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The New Keynesian Model and the Long-run Vertical Phillips Curve: Does it hold for Germany?

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Author Info
Ulrich Fritsche () (Department for Economics and Politics, University of Hamburg, and DIW Berlin)
Jan Gottschalk () (International Monetary Fund)

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Abstract

New-Keynesian macroeconomic models typically assume that any long-run trade-off between inflation and unemployment is ruled out. While this appears to be a reasonable characterization of the US economy, it is less clear that the natural rate hypothesis necessarily holds in a European country like Germany where hysteretic effects may invalidate it. Inspired by the framework developed by Farmer (2000) and Beyer and Farmer (2002), we investigate the long-run relationships between the interest rate, unemployment and inflation in West Germany from the early 1960s up to 2004 using a multivariate co-integration analysis technique. The results point to a structural break in the late 1970s. In the later time period we find for west Germany data a strong negative correlation between the trend components of inflation and unemployment. We show that this finding contradicts the natural rate hypothesis, introduce a version of the New Keynesian model which allows for some hysteresis and compare the effectiveness of monetary policy in these two models. In general, a policy rule with an aggressive response to a rise in unemployment performs better in a model with hysteretic characteristics than in a model without.

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File URL: http://www.wiso.uni-hamburg.de/hepdoc/macppr_1_2006.pdf
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Publisher Info
Paper provided by Hamburg University, Department Wirtschaft und Politik in its series Macroeconomics and Finance Series with number 200601.

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Length: 45 pages
Date of creation: Apr 2006
Date of revision:
Handle: RePEc:hep:macppr:200601

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Web page: http://www.wiso.uni-hamburg.de/dwp
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Related research
Keywords: Cointegration; Vector error Correction Model; Unemployment; Phillips Curve; Hysteresis;

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Find related papers by JEL classification:
B22 - Schools of Economic Thought and Methodology - - History of Economic Thought since 1925 - - - Macroeconomics
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
E24 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Ulrich Fritsche & Vladimir Kuzin, 2007. "Unit Labor Cost Growth Differentials in the Euro Area, Germany, and the US: Lessons from PANIC and Cluster Analysis," Discussion Papers of DIW Berlin 667, DIW Berlin, German Institute for Economic Research. [Downloadable!]
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