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The Phillips curve under state-dependent pricing

  • Bakhshi, Hasan
  • Khan, Hashmat
  • Rudolf, Barbara

This paper is related to a large recent literature studying the Phillips curve in sticky-price equilibrium models. It differs in allowing for the degree of price stickiness to be determined endogenously. A closed-form solution for short-term inflation is derived from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing originally developed by Dotsey, King and Wolman. This generalised Phillips curve encompasses the New Keynesian Phillips curve (NKPC) based on Calvo-type price-setting as a special case. It describes current inflation as a function of lagged inflation, expected future inflation, and current and expected future real marginal costs. The paper demonstrates that inflation dynamics generated by the model for a broad class of time and state-dependent price-setting behaviours are well approximated by the popular hybrid NKPC (with one lag of inflation) in a low-inflation environment. This provides an explanation of why the hybrid NKPC performs well in describing inflation dynamics across industrial countries. It implies, however, that the reduced-form coefficients of the hybrid NKPC may not have a structural interpretation

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 8 (November)
Pages: 2321-2345

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Handle: RePEc:eee:moneco:v:54:y:2007:i:8:p:2321-2345
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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