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Testing an alternative price-setting behavior in the new Keynesian Phillips curve: Extrapolative price-setting mechanism

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  • Choi, Yoonseok
  • Kim, Sunghyun

Abstract

In this paper, we propose an expanded version of the hybrid NKPC by incorporating the extrapolative price-setting mechanism in the backward-looking part. We assume that when firms set the price at time t, they use information on the price in period t−1 plus a portion of change in prices between t−1 to t−2 (a partial error correction). Under this expanded setting, we explicitly derive both structural and reduced-form NKPCs. The empirical results show that the extrapolative component is strongly significant in explaining inflation dynamics. In addition, the expanded version of the hybrid NKPC exhibits a better empirical performance than the original hybrid NKPC proposed by Galí and Gertler (1999) in terms of various statistical criteria.

Suggested Citation

  • Choi, Yoonseok & Kim, Sunghyun, 2016. "Testing an alternative price-setting behavior in the new Keynesian Phillips curve: Extrapolative price-setting mechanism," International Review of Economics & Finance, Elsevier, vol. 44(C), pages 253-265.
    • Handle: RePEc:eee:reveco:v:44:y:2016:i:c:p:253-265
    DOI: 10.1016/j.iref.2016.02.019
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    More about this item

    Keywords

    Extrapolative price-setting; Inflation dynamics; New Keynesian Phillips curve; Forward-looking; Backward-looking;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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