Modelling Inflation in Australia
AbstractThis 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 InfoPaper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2010-03.
Date of creation: Jun 2010
Date of revision:
Find related papers by JEL classification:
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-07-17 (All new papers)
- NEP-CBA-2010-07-17 (Central Banking)
- NEP-MON-2010-07-17 (Monetary Economics)
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