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Expectation horizon and the Phillips Curve: the solution to an empirical puzzle

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  • Charles R. Nelson

    (Department of Economics, University of Washington, Seattle, Washington, USA)

  • Jaejoon Lee

    (Samsung Research Institute of Finance, Seoul, Korea)

Abstract

Estimates of the slope of the Phillips curve reported in the literature cover a range from roughly − 0.6 to zero depending on specification. Forward-looking specifications, favored by theory, produce the smallest slope estimates. This paper addresses this puzzle by studying the bivariate process of inflation and unemployment in a fairly general unobserved components framework allowing for stochastic trends and related cycles. Analysis reveals that the slope of the implied Phillips curve will depend critically on the horizon of the forward-looking inflation expectation provided the cyclical component of unemployment is highly persistent. Empirical analysis results show that is the case, suggesting that the choice of expectation horizon, generally set at one quarter in the New Keynesian literature, may play an important role in this debate. Copyright © 2007 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 22 (2007)
Issue (Month): 1 ()
Pages: 161-178

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Handle: RePEc:jae:japmet:v:22:y:2007:i:1:p:161-178

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References

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  1. Thomas Laubach, 1997. "Measuring the NAIRU : evidence from seven economies," Research Working Paper 97-13, Federal Reserve Bank of Kansas City.
  2. Arturo Estrella & Jeffrey C. Fuhrer, 2002. "Dynamic Inconsistencies: Counterfactual Implications of a Class of Rational-Expectations Models," American Economic Review, American Economic Association, vol. 92(4), pages 1013-1028, September.
  3. Mark Gertler & Jordi Gali & Richard Clarida, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December.
  4. Robert G. King & Mark W. Watson, 1994. "The post-war U.S. Phillips curve: a revisionist econometric history," Working Paper Series, Macroeconomic Issues 94-14, Federal Reserve Bank of Chicago.
  5. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  6. Jeffrey C. Fuhrer, 1995. "The Phillips curve is alive and well," New England Economic Review, Federal Reserve Bank of Boston, issue Mar, pages 41-56.
  7. James C. Morley & Charles Nelson & Eric Zivot, 2000. "Why Are Beveridge-Nelson and Unobserved-Component Decompositions of GDP So Different?," Discussion Papers in Economics at the University of Washington 0013, Department of Economics at the University of Washington.
  8. Roberts, John M, 1995. "New Keynesian Economics and the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(4), pages 975-84, November.
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Citations

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Cited by:
  1. Dees, Stephane & Pesaran, M. Hashem & Smith, L. Vanessa & Smith, Ron P., 2008. "Identification of New Keynesian Phillips Curves from a Global Perspective," IZA Discussion Papers 3298, Institute for the Study of Labor (IZA).
  2. Ron Smith & M. Hashem Pesaran, 2007. "Monetary Policy Transmission and the Phillips Curve in a Global Context," Kiel Working Papers 1366, Kiel Institute for the World Economy.
  3. Chang-Jin Kim & Pym Manopimoke & Charles R. Nelson, 2013. "Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve," Discussion Paper Series 1305, Institute of Economic Research, Korea University.
  4. T. Berger, 2008. "Estimating Europe’s Natural Rates from a forward-looking Phillips curve," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 08/498, Ghent University, Faculty of Economics and Business Administration.
  5. Juselius, Mikael, 2008. "Testing the New Keynesian Model on U.S. and Euro Area Data," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 2(24), pages 1-26.
  6. Winkelried, Diego, 2013. "Modelo de Proyección Trimestral del BCRP: Actualización y novedades," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 9-60.
  7. Tino Berger, 2011. "Estimating Europe’s natural rates," Empirical Economics, Springer, vol. 40(2), pages 521-536, April.
  8. Kajuth, Florian, 2012. "Identifying the Phillips curve through shifts in volatility," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 975-991.
  9. Norden, Simon van & Tian, Jing & Jacobs, Jan & Dungey, Mardi, 2012. "On trend-cycle decomposition and data revision," Research Report 12009-EEF, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  10. Lahiri, Kajal & Sheng, Xuguang, 2008. "Evolution of forecast disagreement in a Bayesian learning model," Journal of Econometrics, Elsevier, vol. 144(2), pages 325-340, June.

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