Inflation Dynamics and the Hybrid Neo Keynesian Phillips Curve: The Case of Chile

It is recognised that the understanding and accurate forecasts of key macroeconomic variables are fundamental for the success of any economic policy. In the case of monetary policy, many efforts have been made towards understanding the relationship between past and expected values of inflation, resulting in the so-called Hybrid Neo-Keynesian Phillips Curve (HNKPC). In this article I investigate to which extent the HNKPC help to explain inflation dynamics as well as its out-ofsample forecast for the case of the Chilean economy. The results show that the forward-looking component is significant and accounts from 1.58 to 0.40 times the lagged inflation coefficient. Also, I find predictive gains close to 45% (respect to a backward-looking specification) and up to 80% (respect to the random walk) when forecasting at 12-months ahead. The output gap building process plays a key role delivering better results than similar benchmark. None of the two openness measures used—neither real exchange rate nor oil price—are significant in the reduced form. A final estimation using the annual variation of a monthly indicator of GDP deliver reasonable forecast accuracy but not as good as the preferred forecast-implied output gap measure.