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Can rational expectations sticky-price models explain inflation dynamics?

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  • Karl Whelan
  • Jeremy Rudd

Abstract

The canonical inflation specification in sticky-price rational expectations models (the new-Keynesian Phillips curve) is often criticized for failing to account for the dependence of inflation on its own lags. In response, many studies employ a “hybrid” specification in which inflation depends on its lagged and expected future values, together with a driving variable such as the output gap. We consider some simple tests of the hybrid model that are derived from its closed form. We find that the hybrid model describes inflation dynamics poorly, and find little empirical evidence for the type of rational, forward-looking behavior that the model implies.

Suggested Citation

  • Karl Whelan & Jeremy Rudd, 2006. "Can rational expectations sticky-price models explain inflation dynamics?," Open Access publications 10197/199, School of Economics, University College Dublin.
    • Handle: RePEc:ucn:oapubs:10197/199
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    File URL: http://hdl.handle.net/10197/199
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    More about this item

    Keywords

    Inflation (Finance); Rational expectations (Economic theory); Economic policy; Pricing; Inflation (Finance)--Mathematical models; Rational expectations (Economic theory)--United States; Pricing--United States;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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