It is often argued that the New Keynesian Phillips curve is at odds with the data because itcannot explain inflation persistence — the difficulty of returning inflation immediately totarget after a shock without any loss of output. This paper explains how a model where newerprices are stickier than older prices is consistent with this phenomenon, even though itintroduces no deviation from optimizing, forwards-looking price setting. The probability ofadjusting new and old prices is estimated using a novel method that draws only onmacroeconomic data, and the findings strongly support the premise of the model.
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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number
dp0837.
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