Inflation dynamics with search frictions: A structural econometric analysis

The New Keynesian Phillips curve explains inflation dynamics as being driven by current and expected future real marginal costs. In competitive labor markets, the labor share can serve as a proxy for the latter. In this paper, we study the role of real marginal cost components implied by search frictions in the labor market. We construct a measure of real marginal costs by using newly available labor market data on worker finding rates. Over the business cycle, the measure is highly correlated with the labor share. Estimates of the Phillips curve using generalized method of moments reveal that the marginal cost measure remains significant, and that inflation dynamics are mainly driven by the forward-looking component. Bayesian estimation of the full New Keynesian model with search frictions helps us disentangle which shocks are driving the economy to generate the observed unit labor cost dynamics. We find that mark-up shocks are the dominant force in labor market fluctuations.     

International Evidence on the New Keynesian Phillips Curve Using Aggregate and Disaggregate Data

We present a unique empirical analysis of the properties of the New Keynesian Phillips Curve (NKPC) using an international data set of aggregate and disaggregate sectoral inflation. Our results from panel time‐series estimation clearly indicate that sectoral heterogeneity has important consequences for aggregate inflation behavior. Heterogeneity helps to explain the overestimation of inflation persistence and underestimation of the role of marginal costs in empirical investigations of the NKPC that use aggregate data. We find that combining disaggregate information with heterogeneous‐consistent estimation techniques helps to reconcile, to a large extent, the NKPC with the data.     

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

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 nonunitary factor substitution, nonneutral 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 U.S. time series. The cost measure comprises conventional countercyclical cost elements plus procyclical (and covarying) utilization rates. Although procyclical 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.     

The (ir)relevance of real wage rigidity in the New Keynesian model with search frictions

We develop a New Keynesian model with search and matching frictions in the labor market. We show that the model generates counterfactual labor market dynamics. In particular, it fails to generate the negative correlation between vacancies and unemployment in the data, i.e., the Beveridge curve. Introducing real wage rigidity leads to a negative correlation, and increases the magnitude of labor market flows to more realistic values. However, inflation dynamics are only weakly affected by real wage rigidity. The reason is that labor market frictions give rise to long-run employment relationships. The measure of real marginal costs that is relevant for inflation in the Phillips curve contains a present value component that varies independently of the real wage.     

通胀—增长权衡和中国菲利普斯曲线的平坦化

近年来发达经济体出现了菲利普斯曲线平坦化现象,但有关中国的研究尚缺乏共识。本文基于实证和理论分析,系统研究了中国菲利普斯曲线的平坦化问题。首先,结合货币政策冲击和月度SVAR框架,发现通胀的响应程度在2010年后大幅下降。由于证据显示总需求曲线并未平坦化,因此通胀响应弱化可解读为菲利普斯曲线的平坦化。数据显示,菲利普斯曲线平坦化与生产率增长放缓同时发生,因此,本文在标准DSGE模型中引入纵向内生增长渠道,该渠道基于研发投入和知识资本积累,从而使生产率内生于经济周期。研究发现：(1)内生增长渠道放大了需求冲击对产出的影响,但缩小了需求冲击对通胀的影响;(2)内生增长渠道改变通胀和增长之间的替代关系,但不改变边际成本向通胀的传导。分段估计显示,2010年后,通胀和增长的关系弱化是边际成本传导变弱和内生增长渠道变强共同作用的结果。本文认为,由于菲利普斯曲线的平坦化,中央银行应继续坚持稳增长和就业优先战略,关注但不必过于担心由此引发的通胀压力。     

Does Global Liquidity Help to Forecast U.S. Inflation?

We construct a measure of global liquidity using the growth rates of broad money for the G7 economies. Global liquidity produces forecasts of U.S. inflation that are significantly more accurate than the forecasts based on U.S. money growth, Phillips curve, and autoregressive and moving average models. The marginal predictive power of global liquidity is strong at 3-year horizons. Results are robust to alternative measures of inflation.     

Do expected future marginal costs drive inflation dynamics?

This article discusses a more general interpretation of the two-step minimum distance estimation procedure proposed in Sbordone (2002). The estimator is again applied to a version of the New Keynesian Phillips curve, where inflation dynamics are driven by the expected evolution of marginal costs. The article clarifies econometric issues, addresses concerns about uncertainty and model misspecification raised in recent studies, and assesses the robustness of previous results. While confirming the importance of forward-looking terms in accounting for inflation dynamics, it suggests how the methodology can be applied to extend the analysis of inflation to a multivariate setting.     

Optimal Monetary Policy in a Model with Agency Costs

This paper integrates a fully explicit model of agency costs into an otherwise standard Dynamic New Keynesian model in a particularly transparent way. A principal result is the characterization of agency costs as endogenous markup shocks in an output‐gap version of the Phillips curve. The model's utility‐based welfare criterion is derived explicitly and includes a measure of credit market tightness that we interpret as a risk premium. The paper also fully characterizes optimal monetary policy and provides conditions under which zero inflation is the optimal policy. Finally, optimal policy can be expressed as an inflation targeting criterion that (depending upon parameter values) can be either forward or backward looking.     

A Theory of Intrinsic Inflation Persistence

We propose a novel theory of intrinsic inflation persistence by introducing trend inflation and Kimball (1995)-type aggregators of individual differentiated goods and labor in a model with staggered price- and wage-setting. Under nonzero trend inflation, the non-CES (constant elasticity of substitution) aggregator of goods and staggered price-setting give rise to a variable real marginal cost of goods aggregation, which becomes a driver of inflation. This marginal cost consists of an aggregate of the goods' relative prices, which depends on past inflation, thereby generating intrinsic inertia in inflation. Likewise, the non-CES aggregator of labor and staggered wage-setting lead to intrinsic inertia in wage inflation, which enhances the persistence of price inflation. With the theory we show that inflation exhibits a persistent, hump-shaped response to monetary policy shocks. We also demonstrate that lower trend inflation reduces inflation persistence and that a credible disinflation leads to a gradual decline in inflation and a fall in output.     

An open-economy new Keynesian Phillips curve for the U.K.

We estimate a pricing equation or “new Keynesian Phillips curve” (NKPC) obtained from a structural dynamic model of price setting based on Rotemberg [1982. Sticky prices in the United States. Journal of Political Economy 90(6), 1187-1211] and extended to capture employment adjustment costs and the openness of the United Kingdom. This model nests the baseline Galí and Gertler [1999. Inflation dynamics: a structural econometric analysis. Quarterly Journal of Economics 110, 127-159) and Sbordone [2002. Prices and unit labor costs: a new test of price stickiness. Journal of Monetary Economics 49, 265-292] relationship between inflation and marginal cost in the limiting case of no employment adjustment costs, no impact of relative prices of imported inputs on real marginal cost and a constant equilibrium markup. Our findings indicate that each of our modifications to the baseline NKPC model is important for U.K. data, so that inflation in the U.K. is explained both by changes in employment and by changes in real import prices, in general, and real oil prices, in particular. External competitive pressures also seem to affect U.K. inflation via their impact on the equilibrium price markup of domestic firms.     

Dynamic pricing and imperfect common knowledge

Introducing private information into the dynamic pricing decision of firms by adding an idiosyncratic component to marginal cost can help explain two stylised facts about price changes: Aggregate inflation responds gradually and with inertia to shocks at the same time as individual price changes can be large. The inertial behaviour of inflation is driven by privately informed firms strategically ‘herding’ on the public information contained in the observations of lagged aggregate variables. The model also matches the average duration between price changes found in the data and it nests the standard New-Keynesian Phillips Curve as a special case. To solve the model, the paper derives an algorithm for solving a class of dynamic models with higher order expectations.     

The Phillips curve under state-dependent pricing

We derive a Phillips curve equation from the dynamic stochastic general equilibrium (DSGE) model with state-dependent pricing developed by Dotsey et al. [1999. State-dependent pricing and the general equilibrium dynamics of money and output. Quarterly Journal of Economics 114, 655-690]. This state-dependent Phillips curve encompasses the new Keynesian Phillips curve (NKPC) based on Calvo-type price setting as a special case. We analyze the effect of the state-dependent terms (that is, the variations in the distributions of price vintages) on inflation persistence, and we examine whether the hybrid NKPC (that is, the NKPC extended by a lagged inflation term) can adequately describe inflation dynamics generated in a calibrated state-dependent pricing economy.     

Quantifying the uncertainty about the fit of a new Keynesian pricing model

Recent studies by Gali and Gertler [1999. Inflation dynamics: a structural econometric analysis, Journal of Monetary Economics 44, 195-222] and Sbordone [2002. Prices and unit labor costs: testing models of pricing, Journal of Monetary Economics 49, 265-292] conclude that a theoretical inflation series implied by a forward-looking New Keynesian pricing equation fits post-1960 U.S. inflation closely. Their theoretical inflation series is conditional on (i) a reduced-form forecasting process for real marginal cost; and (ii) the calibration of the pricing equation. The present paper shows that both of these determinants are surrounded by considerable uncertainty. When quantifying the impact of this uncertainty on theoretical inflation, we can no longer say whether the forward-looking pricing equation explains observed inflation dynamics very well or very poorly.     

What Makes the Output–Inflation Trade‐Off Change? The Absence of Accelerating Deflation in Japan

It is standard to model the output–inflation trade-off as a linear relationship with a time-invariant slope. We assess empirical evidence for two sets of theories that allow for endogenous variation in the slope of the short-run Phillips curve. At an empirical level, we examine why large negative output gaps in Japan in the late 1990s did not lead to accelerating deflation but instead coincided with stable, albeit moderately negative inflation. Our results suggest that this episode is most convincingly interpreted as reflecting a gradual flattening of the Phillips curve. We find that this flattening is best explained by models with endogenous price durations. These models imply that in any economy where trend inflation is substantially lower (or substantially higher) today than in past decades, time variation in the slope of the Phillips curve has become too important to ignore.     

In search of the natural rate of unemployment

The natural rate of unemployment can be measured as the time-varying steady state of a structural vector autoregression. For post-War US data, the natural rate implied by this approach is more volatile than most previous estimates, with its movements accounting for the bulk of the variation in the unemployment rate, as well as substantial portions of the variation in aggregate output and inflation. These movements, in turn, can be related to variables associated with labor-market search theory, including unemployment benefits, labor productivity, real wages, and sectoral shifts in the labor market. There is also a strong negative relationship between inflation and the corresponding measure of cyclical unemployment, supporting the existence of a short-run Phillips curve.     

Inflation and Welfare: A Search Approach

This paper uses a search model of monetary exchange to provide new insights for evaluating the welfare costs of inflation. We first show that the search model of money can rationalize the estimates of the welfare cost of inflation based on the "welfare triangle" methodology of Bailey (1956) and Lucas (2000) provided that buyers appropriate the social marginal benefit of their real balances. For other mechanisms, the measure given by the welfare triangle has to be scaled up by a factor that increases with sellers' market power. We introduce capital and endogenous participation decisions and study how the cost of inflation is affected. We provide calibrated examples in which a deviation from the Friedman rule is optimal.     

The New Keynesian Phillips Curve: From Sticky Inflation to Sticky Prices

The New Keynesian Phillips Curve (NKPC) model of inflation dynamics based on forward-looking expectations is of great theoretical significance in monetary policy analysis. Empirical studies, however, often find that backward-looking inflation inertia dominates the dynamics of the short-run aggregate supply curve. This inconsistency is examined by investigating multiple structural changes in the NKPC for the U.S. between 1960 and 2005, employing both inflation expectations survey data and a rational expectations approximation. We find that forward-looking behavior plays a smaller role during the high and volatile inflation regime to 1981 than in the subsequent period of moderate inflation, providing empirical support for sticky price models over the last two decades. A break in the intercept of the NKPC is also identified around 2001 and this may be associated with U.S. monetary policy in that period.     

New tests of the new-Keynesian Phillips curve

Lagged dependent variables typically play an important role in empirical models of inflation. Do these lags reflect backward-looking inflation expectations, or do they proxy for rational forward-looking expectations, as in the new-Keynesian Phillips curve? Galí and Gertler [1999. Inflation dynamics: a structural econometric analysis. Journal of Monetary Economics 44, 195-222] attempt to answer this question using GMM to estimate specifications incorporating both lagged and future inflation. They report small coefficients on lagged inflation and conclude that the new-Keynesian model provides a good first approximation to inflation dynamics. We show that these tests have low power against alternative backward-looking specifications, and demonstrate that their results are also consistent with a backward-looking Phillips curve. Using an alternative approach, we find that the new-Keynesian pricing model cannot explain the importance of lagged inflation in standard inflation regressions, and find that forward-looking terms play a very limited role in explaining inflation dynamics.     

Deep Habits in the New Keynesian Phillips Curve

We derive and estimate a New Keynesian Phillips Curve (NKPC) in a model with deep habits. Habits are deep in that they apply to individual consumption goods instead of aggregate consumption. This alters the NKPC in a fundamental manner since it introduces consumption growth and future demand terms into the NKPC equation. We construct the driving process in the deep habits NKPC by using the model's optimality conditions to impute time series for unobservable variables. The resulting series is considerably more volatile than unit labor cost. Generalized methods of moments estimation shows an improved fit and a much lower degree of indexation compared to the standard NKPC.     

A Phillips Curve with Anchored Expectations and Short‐Term Unemployment

This paper examines the behavior of U.S. core inflation, as measured by the weighted median of industry price changes. We find that core inflation since 1985 is well‐explained by an expectations‐augmented Phillips curve in which expected inflation is measured with professional forecasts and labor‐market slack is captured by the short‐term unemployment rate. We also find that expected inflation was backward‐looking until the late 1990s, but then became strongly anchored at the Federal Reserve's target. This shift in expectations changed the relationship between inflation and unemployment from an accelerationist Phillips curve to a level‐level Phillips curve. Our specification explains why high unemployment during the Great Recession did not reduce inflation greatly: partly because inflation expectations were anchored, and partly because short‐term unemployment rose less sharply than total unemployment.