Output gap measurement and the New Keynesian Phillips curve for China

The New Keynesian Phillips curve implies that the output gap, the deviation of the actual output from its natural level due to nominal rigidities, drives the dynamics of inflation relative to expected inflation and lagged inflation. This paper exploits the empirical success of the New Keynesian Phillips curve in explaining China's inflation dynamics with a new measure of the output gap. We estimate the output gap using the Bayesian multivariate Beveridge–Nelson decomposition method, based on a multivariate dynamic model featuring distinct interactions among inflation, money, and real output in China. The empirical results using quarterly data spanning 1979–2010 show that the new measure of the output gap outperforms the traditional measures in fitting the New Keynesian Phillips curve. This result provides useful insights for inflation dynamics and monetary policy analysis in China.     

Inflation forecasting using the New Keynesian Phillips Curve with a time-varying trend

Does theory aid inflation forecasting? To address this question, we develop a novel forecasting procedure based upon a New Keynesian Phillips Curve that incorporates time-varying trend inflation, to capture shifts in central bank preferences and monetary policy frameworks. We generate theory-implied predictions for both the trend and cyclical components of inflation, and recombine them to obtain an overall inflation forecast. Using quarterly data for the Euro Area and the United States that cover almost half a century, we compare our inflation forecasting procedure against the most popular time series models. We find that our theory-based forecasts outperform these benchmarks that previous studies found difficult to beat. Our results are shown to be robust to structural breaks, geographic areas, and variants of the econometric specification. Our findings suggest that the scepticism concerning the use of theory in forecasting is unwarranted, and theory should continue to play an important role in policymaking.     

Cost-based Phillips Curve forecasts of inflation

It is a well-established idea that prices are a function of marginal cost, yet estimating a reliable measure of marginal cost is difficult to do. Stock and Watson (1999) use the Phillips Curve to forecast inflation for a variety of existing activity variables that researchers commonly use to proxy for marginal cost. This paper uses a similar type of approach to examine the performance of a new candidate for the activity variable, which is marginal cost measured following the theoretical methodology of Bils (1987), which we find to be simple yet powerful when implemented empirically. We then use the Phillips Curve to conduct pseudo out-of-sample inflation forecasts for the US using: output, unemployment, hours, the labor share, the capacity utilization rate, and the new measure of marginal cost. For almost all cases, forecast errors are lowest in the regressions with the new marginal cost variable, indicating that this new measure is an improvement over previous attempts to proxy for marginal cost.     

The empirical validity of the New Keynesian Phillips curve using survey forecasts of inflation

This paper investigates the performance of the New Keynesian Phillips curve when survey forecasts of inflation are used to proxy for inflation expectations. Previous authors such as Brissimis and Magginas (2008) have applied survey measures of inflation expectations to the NKPC, and have concluded that these estimates are superior to those estimated using actual data on future inflation. However this approach employs the use of the labor income share as the proxy for real marginal cost, something which is highly problematic once we consider the countercyclicality of this variable. This paper develops and tests a procyclical marginal cost variable alongside various survey measures of inflation forecasts in the NKPC, while recognizing the problem of weak instruments that occurs when estimating the model using conventional GMM. We find that the NKPC produces a counter-intuitive negative and significant coefficient on procyclical marginal cost when surveys of inflation forecasts are used, which casts serious doubt on the empirical viability of the NKPC model, even when estimated with survey inflation forecasts.     

Central Bank Independence,Inflation and Uncertainty: The Case of Colombia

Colombia undertook reform of its central bank in 1991, pushing it in the direction of greater independence. We find that this reform led to a significant decrease in the level of inflation, as well as inflation uncertainty, suggesting an increase in credibility. However, there has also been an increase in inflation persistence since reform. The lower mean but greater persistence of inflation indicates that central bank independence has shifted the Phillips curve inward but also flattened it, a result consistent with recent research for the Euro-zone and the United States. Finally, further analysis reveals that, in accordance with the Friedman-Ball hypothesis, higher inflation raises uncertainty in Colombia, but that uncertainty does not increase inflation.     

Can the Phillips Curve Explain Inflation over the Past Half-Century?

International Advances in Economic Research - Standard Phillips curve models of price inflation suggest that the United States should have experienced an episode of deflation during the Great...     

Inflation and real sectoral output shares: Dynamic panel model evidence from seven OECD countries

Models of the cost of inflation often conclude that inflation misallocates resources. For example, inflation may lead to an increase in the variability of relative prices and it is often claimed that this increase in variability leads to a misallocation of resources. This claim raises the following empirical question, does inflation alter the composition of real output; that is, does it change real output shares? We examine this question using dynamic panel data methods for nine sector panels each with seven OECD countries from 1970 to 2005. We find evidence that inflation changes the real shares of some sectors even when inflation is treated as endogenous.     

The long-run Phillips curve and non-stationary inflation

Modern theories of inflation incorporate a vertical long-run Phillips curve and are usually estimated using techniques that ignore the non-stationary behaviour of inflation. Consequently, the estimates obtained are imprecise and unable to test the veracity of a vertical long-run Phillips curve. We estimate a Phillips curve model taking into account the non-stationary properties in inflation and identify a small but significant positive relationship between inflation and unemployment. The results also provide some evidence that the trade-off between inflation and the rate of unemployment in the short-run worsens as the mean rate of inflation increases.     

THE DYNAMICS OF LABOUR'S INCOME SHARES AND THE WAGE CURVE–PHILLIPS CURVE CONTROVERSY

Based on a re-parameterised Blanchflower–Oswald model this paper uses long macro-data from the OECD countries to discriminate between the Philips curve and the wage curve and examines whether there are any differences in wage dynamics between Europe and the United States. The evidence gives support for the Phillips curve and shows that wage dynamics are no different between the United States and Europe.     

On the feasibility of monetary union: Does it make sense to look for shocks symmetry across countries when none of the countries constitutes an optimum currency area?

Usually, a monetary union is not considered feasible between countries if the correlations of shocks are positive but weak. This may not be so if the country with the larger output gap converges to full-employment equilibrium faster than the country with the smaller gap. We argue that common monetary policy can be destabilizing when countries' responses to non-monetary shocks are perfectly symmetric with a correlation of 1 but exhibit differing investment sensitivities to the real interest rate. We use Canada, Mexico and the United States to test the feasibility of a monetary union by documenting whether: 1) gross investments in Canada and Mexico are equally responsive to the real fund rate, and 2) Canada and Mexico's output growth and inflation respond differently to US monetary policy shocks and oil price shocks. This approach implicitly dictates whether the shocks themselves are symmetric or asymmetric. Using quarterly data and SVAR methodology, we conducted two layers of analysis. We estimated SVARs for the periods 1970–2008, 1970–1990 and 1991–2008 to find that a monetary union is feasible between Canada and the US for the first two sample periods. For Canada and Mexico, we find similar responses of output growth to US monetary policy shocks. We conducted further robustness tests by estimating two identified VARs with common US variables and oil prices for Canada and Mexico to assess commonality in responses to shocks with the US. These results affirm that a monetary union is also feasible between Canada and the US.     

Unemployment–inflation trade-offs in OECD countries

Inflation and unemployment reduce welfare of individuals and should be as low as possible in any economy. Cointegration and Granger causality tests suggest that there are long run relations between these two variables among the OECD economies. While rates of unemployment vary significantly among these economies, rates of inflation have stabilised at lower rates as a result of inflation targeting policies adopted in them during the last two decades. The Phillips curve phenomena are still empirically significant for 28 out of 35 of these OECD economies in country specific regressions; in fixed and random effect panel data models and in a panel VAR model for 1990:1 to 2014:4. Country specific supply curves and Okun curves are consistent to thin Phillips curve relations. Leftward shifts in the Beveridge and Phillips curves require labour market reforms balancing between job creations and destructions. Complementing macro stimulations by microeconomic structural and institutional reforms can bring efficiency in bargaining for wages and employment among firms and workers to make unemployment–inflation trade-offs more significant and relevant in these economies.     

UNEMPLOYMENT PERSISTENCE AND THE NAIRU: A BAYESIAN APPROACH

This paper estimates the United States and euro area NAIRU in a Bayesian framework. We set out a simple structural model explaining unemployment by demand and supply factors, which are treated as unobserved variables that have observable effects on measured unemployment, output and inflation. The model allows for unemployment persistence and a time-varying core inflation rate. The results show that although cyclical shocks are very persistent, most of the increase in European unemployment is driven by structural factors. The degree of persistence is lower in the United States but demand shocks seem to be more important in explaining variation in unemployment.     

Formal targets, central bank independence and inflation dynamics in the UK: A Markov-Switching approach

We examine inflation and uncertainty in the UK with a version of the Markov Switching model, which allows for changes in the variance as well as in the mean and persistence of a series. We find that the UK’s attempts at exchange rate pegs in the form of shadowing the deutschmark and entering the ERM were ineffective, and in the latter case counterproductive in lowering inflation uncertainty. The 1981 budget, however, greatly lowered uncertainty, and the adoption of a formal inflation target also had a palpable, negative impact on inflation uncertainty. As a suggestive exercise, we examine inflation uncertainty in the US, and find that, over 2005–2008, in the absence of an inflation target, uncertainty rose in the US, while uncertainty remained low in the UK over this period of rising commodity prices and financial turmoil.     

Is the slope of the Phillips curve time-varying? Evidence from unobserved components models

This paper formally tests for time variation in the slope of the Phillips curve using a variety of measures of inflation expectations and real economic slack. We find that time variation in the slope of the Phillips curve depends on the measure of inflation expectations rather than the measure of real economic slack. We find strong evidence in support of the time-varying slopes of the Phillips curve with different measures of inflation expectations. Thus, we conclude that the slope of the Phillips curve is time-varying.     

UK INFLATION: PERSISTENCE, SEASONALITY AND MONETARY POLICY

In the light of the changes to UK monetary policy since the early 1980s, we study the existence and nature of changes in the properties of retail price inflation over this period. A feature of our analysis is the attention paid to the marked seasonal pattern of monthly UK inflation. After taking account of seasonality, both univariate and Phillips curve models provide strong evidence of changes in the level and persistence of inflation around the end of 1992, at the time of the introduction of inflation targeting. Indeed, all models point to the effective disappearance of inflation persistence after this date, implying that constant-parameter models estimated using both pre- and post-inflation targeting data periods should be treated with considerable caution.     

NAIRU Estimates for Germany: New Evidence on the Inflation–Unemployment Tradeoff

Meaningful estimates of the non‐accelerating inflation rate of unemployment (NAIRU) within a Phillips curve framework require an identified tradeoff between inflation and unemployment. However, observations of inflation and unemployment are equilibrium points giving rise to a simultaneity problem. We assess conventional identifying assumptions in the literature on the German NAIRU in a general bi‐variate equations system of inflation and unemplyoment. We use a data‐driven method for identification based on shifts in the relative volatility of shocks to unemployment and inflation to identify the tradeoff for Germany. Our results support models which estimate a contemporaneous effect of unemployment on inflation and those which model inflation and unemployment jointly.     

Comparing alternative Phillips curve specifications: European results with survey-based expectations

This article examines inflation dynamics in Europe. Econometric specification tests with pooled European data are used to compare the empirical performance of the New Classical, New Keynesian and Hybrid specifications of the Phillips curve. Instead of imposing any specific form of expectations formation, direct measures, i.e. Consensus Economics survey data are used to proxy economic agents’ inflation expectations. According to the results, the New Classical Phillips curve has satisfactory statistical properties. Moreover, the purely forward-looking New Keynesian Phillips curve is clearly outperformed by the New Classical and Hybrid Phillips curves. We interpret our results as indicating that the European inflation process is not purely forward looking and inflation cannot instantaneously adjust to changes in expectations. Consequently, even allowing for possible nonrationality in expectations results in a lagged inflation term entering the New Keynesian Phillips curve for inflation dynamics in Europe.     

Asymmetric and Time‐Varying Causality between Inflation and Inflation Uncertainty in G‐7 Countries

We use Granger causality tests within a conditional Gaussian Markov switching vector autoregressive (MS‐VAR) model using monthly data for G‐7 countries covering the period 1959:12–2008:10 to examine the relationship between inflation and inflation‐uncertainty. The MS‐VAR model allows us to model parameter time‐variation so as to reflect changes in Granger causality, assuming that these changes are stochastic and governed by an unobservable Markov chain. Inflation uncertainty is measured as the conditional variance generated by a Fractionally Integrated Smooth Transition Autoregressive Moving Average‐Asymmetric Power ARCH (FISTARMA‐APARCH) model. The distinguishing feature of our approach from the previous studies is the determination of the sign of the Granger causality relationship between inflation and its uncertainty over time. First, using a rolling VAR model, we show that the relationship between inflation and inflation uncertainty is time varying with frequent breaks. Second, using the MS‐VAR model, we obtain strong evidence in favour of the Holland's ‘stabilizing Fed hypothesis’ for Canada, France, Germany, Japan, United Kingdom, and the United States. We also find evidence in favour of the Friedman hypothesis for Canada and the United States.     

MONEY AND INFLATION IN INDIA: EVIDENCE FROM P‐STAR MODEL

This study uses P‐star model to examine the role of money in explaining inflation in India. In particular, we compare the performance of traditional Phillips curve approach against P‐star model in forecasting inflation. Moreover, the study estimates P‐star model using the alternative measures of money such as simple sum and Divisia M3, to examine the relevance of aggregation theoretic monetary aggregates in explaining inflation. The empirical results indicate that P‐star model with real money gap has an edge over traditional Phillips curve approach in forecasting inflation. More importantly, we found that the P‐star model estimated with Divisia real money gap performs better than its simple sum counterpart. These empirical findings suggest that the changes in real money gap play a crucial role in explaining inflation in India.     

Phillips curve in US: New insights in time and frequency

The paper explores the co-movement between unemployment and inflation rates in US by using a battery of wavelet tools. The dataset covers the period 1945Q1–2017Q4, having quarterly frequency.The main findings reveal a not stable Phillips curve in US, depending on economic context, seasonality and time-persistence. The Phillips curve is not validated during economic turbulences, while it works over expansion economic periods. Even so, the trade-off between unemployment and inflation is unstable under seasonal growth components and time-persistence, running from short- to medium-term. No link between unemployment and inflation is found in the long-term.