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Introducing price-setting behaviour in the Phillips Curve: the role of nonlinearities

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  • Saglio, Sophie
  • López-Villavicencio, Antonia

Abstract

Based on the theoretical literature on price setting behavior, we model three distinct forms of nonlinearity that can describe the reduced-form Phillips curve: reaction asymmetry, state dependence and a mix of both. Employing these models to the G5 for the 1985-2011 period, we find that: (i) the Phillips curve is unstable and nonlinear and (ii) there exist threshold levels of inflation and capacity utilization that erode price rigidity. Our results reinforce the existence of downward price rigidity in Japan, helping to explain the puzzle of gradual deflation. In opposition, downward price flexibility is verified for U.S.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 46646.

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Date of creation: 11 Dec 2012
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Handle: RePEc:pra:mprapa:46646

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Keywords: Phillips Curve; deflation; rigidity; capacity constraint; non-linearity;

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  16. Assaf Razin & Alon Binyamini, 2007. "Flattened Inflation-Output Tradeoff and Enhanced Anti-Inflation Policy: Outcome of Globalization?," NBER Working Papers 13280, National Bureau of Economic Research, Inc.
  17. Joseph Stiglitz, 1997. "Reflections on the Natural Rate Hypothesis," Journal of Economic Perspectives, American Economic Association, vol. 11(1), pages 3-10, Winter.
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