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Technology, Utilization and Inflation: What Drives the New Keynesian Phillips Curve?

  • Peter McAdam

    (University of Surrey and European Central Bank)

  • Alpo Willman

    (European Central Bank)

We argue that the New-Keynesian Phillips Curve literature has failed to deliver a convincing measure of real marginal costs. We start from a careful modeling of optimal price setting allowing for non-unitary factor substitution, non-neutral technical change and time-varying factor utilization rates. This ensures the resulting real marginal cost measures match volatility reductions and level changes witnessed in many US time series. The cost measure comprises conventional counter-cyclical cost elements plus pro-cyclical (and co-varying) utilization rates. Although pro-cyclical elements seem to dominate, the components of real marginal cost components are becoming less cyclical over time. Incorporating this richer driving variable produces more plausible price-stickiness estimates than otherwise and suggests a more balanced weight of backward and forward-looking inflation expectations than commonly found. Our results challenge existing views of inflation determinants and have important implications for modeling inflation in New-Keynesian models.

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Paper provided by School of Economics, University of Surrey in its series School of Economics Discussion Papers with number 0912.

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Length: 33 pages
Date of creation: Aug 2012
Date of revision:
Handle: RePEc:sur:surrec:0912
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