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The Canadian Phillips Curve and Regime Shifting

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  • Frédérick Demers

Abstract

Phillips curves are generally estimated under the assumption of linearity and parameter constancy. Linear models of inflation, however, have recently been criticized for their poor forecasting performance. The author investigates the linearity and constancy assumptions of a standard reduced-form Phillips curve for Canada using two different techniques: (i) the methodology proposed by Bai and Perron (1998), which allows for an unknown number of breaks at unknown dates, and (ii) a three-regimes Markov-switching regression model. Both methodologies strongly reject the linearity and parameter constancy assumptions. The author finds that the output-inflation relationship does not hold under the current monetary policy of inflation targeting, with its low and stable inflation. Since the inflation-control targets were adopted, inflation expectations appear to be more forward looking and well anchored at 2 per cent, the official target rate. Core inflation exhibits very low persistence and there do not appear to be significant asymmetries in the inflation response to output-gap shocks within regimes. Generalized impulse responses are computed to illustrate some properties of the Markov-switching Phillips curve model.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 03-32.

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Length: 34 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:bca:bocawp:03-32

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References

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  1. Gabriel Rodriguez, 2001. "Estimation of the Taylor Rule for Canada Under Multiple Structural Changes," Working Papers 0107E, University of Ottawa, Department of Economics.
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  11. Todd E. Clark & Michael W. McCracken, 2003. "The predictive content of the output gap for inflation : resolving in-sample and out-of-sample evidence," Research Working Paper RWP 03-06, Federal Reserve Bank of Kansas City.
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Citations

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Cited by:
  1. Calista Cheung & Frédérick Demers, 2007. "Evaluating Forecasts from Factor Models for Canadian GDP Growth and Core Inflation," Working Papers 07-8, Bank of Canada.
  2. Todd E. Clark & Michael W. McCracken, 2003. "The predictive content of the output gap for inflation : resolving in-sample and out-of-sample evidence," Research Working Paper RWP 03-06, Federal Reserve Bank of Kansas City.
  3. Islam, Faridul & Shahbaz, Muhammad & Shabbir, Muhammad, 2011. "Phillips curve in a small open economy: A time series exploration of North Cyprus," MPRA Paper 28397, University Library of Munich, Germany.
  4. Parusan Janhorm & Chaipat Poonpatpobul & Pinrat Pongsinsirikul, 2004. "Exploring Inflation in Thailand Through Sectoral Price Settting Behavior and Underlying Trend," Working Papers 2004-03, Economic Research Department, Bank of Thailand.
  5. Christensen, Ian & Frédéric Dion & Christopher Reid, 2004. "Real Return Bonds, Inflation Expectations, and the Break-Even Inflation Rate," Working Papers 04-43, Bank of Canada.
  6. David Jamieson Bolder & Simon Deeley, 2011. "The Canadian Debt-Strategy Model: An Overview of the Principal Elements," Discussion Papers 11-3, Bank of Canada.
  7. Robert Amano & Steve Ambler & Nooman Rebei, 2006. "The Macroeconomic Effects of Non-Zero Trend Inflation," Working Papers 06-34, Bank of Canada.
  8. David Bolder & Shudan Liu, 2007. "Examining Simple Joint Macroeconomic and Term-Structure Models: A Practitioner's Perspective," Working Papers 07-49, Bank of Canada.
  9. Gabriele Galati & William R. Melick, 2006. "The evolving inflation process: an overview," BIS Working Papers 196, Bank for International Settlements.
  10. Jean-Philippe Cayen & Marc-André Gosselin & Sharon Kozicki, 2009. "Estimating DSGE-Model-Consistent Trends for Use in Forecasting," Working Papers 09-35, Bank of Canada.
  11. André Binette & Sylvain Martel, 2005. "Inflation and Relative Price Dispersion in Canada: An Empirical Assessment," Working Papers 05-28, Bank of Canada.
  12. Jamie Armour, 2006. "An Evaluation of Core Inflation Measures," Working Papers 06-10, Bank of Canada.
  13. Mikael Khan & Louis Morel & Patrick Sabourin, 2013. "The Common Component of CPI: An Alternative Measure of Underlying Inflation for Canada," Working Papers 13-35, Bank of Canada.
  14. Kevin Clinton, 2006. "Core inflation at the Bank of Canada: A critique," Working Papers 1077, Queen's University, Department of Economics.
  15. Marc-André Gosselin & René Lalonde, 2006. "An Eclectic Approach to Estimating U.S. Potential GDP," Empirical Economics, Springer, vol. 31(4), pages 951-975, November.
  16. Frédérick Demers & Annie De Champlain, 2005. "Forecasting Core Inflation in Canada: Should We Forecast the Aggregate or the Components?," Working Papers 05-44, Bank of Canada.

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