Inflation dynamics: A structural econometric analysis

TLDR: In this paper, the authors developed and estimated a structural model of inflation that allows for a fraction of firms that use a backward-looking rule to set prices, and the model nests the purely forward-looking New Keynesian Phillips curve as a particular case.

About: This article is published in Journal of Monetary Economics.The article was published on 1999-10-01 and is currently open access. It has received 2514 citations till now. The article focuses on the topics: Phillips curve & Inflation.

Figures

Table 1 Estimates of the New Phillips Curve

Figure 1: Dynamic Cross-Correlations

Table 4 Robustness Analysis: Subsample Stability

Table 3 Robustness Analysis: Extra Inflation Lags

Table 2 Estimates of the New Hybrid Phillips Curve

Figure 2. Inflation: Actual vs. Fundamental

Frequently asked questions

Q1. What are the contributions in this paper?

The authors thank participants at the JME-SNB Gerzensee Conference on “ The Return of the Phillips Curve, NBER Summer Institute and ME Meetings, and seminars at Lausanne, UPF, Delta, Chicago, Michigan, Princeton, Yale, Columbia, San Francisco Fed, BIS, IIES, and the ECB, for useful comments. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research. 

Q2. What is the econometric issue that the authors must confront?

One econometric issue the authors must confront is that, in small samples, nonlinear estimation using GMM is sometimes sensitive to the way the orthogonality conditions are normalized. 

Q3. What is the typical starting point for the derivation of the new Phillips curve?

The typical starting point for the derivation of the new Phillips curve is an environment of monopolistically competitive firms that face some type of constraints on price adjustment. 

Q4. What is the main problem of the new Phillips curve?

The essential problem, as emphasized by Fuhrer and Moore (1995), is that the benchmark new Phillips curve implies that inflation should lead the output gap over the cycle, in the sense that a rise (decline) in current inflation should signal a subsequent rise (decline) in the output gap. 

Q5. How do the authors estimate the structural parameters?

Their approach is to directly estimate the structural parameters using an instrumental variables procedure that is based on the orthogonality conditions that evolve from the underlying theory. 

Q6. What is the relationship between the output gap and the marginal cost?

5Combining the relation between marginal cost and the output gap with equation (3) yields a Phillips curve-like relationship:πt = λκ xt + β Et{πt+1} (6)As with the traditional Phillips curve, inflation depends positively on the output gap and a “cost push” term that reflects the influence of expected inflation. 

Q7. What is the reason for the strong counterfactual contemporaneous positive correlation between output and real?

a likely reason for the strong counterfactual contemporaneous positive correlation between output and real marginal cost in the standard sticky price framework is the absence of any type of labor market frictions [see, e.g., the discussion in Christiano, Eichenbaum and Evans (1997)]. 

Q8. What is the empirical version of the hybrid Phillips curve?

The empirical version of their hybrid Phillips curve is accordingly given by:πt = λ st + γf Et{πt+1}+ γb πt−1 (26)together with equation (25), which describes the relation between the reduced form and structural parameters. 

Q9. What is the basis for estimating the model?

The orthogonality condition given by equation (17) then forms the basis for estimating the model via Generalized Method of Moments (GMM).