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Inflation Forecasts and the New Keynesian Phillips Curve

  • Sophocles N. Brissimis

    (Economic Research Department, Bank of Greece and Department of Economics, University of Piraeus)

  • Nicholas S. Magginas

    (Strategy and Economic Research Division, National Bank of Greece)

We examine the ability of the New Keynesian Phillips curve to explain U.S. inflation dynamics when inflation forecasts (from the Federal Reserve’s Greenbook and the Survey of Professional Forecasters) are used as a proxy for inflation expectations. The New Keynesian Phillips curve is estimated against the alternative of the hybrid Phillips curve, which allows for a backward-looking component in the price-setting behavior in the economy. The results are compared with those obtained using actual data on future inflation as conventionally employed in empirical work under the assumption of rational expectations. The empirical evidence provides, in contrast to most of the relevant literature, considerable support for the standard forward-looking New Keynesian Phillips curve when inflation expectations are measured using inflation forecasts that are observable in real time. In this case, lagged-inflation terms become insignificant in the hybrid specification. The evidence in favor of the New Keynesian Phillips curve becomes even stronger when real-time data on lagged inflation are used instead of the final inflation data used in standard specifications. Our work is closely related to the work of Roberts (1997), who used survey measures of inflation expectations in an empirical inflation model and found evidence that it is less-than-perfectly rational expectations and not the underlying structure of the economy that account for the presence of lagged inflation in empirical estimates of the New Keynesian model.

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Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 2 (June)
Pages: 1-22

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Handle: RePEc:ijc:ijcjou:y:2008:q:2:a:1
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