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A Bounded Model of Time Variation in Trend Inflation, NAIRU and the Phillips Curve

  • Joshua C.C. Chan
  • Gary Koop
  • Simon M. Potter

In this paper, we develop a bivariate unobserved components model for inflation and unemployment. The unobserved components are trend inflation and the non-accelerating inflation rate of unemployment (NAIRU). Our model also incorporates a time-varying Phillips curve and time-varying inflation persistence. What sets this paper apart from the existing literature is that we do not use unbounded random walks for the unobserved components, but rather use bounded random walks. For instance, trend inflation is assumed to evolve within bounds. Our empirical work shows the importance of bounding. We find that our bounded bivariate model forecasts better than many alternatives, including a version of our model with unbounded unobserved components. Our model also yields sensible estimates of trend inflation, NAIRU, inflation persistence and the slope of the Phillips curve.

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File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2014-01/10_2014_chan_koop_potter.pdf
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Paper provided by Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University in its series CAMA Working Papers with number 2014-10.

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Length: 35 pages
Date of creation: Jan 2014
Date of revision:
Handle: RePEc:een:camaaa:2014-10
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  1. Tim W. Cogley, 2003. "Drifts and Volatilities: Monetary Policies and Outcomes in the Post War U.S," Working Papers 35, University of California, Davis, Department of Economics.
  2. Michael Dotsey & Shigeru Fujita & Tom Stark, 2011. "Do Phillips curves conditionally help to forecast inflation?," Working Papers 11-40, Federal Reserve Bank of Philadelphia.
  3. Andrea Stella & James H. Stock, 2012. "A state-dependent model for inflation forecasting," International Finance Discussion Papers 1062, Board of Governors of the Federal Reserve System (U.S.).
  4. Timothy Cogley & Argia M. Sbordone, 2008. "Trend Inflation, Indexation, and Inflation Persistence in the New Keynesian Phillips Curve," American Economic Review, American Economic Association, vol. 98(5), pages 2101-26, December.
  5. Koop, Gary & Korobilis, Dimitris, 2009. "Bayesian Multivariate Time Series Methods for Empirical Macroeconomics," MPRA Paper 20125, University Library of Munich, Germany.
  6. Timothy Cogley & Giorgio E. Primiceri & Thomas J. Sargent, 2008. "Inflation-Gap Persistence in the U.S," NBER Working Papers 13749, National Bureau of Economic Research, Inc.
  7. Chan, Joshua & Strachan, Rodney, 2012. "Estimation in Non-Linear Non-Gaussian State Space Models with Precision-Based Methods," MPRA Paper 39360, University Library of Munich, Germany.
  8. Andrew Atkeson & Lee E. Ohanian., 2001. "Are Phillips curves useful for forecasting inflation?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 2-11.
  9. Charles L. Weise, 2012. "Political Pressures on Monetary Policy during the US Great Inflation," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(2), pages 33-64, April.
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