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Is the New Keynesian Phillips curve flat?

  • Kuester, Keith
  • Müller, Gernot J.
  • Stölting, Sarah

Macroeconomic data suggest that the New Keynesian Phillips curve is quite flat - despite microeconomic evidence implying frequent price adjustments. While real rigidities may help to account for the conflicting evidence, we propose an alternative explanation: if price markup/cost-push shocks are persistent and negatively correlated with the labor share, the latter being a widely used measure for marginal costs, the estimated pass-through of measured marginal costs into inflation is limited, even if prices are fairly flexible. Using a standard New Keynesian model, we show that the GMM approach to the New Keynesian Phillips curve leads to inconsistent and upward biased estimates if cost-push shocks indeed are persistent. Monte Carlo experiments suggest that the bias is quite sizeable: we find average price durations estimated as high as 12 quarters, when the true value is about 2 quarters. Moreover, alternative estimators appear to be biased as well, while standard diagnostic tests fail to signal a misspecification of the model. JEL Classification: E30, C15

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Paper provided by European Central Bank in its series Working Paper Series with number 0809.

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Date of creation: Sep 2007
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Handle: RePEc:ecb:ecbwps:20070809
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