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Monetary policy shifts and inflation dynamics

Listed author(s):
  • Paolo Surico

The New Keynesian Phillips Curve plays a central role in modern macroeconomic theory. A vast empirical literature has estimated this structural relationship over various post-war full samples. While it is well known that in a standard sticky price model a 'weak' central bank response to inflation generates sunspot fluctuations, the consequences of pooling observations from different monetary policy regimes for (i) the estimates of the structural Phillips curve and (ii) the estimates of inflation persistence had not been investigated. Using Monte Carlo simulations from a purely forward-looking model, this paper shows that indeterminacy can introduce a sizable persistence in the process of inflation. On the reduced form, our results show that inflation persistence can be endogenous to the policy regime rather than intrinsic to the structure of the economy. On the structural form, we find that by neglecting equilibrium indeterminacy the estimates of the forward-looking term of the New Keynesian Phillips Curve are biased downward. The implications are in line with the empirical evidence for the United Kingdom and United States.

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File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2008/WP338.pdf
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Paper provided by Bank of England in its series Bank of England working papers with number 338.

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Date of creation: Jan 2008
Handle: RePEc:boe:boeewp:338
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  1. Kenneth N. Kuttner & Adam S. Posen, 1999. "Does Talk Matter After All? Inflation Targeting and Central Bank Behavior," Working Paper Series WP99-10, Peterson Institute for International Economics.
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  14. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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  16. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
  17. Rudd, Jeremy & Whelan, Karl, 2005. "New tests of the new-Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 52(6), pages 1167-1181, September.
  18. Tim W. Cogley & Argia M. Sbordone, 2005. "A Search for a Structural Phillips Curve," Working Papers 510, University of California, Davis, Department of Economics.
  19. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
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