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The New Keynesian Hybrid Phillips Curve: An Assessment of Competing Specifications for the United States

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  • David Dupuis
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    Abstract

    Inflation forecasting is fundamental to monetary policy. In practice, however, economists are faced with competing goals: accuracy and theoretical consistency. Recent work by Fuhrer and Moore (1995), Galí and Gertler (1999), Galí, Gertler, and Lopez-Salido (2001), Sbordone (2002), and Kozicki and Tinsley (2002a, b) suggests that the two objectives need not be mutually exclusive in the context of inflation forecasts. The New Keynesian Phillips curve is theoretically appealing, because its purely forward-looking specification is based on a model of optimal pricing behaviour with rational expectations. This specification, however, does not properly capture observed inflation persistence. The author estimates three structural models of U.S. inflation that incorporate price frictions to justify the presence of lags in the forward-looking New Keynesian Phillips curve. The models, based on Galí and Gertler (1999) and Kozicki and Tinsley (2002a, b), are tested on the basis of forecast performances. The results show that the new Keynesian hybrid Phillips curve with the output gap as an explanatory variable performs marginally better than the two alternative specifications.

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    Bibliographic Info

    Paper provided by Bank of Canada in its series Working Papers with number 04-31.

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    Length: 36 pages
    Date of creation: 2004
    Date of revision:
    Handle: RePEc:bca:bocawp:04-31

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    Keywords: Inflation and prices; Economic models;

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    References

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    1. Robert G. King & Alexander L. Wolman, 1996. "Inflation Targeting in a St. Louis Model of the 21st Century," NBER Working Papers 5507, National Bureau of Economic Research, Inc.
    2. P.A. Tinsley, 1993. "Fitting both data and theories: polynomial adjustment costs and error- correction decision rules," Finance and Economics Discussion Series 93-21, Board of Governors of the Federal Reserve System (U.S.).
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    8. F. Brayton & P. Tinsley, 1996. "A guide to FRB/US: a macroeconomic model of the United States," Finance and Economics Discussion Series 96-42, Board of Governors of the Federal Reserve System (U.S.).
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    10. Dixit, Avinash K & Stiglitz, Joseph E, 1977. "Monopolistic Competition and Optimum Product Diversity," American Economic Review, American Economic Association, vol. 67(3), pages 297-308, June.
    11. Andrew Rennison, 2003. "Comparing Alternative Output-Gap Estimators: A Monte Carlo Approach," Working Papers 03-8, Bank of Canada.
    12. Flint Brayton & Eileen Mauskopf & David Reifschneider & Peter Tinsley & John Williams, 1997. "The role of expectations in the FRB/US macroeconomic model," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Apr, pages 227-245.
    13. Wickens, Michael R., 1996. "Interpreting cointegrating vectors and common stochastic trends," Journal of Econometrics, Elsevier, vol. 74(2), pages 255-271, October.
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    15. Sharon Kozicki & P.A. Tinsley, 2001. "Dynamic specifications in optimizing trend-deviation macro models," Research Working Paper RWP 01-03, Federal Reserve Bank of Kansas City.
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    Cited by:
    1. Balfoussia, Hiona & Brissimis, Sophocles & Delis, Manthos D, 2011. "The theoretical framework of monetary policy revisited," MPRA Paper 32236, University Library of Munich, Germany.
    2. Masso, Jaan & Staehr, Karsten, 2005. "Inflation dynamics and nominal adjustment in the Baltic States," Research in International Business and Finance, Elsevier, vol. 19(2), pages 281-303, June.
    3. Juan José Echavarría S. & Enrique López E. & Martha Misas A., 2010. "La persistencia estadística de la inflación en Colombia," BORRADORES DE ECONOMIA 007573, BANCO DE LA REPÚBLICA.

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