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Modeling the Phillips curve with unobserved components

The relationship between in.ation and the output gap can be modeled 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 in.ation. The model may be generalized to 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 fited as a single equation and as part of a bivariate model that includes an equation for GDP. Fitting the bivariate model highlights some new aspects of unobserved components modeling. Single equation and bivariate models tell a similar story: an output gap two per cent above trend is associated with an annual inflation rate that is one percent above core inflation.

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Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 0805.

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Length: 24
Date of creation: Jan 2008
Date of revision:
Handle: RePEc:cam:camdae:0805
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  1. Basistha, Arabinda & Nelson, Charles R., 2007. "New measures of the output gap based on the forward-looking new Keynesian Phillips curve," Journal of Monetary Economics, Elsevier, vol. 54(2), pages 498-511, March.
  2. Martin Fukac & Adrian Pagan, 2006. "Issues In Adopting Dsge Models For Use In The Policy Process," CAMA Working Papers 2006-10, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  3. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  4. 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.
  5. Pesaran, M. H., 1981. "Identification of rational expectations models," Journal of Econometrics, Elsevier, vol. 16(3), pages 375-398, August.
  6. Athanasios Orphanides & Simon Van_Norden, 2000. "The Reliability of Output Gap Estimates in Real Time," Econometric Society World Congress 2000 Contributed Papers 0768, Econometric Society.
  7. M. Dossche & G. Everaert, 2005. "Measuring inflation persistence: a structural time series approach," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 05/340, Ghent University, Faculty of Economics and Business Administration.
  8. Timothy Cogley, 1998. "A simple adaptive measure of core inflation," Working Papers in Applied Economic Theory 98-06, Federal Reserve Bank of San Francisco.
  9. Planas, Christophe & Rossi, Alessandro & Fiorentini, Gabriele, 2008. "Bayesian Analysis of the Output Gap," Journal of Business & Economic Statistics, American Statistical Association, vol. 26, pages 18-32, January.
  10. Harvey, A.C. & Trimbur, T.M. & van Dijk, H.K., 2005. "Trends and cycles in economic time series: A Bayesian approach," Econometric Institute Research Papers EI 2005-27, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  11. Andrew C. Harvey & Thomas M. Trimbur, 2003. "General Model-Based Filters for Extracting Cycles and Trends in Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 85(2), pages 244-255, May.
  12. Mavroeidis, Sophocles, 2005. "Identification Issues in Forward-Looking Models Estimated by GMM, with an Application to the Phillips Curve," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 421-48, June.
  13. Kuttner, Kenneth N, 1994. "Estimating Potential Output as a Latent Variable," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 361-68, July.
  14. Mise, Emi & Kim, Tae-Hwan & Newbold, Paul, 2005. "On suboptimality of the Hodrick-Prescott filter at time series endpoints," Journal of Macroeconomics, Elsevier, vol. 27(1), pages 53-67, March.
  15. Gali, Jordi & Gertler, Mark, 1999. "Inflation dynamics: A structural econometric analysis," Journal of Monetary Economics, Elsevier, vol. 44(2), pages 195-222, October.
  16. Christophe Planas & Alessandro Rossi, 2004. "Can inflation data improve the real-time reliability of output gap estimates?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 19(1), pages 121-133.
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