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Closed-form estimates of the New Keynesian Phillips curve with time-varying trend inflation

Author

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  • Michelle L. Barnes
  • Fabia Gumbau-Brisa
  • Denny Lie
  • Giovanni P. Olivei

Abstract

We compare estimates of the New Keynesian Phillips Curve (NKPC) when the curve is specified in two different ways. In the standard difference equation (DE) form, current inflation is a function of past inflation, expected future inflation, and real marginal costs. The alternative closed form (CF) specification explicitly solves the DE form to express inflation as a function of past inflation and a present-discounted value of current and expected future marginal costs. The CF specification places model-consistent constraints on expected future inflation that are not imposed in the DE form. In a Monte Carlo exercise, we show that estimating the CF version of the NKPC gives estimates that are much more efficient than the estimates obtained from the DE specification. We then compare DE and CF estimates of the NKPC with time-varying trend inflation on actual data. The data and estimation methodology are the same as in Cogley and Sbordone (2008). We show that DE and CF estimates differ substantially and have very different implications for inflation dynamics. As in Cogley and Sbordone, it is possible to estimate DE specifications of the NKPC where lagged inflation plays no role once trend inflation is taken into account. The CF estimates of the NKPC, however, typically imply as large a role for lagged inflation as for expected future inflation. These estimates thus suggest that trend inflation is not in itself sufficient to explain the persistent dynamics of inflation.

Suggested Citation

  • Michelle L. Barnes & Fabia Gumbau-Brisa & Denny Lie & Giovanni P. Olivei, 2009. "Closed-form estimates of the New Keynesian Phillips curve with time-varying trend inflation," Working Papers 09-15, Federal Reserve Bank of Boston.
    • Handle: RePEc:fip:fedbwp:09-15
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    Cited by:

    1. Sophocles Mavroeidis & Mikkel Plagborg-Møller & James H. Stock, 2014. "Empirical Evidence on Inflation Expectations in the New Keynesian Phillips Curve," Journal of Economic Literature, American Economic Association, vol. 52(1), pages 124-188, March.
    2. Ascari, Guido & Castelnuovo, Efrem & Rossi, Lorenza, 2011. "Calvo vs. Rotemberg in a trend inflation world: An empirical investigation," Journal of Economic Dynamics and Control, Elsevier, vol. 35(11), pages 1852-1867.
    3. Di Bartolomeo, Giovanni & Tirelli, Patrizio & Acocella, Nicola, 2014. "Trend inflation, the labor market wedge, and the non-vertical Phillips curve," Journal of Policy Modeling, Elsevier, vol. 36(6), pages 1022-1035.
    4. Fuhrer, Jeffrey C., 2010. "Inflation Persistence," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 9, pages 423-486, Elsevier.
    5. Di Bartolomeo Giovanni & Tirelli Patrizio & Acocella Nicola, 2010. "Trend inflation, endogenous mark-ups and the non-vertical Phillips curve," wp.comunite 0065, Department of Communication, University of Teramo.
    6. Guido Ascari & Nicola Branzoli, 2015. "Inflation Persistence, Price Indexation and Optimal Simple Interest Rate Rules," Manchester School, University of Manchester, vol. 83, pages 1-30, September.
    7. Guido Ascari & Argia M. Sbordone, 2014. "The Macroeconomics of Trend Inflation," Journal of Economic Literature, American Economic Association, vol. 52(3), pages 679-739, September.
    8. Di Bartolomeo Giovanni & Tirelli Patrizio, 2016. "Public finance and the optimal inflation rate," wp.comunite 00128, Department of Communication, University of Teramo.

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    Keywords

    Inflation (Finance); Phillips curve;

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