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Inflation Forecasts and the New Keynesian Phillips Curve

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Author Info
Sophocles N. Brissimis (Economic Research Department, Bank of Greece and Department of Economics, University of Piraeus)
Nicholas S. Magginas (Strategy and Economic Research Division, National Bank of Greece)

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Abstract

We examine the ability of the New Keynesian Phillips curve to explain U.S. inflation dynamics when inflation forecasts (from the Federal Reserve’s Greenbook and the Survey of Professional Forecasters) are used as a proxy for inflation expectations. The New Keynesian Phillips curve is estimated against the alternative of the hybrid Phillips curve, which allows for a backward-looking component in the price-setting behavior in the economy. The results are compared with those obtained using actual data on future inflation as conventionally employed in empirical work under the assumption of rational expectations. The empirical evidence provides, in contrast to most of the relevant literature, considerable support for the standard forward-looking New Keynesian Phillips curve when inflation expectations are measured using inflation forecasts that are observable in real time. In this case, lagged-inflation terms become insignificant in the hybrid specification. The evidence in favor of the New Keynesian Phillips curve becomes even stronger when real-time data on lagged inflation are used instead of the final inflation data used in standard specifications. Our work is closely related to the work of Roberts (1997), who used survey measures of inflation expectations in an empirical inflation model and found evidence that it is less-than-perfectly rational expectations and not the underlying structure of the economy that account for the presence of lagged inflation in empirical estimates of the New Keynesian model.

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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 2 (June)
Pages: 1-22
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Handle: RePEc:ijc:ijcjou:y:2008:q:2:a:1

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Find related papers by JEL classification:
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation
E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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Cited by:
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  1. Richard N. Cooper & Michael Bordo & Harold James, 2006. "What About a World Currency? Proposal for a Common Currency among Rich Democracies. One World Money, Then and Now," Working Papers 44, Bank of Greece. [Downloadable!]
  2. Andreas S. Andreou & George A. Zombanakis, 2006. "Computational Intelligence in Exchange-Rate Forecasting," Working Papers 49, Bank of Greece. [Downloadable!]
  3. George Hondroyiannis & P.A.V.B. Swamy & George S. Tavlas, 2007. "The New Keynesian Phillips Curve and Lagged Inflation: A Case of Spurious Correlation?," Working Papers 57, Bank of Greece. [Downloadable!]
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