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Can Rational Expectations Sticky-Price Models Explain Inflation Dynamics?

  • Karl Whelan
  • Jeremy Rudd

The canonical inflation specification in sticky-price rational expectations models (the new-Keynesian Phillips curve) is often criticized on the grounds that it fails to account for the dependence of inflation on its own lags. In response, many recent studies have employed a "hybrid" sticky-price specification in which inflation depends on a weighted average of lagged and expected future values of itself, in addition to a driving variable such as the output gap. In this paper, we consider some simple tests of the hybrid model that are derived from the model's closed-form solution. Our results suggest that the hybrid model provides a poor description of empirical inflation dynamics, and that there is little evidence of the type of rational forward-looking behavior implied by the model.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2003 with number 181.

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Date of creation: 01 Aug 2003
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Handle: RePEc:sce:scecf3:181
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