Inflation in the G7: mind the gap(s)?
We investigate the importance of trend inflation and the real-activity gap for explaining observed inflation variation in G7 countries since 1960. Our results are based on a bivariate unobserved-components model of inflation and unemployment in which inflation is decomposed into a stochastic trend and transitory component. As in recent implementations of the New Keynesian Phillips Curve, it is the transitory component of inflation, or “inflation gap”, that is driven by the real-activity gap, which we measure as the deviation of unemployment from its natural rate. Even when allowing for changes in the contributions of trend inflation and the inflation gap, we find that both are important determinants of inflation variation at business cycle horizons for all G7 countries throughout much of the past 50 years. Also, the real-activity gap explains a large fraction of the variation in the inflation gap for each country, both historically and in recent years. Taken together, the results suggest the New Keynesian Phillips Curve, once augmented to include trend inflation, is an empirically relevant model for the G7 countries. We also provide new estimates of trend inflation for the G7 that incorporate information in the real-activity gap for identification and, through formal model comparisons, new statistical evidence regarding structural breaks in the variability of trend inflation and the inflation gap.
|Date of creation:||2011|
|Date of revision:|
|Contact details of provider:|| Postal: P.O. Box 442, St. Louis, MO 63166|
Web page: http://www.stlouisfed.org/
More information through EDIRC
|Order Information:|| Email: |
When requesting a correction, please mention this item's handle: RePEc:fip:fedlwp:2011-011. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Anna Xiao)
If references are entirely missing, you can add them using this form.