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.     

Do search frictions matter for inflation dynamics?

We assess the empirical relevance for inflation dynamics of accounting for the presence of search frictions in the labor market. The new Keynesian Phillips curve explains inflation as being mainly driven by current and expected future marginal costs. Recent empirical research has emphasized different measures of real marginal costs to be consistent with observed inflation persistence. We argue that, allowing for search frictions in the labor market, real marginal cost should also incorporate the cost of generating and maintaining long-term employment relationships, along with conventional measures, such as real unit labor costs. In order to construct a synthetic measure of real marginal costs, we use newly available labor market data on worker finding and separation rates that reflect hiring and firing costs. We then estimate a new Keynesian Phillips curve by generalized method of moments (GMM) using the imputed marginal cost series as an observable and find that the contribution of labor market frictions in explaining inflation dynamics is small.     

New Phillips curve under alternative production technologies for Canada, the United States, and the Euro area

This paper shows that alternative production technologies imply two modifications to the New Phillips Curve (NPC): A specific ‘strategic complementarity parameter’ that affects the relationship between real marginal cost and inflation and a specific modification to the labour share measure of real marginal cost. Estimates of average duration of nominal price stickiness obtained conditional on the strategic complementarity parameter are substantially smaller, and therefore more plausible, relative to when this parameter is ignored. Modifications to the marginal cost measure alone have little effect on the NPC estimates. The empirical fit of the NPC under alternative production technologies is similar.     

Globalization and inflation: A threshold investigation

We use a threshold methodology to investigate the importance of non-linear effects in the analysis of the inflation globalization hypothesis. Accounting for potential non-linearities in the Phillips Curve, we show that trade openness is not rejected as a threshold variable for the effects of domestic and foreign slack on inflation in many advanced economies, and we find a switch of the output gap slopes from one regime to the other that is consistent with the key predictions of the inflation globalization hypothesis. For some countries the threshold Phillips Curve model also leads to improvements in out-of-sample forecast over the linear Phillips models, especially at longer horizons. Contrary to most of the previous literature which ignores such non-linearities, our new approach provides some interesting empirical evidence supportive of the effect globalization has on a country’s inflation dynamics.     

Output,Inflation and the New Keynesian Phillips Curve

Explicit modelling of factor markets clarifies two fundamental aspects of the New Keynesian Phillips Curve (NKPC). First, we clarify the relationship between output and marginal cost. Second, for the NKPC in inflation–output space, we identify the key stochastic influences on inflation without recourse to ad hoc cost or excess demand shocks. The econometric implementation of this clarified NKPC, which evolves strictly according news on the stream of future marginal costs, allows us jointly to derive inflation as a forecast of future variables. Our approach clarifies the empirical successes and failures of the NKPC and allows us to provide new aggregate evidence on the degree of price rigidity in the UK economy.     

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.     

New Keynesian Phillips Curve and inflation dynamics in Australia

The New Keynesian Phillips Curve (NKPC) was developed as a response to the New Classical critique that Keynesian macroeconomics lacked micro-foundations. The NKPC provides theoretical micro-foundations that attempt to explain, inter alia, nominal rigidities and, explicitly price stickiness. This paper investigates the validity of the NKPC for Australia. In contrast to the findings for the USA and Euro area, we find that neither the output gap nor marginal cost appears to be a key driving force variable across different set of instruments and estimators (GMM and 2SLS) over the sample period from 1959 to 2009. The flattening of the NKPC along with significant presence of price stickiness is also found in the data. In particular, the reduced form coefficients and implied estimates from the structural parameters of the model support the view that inflation dynamics are forward looking while the role of lagged inflation is also statistically important only after 1980s. However, we claim that the forward looking baseline NKPC contrary to the hybrid NKPC is stable and better explains inflation dynamics for the Australian economy.     

Vacancies, unemployment, and the Phillips curve

The canonical new Keynesian Phillips curve has become a standard component of models designed for monetary policy analysis. However, in the basic new Keynesian model, there is no unemployment, all variation in labor input occurs along the intensive hours margin, and the driving variable for inflation depends on workers’ marginal rates of substitution between leisure and consumption. In this paper, we incorporate a theory of unemployment into the new Keynesian theory of inflation and empirically test its implications for inflation dynamics. We show how a traditional Phillips curve linking inflation and unemployment can be derived and how the elasticity of inflation with respect to unemployment depends on structural characteristics of the labor market such as the matching technology that pairs vacancies with unemployed workers. We estimate on US data the Phillips curve generated by the model. While we can reject the baseline new Keynesian Phillips curve in favor of the search-frictions specification, we show it is still too stylized to fully describe the dynamics of firms’ marginal costs.     

The hump-shaped behavior of inflation and a dynamic externality

We propose a general equilibrium model that explains the empirical evidence of the hump-shaped response of inflation to a monetary policy shock. The model replaces backward-looking indexation à la Christiano et al. [2005. Nominal rigidities and the dynamic effect of a shock to monetary policy. Journal of Political Economy 113(1), 1-45] with a dynamic externality into the production function of firms. The model, armed with sticky wages and variable capital utilization, has two offsetting effects on real marginal cost over the business cycle. First, increasing factor prices raise real marginal cost in response to an expansionary monetary policy shock in the intermediate run. Second, a dynamic externality reduces real marginal cost in the short run because it raises productivity in response to an increase in output following the shock. Overall, the resulting short-run decrease and intermediate-run increase in marginal cost replicate the hump-shaped behavior of inflation under purely forward-looking price and wage Phillips curves.     

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.     

Biogeographical conditions, the transition to agriculture and long-run growth

We use new data on the timing of the transition to agriculture, developed by Putterman and Trainor (2006), to test the theory of Diamond (1997) and Olsson and Hibbs (2005) that an earlier transition is reflected in higher incomes today. Our results confirm the theory, even after controlling for institutional quality and other geographical factors. The date of transition is correlated with prehistoric biogeography (the availability of wild grasses and large domesticable animal species). The factors conducive to high per capita incomes today are good institutions, an early transition to agriculture, access to the sea and a low incidence of fatal malaria. Geographical influences have been at work in all of these proximate determinants of per capita income.     

Inventories,inflation dynamics and the New Keynesian Phillips curve

We introduce inventories into an otherwise standard New Keynesian model and study the implications for inflation dynamics. Inventory holdings are motivated as a means to generate sales for demand-constrained firms. We derive various representations of the New Keynesian Phillips curve with inventories and show that one of these specifications is observationally equivalent to the standard model with respect to the behavior of inflation when the model's cross-equation restrictions are imposed. However, the driving variable in the New Keynesian Phillips curve – real marginal cost – is unobservable and has to be proxied by, for instance, real unit labor cost. An alternative approach is to impute marginal cost by using the model's optimality conditions. We show that the stock–sales ratio is linked to marginal cost. We also estimate these various specifications of the New Keynesian Phillips curve using GMM. We find that the predictive power of the inventory-specification at best approaches that of the standard model, but does not improve upon it.     

The New Keynesian Phillips curve and the role of expectations: Evidence from the CESifo World Economic Survey

We provide evidence on the fit of the hybrid New Keynesian Phillips curve for selected Euro zone countries, the US and the UK. Instead of imposing rational expectations and estimating the Phillips curve by the Generalized Method of Moments, we use direct measures of inflation expectations from the CESifo World Economic Survey. Our main findings are as follows: (i) The use of survey data gives empirical results, which are more reliable than those obtained from the GMM approach. (ii) The purely forward-looking Phillips curve can be rejected in favor of the hybrid New Keynesian Phillips curve. (iii) The estimated coefficients on past inflation are higher when using survey expectations than when using the rational expectations GMM approach. (iv) It remains unclear whether real unit labor costs or a measure of the output gap should be used as a proxy for real marginal costs. (v) Theory-based restrictions lead to an improvement of the empirical results.     

Cross-country causes and consequences of the crisis: An update

We update [13] and [Rose and Spiegel, 2010] and search for simple quantitative models of macroeconomic and financial indicators of the “Great Recession” of 2008–09. We use a cross-country approach and examine a number of potential causes that have been found to be successful indicators of crisis intensity by other scholars. We check a number of different indicators of crisis intensity, and a variety of different country samples. While countries with higher income and looser credit market regulation seemed to suffer worse crises, we find few clear reliable indicators in the pre-crisis data of the incidence of the Great Recession. Countries with current account surpluses seemed better insulated from slowdowns.     

A micro-based non-inflationary rate of capacity utilisation as a measure of inflationary pressure: evidence for Austria

We derive a non-inflationary rate of capacity utilisation (NIRCU)—as recently proposed by Köberl and Lein (Can J Econ 44:673–694, 2011)—based on a large Austrian firm-level panel dataset ranging from 1996 to 2011. By conditioning the current capacity utilisation of firms on their current and planned price adjustments, a micro-level NIRCU is defined as the level of capacity utilisation at which there is no need for the firm to adjust its prices. In contrast to other measures of inflationary pressure, this measure (1) is timely available without revisions and (2) does not imply any need for rather arbitrary methods or concepts such as statistical filtering or potential output. In accordance with the results in Köberl and Lein (Can J Econ 44:673–694, 2011), we find that the NIRCU performs well as a driving variable of Austrian inflation in various Phillips Curve estimations. Compared to other inflation driving variables, such as real unit labor cost, the output gap and the unemployment gap, it delivers reasonable parameter estimates which are in line with existing Phillips Curve estimations in the literature.     

AN OPEN-ECONOMY NEW KEYNESIAN PHILLIPS CURVE: EVIDENCE FROM HONG KONG

Abstract. This paper extends the new hybrid Keynesian Phillips Curve (NKPC) to the open‐economy context. We hypothesize that pricing decisions depend on both labour costs and intermediate imported input prices. The results for Hong Kong are consistent with the theory if import prices are given substantial weight in measuring marginal cost, rejecting the labour costs model. We find that forward‐looking behaviour is dominant, and that price stickiness is smaller in Hong Kong than in the USA. The results are sensitive to the choice of instruments, and a model using the output gap instead of marginal cost as the forcing variable also performs well.     

Non-stationary inflation and panel estimates of United States short and long-run Phillips curves

This paper argues that because United States inflation has been non-stationary over the past five decades the vast body of empirical research that proceeds without adequately accounting for the non-stationarity in the data is invalid. Using 50 years of United States inflation data the standard results in the Phillips curve literature are shown to be due to unaccounted shifts in the mean rates of inflation over the period. Short and long-run Phillips curves for the United States are then estimated using time series panel data techniques that account for these shifts in mean.     

Understanding the effects of technology shocks

The research led by Gali (AER 1999) and Basu et al. (AER 2006) raises two important questions regarding the validity of the RBC theory: (i) How important are technology shocks in explaining the business cycle? (ii) Do impulse responses to technology shocks found in the data reject the assumption of flexible prices? Using an RBC model, this paper argues that the conditional impulse responses of the U.S. economy to technology shocks are not grounds to reject the notion that technology shocks are the main driving force of the business cycle and the assumption of flexible prices, in contrast with the conclusions reached by the literature.     

Do professional forecasters behave as if they believed in the New Keynesian Phillips Curve for the euro area?

This paper finds that participants in the European Central Bank’s Survey of Professional Forecasters have submitted forecasts that are consistent with a (mostly forward-looking) empirical version of the New Keynesian Phillips Curve for the euro area. The estimation technique takes advantage of the panel nature of the Survey of Professional Forecasters’ dataset to exploit both its time series and cross-section dimensions, and to control for unobservable individual heterogeneity across forecasters. The estimation results suggest that euro-area inflation forecasts have reacted less to unemployment forecasts after the start of the financial crisis but another cost measure (energy inflation) remains significant. This finding is consistent with a flatter Phillips Curve in the euro area after 2007. However, the reasons suggested by the International Monetary Fund for this finding, namely a better anchoring of inflation expectations and increases in structural unemployment do not seem to find support in the survey data. Instead, the expectations for compensation per employee submitted by professional forecasters are consistent with the existence of downward real-wage rigidities in euro-area labour markets.     

The asymmetry of the New Keynesian Phillips Curve in the euro-area

Using a two-stage quantile regression framework, we uncover significant asymmetries across quantiles for all coefficients in an otherwise standard New Keynesian Phillips Curve (NKPC) for the euro area. A pure NKPC specification accurately captures inflation dynamics at high inflation quantiles.