladenović & Aleksandra Nojković, 2012. "Inflation Persistence in Central and Southeastern Europe: Evidence from Univariate and Structural Time Series Approaches," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 59(2), pages 235-266, May.
  4. Sophocles Mavroeidis & Mikkel Plagborg-Møller & James H. Stock, . "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve," Working Paper 84656, Harvard University OpenScholar.

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