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Modelling Inflation in Australia

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Author Info

  • David Norman

    (Reserve Bank of Australia)

  • Anthony Richards

    (Reserve Bank of Australia)

Abstract

This paper estimates a range of single-equation models of inflation for Australia. We find that traditional models, such as the expectations-augmented standard Phillips curve or mark-up models, outperform the more micro-founded New-Keynesian Phillips curve (NKPC) in explaining trimmed mean inflation, both in terms of in-sample fit and significance of coefficients. This in large part reflects the weak instruments problem in the estimation of the NKPC, and is partly corrected by including a direct measure of inflation expectations, but we still find that the unemployment rate or growth in marginal costs (unit labour cost and import prices) provides a better fit than either the output gap or level of real marginal costs. These traditional models also perform well in out-of-sample tests, relative to alternative models and some common benchmarks, with the standard Phillips curve clearly superior to these benchmarks on this test. As inflation has become better anchored and hence less variable, the magnitude of the errors of the single-equation models has declined, although the explanatory power (in terms of R-squared) has fallen together with this greater stability. We also investigate the empirical importance of some other variables that are commonly cited as determinants of inflation, and find little evidence that either commodity prices or the growth rate of money directly influence Australian underlying inflation.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2010-03.

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Date of creation: Jun 2010
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Handle: RePEc:rba:rbardp:rdp2010-03

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Related research

Keywords: inflation; modelling;

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References

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  1. Ken Kuttner & Tim Robinson, 2008. "Understanding the Flattening Phillips Curve," RBA Research Discussion Papers rdp2008-05, Reserve Bank of Australia.
  2. David Gruen & Adrian Pagan & Christopher Thompson, 1999. "The Phillips Curve in Australia," RBA Research Discussion Papers rdp1999-01, Reserve Bank of Australia.
  3. David Gruen & Tim Robinson & Andrew Stone, 2002. "Output Gaps in Real Time: Are They Reliable Enough to Use for Monetary Policy?," RBA Research Discussion Papers rdp2002-06, Reserve Bank of Australia.
  4. Gunnar B�Rdsen & Stan Hurn & Zo� Mchugh, 2007. "Modelling Wages and Prices in Australia," The Economic Record, The Economic Society of Australia, vol. 83(261), pages 143-158, 06.
  5. Alexandra Heath & Ivan Roberts & Tim Bulman, 2004. "Inflation in Australia: Measurement and Modelling," RBA Annual Conference Volume, in: Christopher Kent & Simon Guttmann (ed.), The Future of Inflation Targeting Reserve Bank of Australia.
  6. Kristoffer Nimark & Jarkko Jääskelä, 2008. "A medium-scale open economy model of Australia," Economics Working Papers 1210, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Michael B. Devereux & Charles Engel, 2001. "Endogenous Currency of Price Setting in a Dynamic Open Economy Model," NBER Working Papers 8559, National Bureau of Economic Research, Inc.
  8. Macallan, Clare & Millard, Stephen & Parker, Miles, 2008. "The cyclicality of mark-ups and profit margins for the United Kingdom: some new evidence," Bank of England working papers 351, Bank of England.
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Cited by:
  1. Elaine Chung & Marion Kohler & Christine Lewis, 2011. "The Exchange Rate and Consumer Prices," RBA Bulletin, Reserve Bank of Australia, pages 9-16, September.
  2. Ivan Kitov & Oleg Kitov, 2011. "The Australian Phillips curve and more," Papers 1102.1851, arXiv.org.

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