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Time Varying U.S. Inflation Dynamics and the New Keynesian Phillips Curve

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  • Kevin Lansing

    (Federal Reserve Bank of San Francisco)

Abstract

This paper introduces a form of boundedly-rational inflation expectations in the New Keynesian Phillips curve. The representative agent is assumed to behave as an econometrician, employing a time series model for inflation that allows for both permanent and temporary shocks. The near-unity coefficient on expected inflation in the Phillips curve causes the agent's perception of a unit root in inflation to become close to self-fulfilling. In a "consistent expectations equilibrium," the value of the Kalman gain parameter in the agent's forecast rule is pinned down using the observed autocorrelation of inflation changes. The forecast errors observed by the agent are close to white noise, making it difficult for the agent to detect a misspecification of the forecast rule. I show that this simple model of inflation expectations can generate time-varying persistence and volatility that is broadly similar to that observed in long-run U.S. data. Model-based values for expected inflation track well with movements in survey-based measures of U.S. expected inflation. In numerical simulations, the model can generate pronounced low-frequency swings in the level of inflation that are driven solely by expectational feedback, not by changes in monetary policy. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 12 (2009)
Issue (Month): 2 (April)
Pages: 304-326

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Handle: RePEc:red:issued:07-129

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Keywords: Inflation expectations; Phillips curve; Time-varying persistence and volatility;

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Cited by:
  1. Hommes, C.H. & Zhu, M., 2012. "Behavioral Learning Equilibria," CeNDEF Working Papers, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance 12-09, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  2. Lansing, Kevin J., 2012. "Speculative growth, overreaction, and the welfare cost of technology-driven bubbles," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 83(3), pages 461-483.
  3. Lena Dräger, 2011. "Endogenous Persistence with Recursive Inattentiveness," KOF Working papers, KOF Swiss Economic Institute, ETH Zurich 11-285, KOF Swiss Economic Institute, ETH Zurich.
  4. Hommes, C.H., 2013. "Behaviorally Rational Expectations and Almost Self-Fulfilling Equilibria," CeNDEF Working Papers, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance 13-17, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  5. Davis, Scott & Mack, Adrienne, 2013. "Cross-country variation in the anchoring of inflation expectations," Staff Papers, Federal Reserve Bank of Dallas, Federal Reserve Bank of Dallas, issue Oct.
  6. Scott Davis, 2012. "The Effect of Commodity Price Shocks on Underlying Inflation: The Role of Central Bank Credibility," Working Papers, Hong Kong Institute for Monetary Research 272012, Hong Kong Institute for Monetary Research.
  7. Cars Hommes, 2013. "Behaviorally Rational Expectations and Almost Self-Ful lling Equilibria," Tinbergen Institute Discussion Papers, Tinbergen Institute 13-204/II, Tinbergen Institute.
  8. Branch, William A. & McGough, Bruce, 2009. "A New Keynesian model with heterogeneous expectations," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(5), pages 1036-1051, May.
  9. Paul Castillo & Alberto Humala & Vicente Tuesta, 2007. "Monetary Policy, Regime Shifts, and Inflation Uncertainty in Peru (1949-2006)," Working Papers, Banco Central de Reserva del Perú 2007-005, Banco Central de Reserva del Perú.

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