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Trend Inflation and the Nature of Structural Breaks in the New Keynesian Phillips Curve

  • Chang-Jin Kim

    ()

    (Department of Economics, University ofWashington, and Department of Economics, Korea University)

  • Pym Manopimoke

    ()

    (Department of Economics, University of Kansas)

  • Charles R. Nelson

    ()

    (Department of Economics, University of Washington)

In this paper, we investigate the nature of structural breaks in inflation by estimating a version of the New Keynesian Phillips curve (NKPC) in the presence of a unit root in inflation. We show that, with a unit root in inflation, the NKPC implies an unobserved components model that consists of three components: a stochastic trend component, a component that depends upon current and future forecasts of real economic activity, and a stationary component which is potentially serially correlated (or a component of inflation that is not explained by the conventional forward-looking NKPC). Our empirical results suggest that, with an increase in trend inflation during the Great Inflation period, the response of inflation to real economic activity decreases and the persistence of the inflation gap increases due to an increase in the persistence of the unobserved stationary component. These results are in line with the predictions of Cogley and Sbordone (2008), who show that the coefficients of the NKPC are functions of time-varying trend inflation.

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Paper provided by Institute of Economic Research, Korea University in its series Discussion Paper Series with number 1305.

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Date of creation: 2013
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Handle: RePEc:iek:wpaper:1305
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  1. Murray, Christian & Nikolsko-Rzhevskyy, Alex & Papell, David, 2008. "Inflation Persistence and the Taylor Principle," MPRA Paper 11353, University Library of Munich, Germany.
  2. Ascari, Guido, 2002. "Staggered Price and Trend Inflation:Some Nuisances," Royal Economic Society Annual Conference 2002 10, Royal Economic Society.
  3. Gabriel Perez-Quiros & Margaret M. McConnell, 2000. "Output Fluctuations in the United States: What Has Changed since the Early 1980's?," American Economic Review, American Economic Association, vol. 90(5), pages 1464-1476, December.
  4. James H. Stock & Mark W. Watson, 2007. "Why Has U.S. Inflation Become Harder to Forecast?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(s1), pages 3-33, 02.
  5. Michael Woodford, 2007. "How Important is Money in the Conduct of Monetary Policy?," Levine's Working Paper Archive 122247000000001419, David K. Levine.
  6. Peter N. Ireland, 2006. "Changes in the Federal Reserve's Inflation Target: Causes and Consequences," NBER Working Papers 12492, National Bureau of Economic Research, Inc.
  7. Charles R. Nelson & Jaejoon Lee, 2007. "Expectation horizon and the Phillips Curve: the solution to an empirical puzzle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 161-178.
  8. 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.
  9. Chib, Siddhartha, 1998. "Estimation and comparison of multiple change-point models," Journal of Econometrics, Elsevier, vol. 86(2), pages 221-241, June.
  10. Kim, C-J., 1991. "Dynamic Linear Models with Markov-Switching," Papers 91-8, York (Canada) - Department of Economics.
  11. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research 35, National Bank of Belgium.
  12. Christopher A. Sims & Tao Zha, 2005. "Were There Regime Switches in U.S. Monetary Policy?," Working Papers 92, Princeton University, Department of Economics, Center for Economic Policy Studies..
  13. Nelson, Charles R & Schwert, G William, 1977. "Short-Term Interest Rates as Predictors of Inflation: On Testing the Hypothesis That the Real Rate of Interest is Constant," American Economic Review, American Economic Association, vol. 67(3), pages 478-86, June.
  14. James H. Stock & Mark W. Watson, 2007. "Erratum to "Why Has U.S. Inflation Become Harder to Forecast?"," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(7), pages 1849-1849, October.
  15. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
  16. Kang Kyu Ho & Kim Chang-Jin & Morley James, 2009. "Changes in U.S. Inflation Persistence," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 13(4), pages 1-23, September.
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