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Modelling the Phillips curve with unobserved components

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  • Andrew Harvey

Abstract

The relationship between inflation and the output gap can be modelled simply and effectively by including an unobserved random walk component in the model. The dynamic properties match the stylized facts and the random walk component satisfies the properties normally required for core inflation. The model may be generalized so as to include a term for the expectation of next period's output, but it is shown that this is difficult to distinguish from the original specification. The model is fitted as a single equation and as part of a bivariate model that includes an equation for Gross Domestic Product (GDP). Fitting the bivariate model highlights some new aspects of Unobserved Components (UC) modelling. Single equation and bivariate models tell a similar story: an output gap 2% above trend is associated with an annual inflation rate that is 1% above core inflation.

Suggested Citation

  • Andrew Harvey, 2011. "Modelling the Phillips curve with unobserved components," Applied Financial Economics, Taylor & Francis Journals, vol. 21(1-2), pages 7-17.
  • Handle: RePEc:taf:apfiec:v:21:y:2011:i:1-2:p:7-17
    DOI: 10.1080/09603107.2011.523169
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    Cited by:

    1. Kavtaradze, Lasha, 2014. "Inflation Dynamics in Georgia," MPRA Paper 59966, University Library of Munich, Germany.
    2. Altug, Sumru & Çakmaklı, Cem, 2016. "Forecasting inflation using survey expectations and target inflation: Evidence for Brazil and Turkey," International Journal of Forecasting, Elsevier, vol. 32(1), pages 138-153.
    3. Florian Kajuth, 2016. "NAIRU Estimates for Germany: New Evidence on the Inflation–Unemployment Tradeoff," German Economic Review, Verein für Socialpolitik, vol. 17(1), pages 104-125, February.
    4. Sumru Altug & Cem Cakmakli, 2014. "Inflation Targeting and Inflation Expectations: Evidence for Brazil and Turkey," Koç University-TUSIAD Economic Research Forum Working Papers 1413, Koc University-TUSIAD Economic Research Forum.
    5. Macchiarelli, Corrado, 2014. "Bond market co-movements, expected inflation and the GBP-USD equilibrium real exchange rate," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(2), pages 242-256.
    6. Mallick, Debdulal, 2016. "Policy Regimes and the Shape of the Phillips Curve in Australia," MPRA Paper 71082, University Library of Munich, Germany, revised 2016.
    7. Kajuth, Florian, 2012. "Identifying the Phillips curve through shifts in volatility," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 975-991.
    8. Fabio Busetti & Michele Caivano, 2016. "The trend–cycle decomposition of output and the Phillips curve: Bayesian estimates for Italy and the Euro area," Empirical Economics, Springer, vol. 50(4), pages 1565-1587, June.
    9. De la Serve, M-E. & Lemoine, M., 2011. "Measuring the NAIRU: a complementary approach," Working papers 342, Banque de France.
    10. Tallman, Ellis W. & Zaman, Saeed, 2017. "Forecasting inflation: Phillips curve effects on services price measures," International Journal of Forecasting, Elsevier, vol. 33(2), pages 442-457.
    11. Mallick, Debdulal, 2014. "A Spectral Representation of the Phillips Curve in Australia," MPRA Paper 59794, University Library of Munich, Germany.
    12. Basistha, Arabinda & Kurov, Alexander, 2010. "Estimating earnings trend using unobserved components framework," Economics Letters, Elsevier, vol. 107(1), pages 55-57, April.
    13. Alicia N. Rambaldi & Ryan R. J. McAllister & Cameron S. Fletcher, 2015. "Decoupling land values in residential property prices: smoothing methods for hedonic imputed price indices," Discussion Papers Series 549, School of Economics, University of Queensland, Australia.
    14. Fabio Busetti & Michele Caivano, 2013. "The trend-cycle decomposition of output and the Phillips curve: Bayesian estimates for Italy," Temi di discussione (Economic working papers) 941, Bank of Italy, Economic Research and International Relations Area.
    15. Antonio Paradiso & Saten Kumar & B. Bhaskara Rao, 2013. "A New Keynesian IS curve for Australia: is it forward looking or backward looking?," Applied Economics, Taylor & Francis Journals, vol. 45(26), pages 3691-3700, September.
    16. Lena Vogel, 2008. "The Relationship between the Hybrid New Keynesian Phillips Curve and the NAIRU over Time," Macroeconomics and Finance Series 200803, Hamburg University, Department Wirtschaft und Politik.
    17. Paradiso, Antonio & Rao, B. Bhaskara, 2011. "Flattening of the Phillips Curve and the Role of Oil Price: An Unobserved Components Model for the USA and Australia," MPRA Paper 29606, University Library of Munich, Germany.
    18. Idrovo Aguirre, Byron & Contreras, Javier, 2015. "Back-splicing of cement production and characterization of its economic cycle: The case of Chile (1991-2015)," MPRA Paper 67387, University Library of Munich, Germany, revised 20 Sep 2015.
    19. Mohammad Naim Azimi, 2016. "Drawing on Phillips curve: does the inverse relation between inflation and unemployment persist in transitional economies," International Journal of Economics and Accounting, Inderscience Enterprises Ltd, vol. 7(2), pages 89-100.
    20. Paradiso, Antonio & Rao, B. Bhaskara, 2012. "Flattening of the Phillips curve and the role of the oil price: An unobserved component model for the USA and Australia," Economics Letters, Elsevier, vol. 117(1), pages 259-262.

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